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NFEC > SEC Filings for NFEC > Form 10-K on 28-Mar-2014All Recent SEC Filings

Show all filings for NF ENERGY SAVING CORP

Form 10-K for NF ENERGY SAVING CORP


28-Mar-2014

Annual Report


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

The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Report on Form 10-K. The discussion in this section of this Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section, those discussed in "Risk Factors" and those discussed elsewhere in this Report on Form 10-K.

FORWARD LOOKING STATEMENTS

Certain statements in this report, including statements of our expectations, intentions, plans and beliefs, including those contained in or implied by "Management's Discussion and Analysis" and the Notes to Consolidated Financial Statements, are "forward-looking statements", within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that are subject to certain events, risks and uncertainties that may be outside our control. The words "believe", "expect", "anticipate", "optimistic", "intend", "will", and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. The Company undertakes no obligation to update or revise any forward-looking statements. These forward-looking statements include statements of management's plans and objectives for our future operations and statements of future economic performance, information regarding our expansion and possible results from expansion, our expected growth, our capital budget and future capital requirements, the availability of funds and our ability to meet future capital needs, the realization of our deferred tax assets, and the assumptions described in this report underlying such forward-looking statements. Actual results and developments could differ materially from those expressed in or implied by such statements due to a number of factors, including, without limitation, those described in the context of such forward-looking statements, our expansion and acquisition strategy, our ability to achieve operating efficiencies, industry pricing and technology trends, evolving industry standards, regulatory matters, general economic and business conditions, the strength and financial resources of our competitors, our ability to find and retain skilled personnel, the political and economic climate in which we conduct operations and the risk factors described from time to time in our other documents and reports filed with the Securities and Exchange Commission (the "Commission"). Additional factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to: 1) our ability to successfully develop, manufacture and deliver our products on a timely basis and in the prescribed condition; 2) our ability to compete effectively with other companies in the same industry; 3) our ability to raise sufficient capital in order to effectuate our business plan; and 4) our ability to retain our key executives.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue, receivable, inventory, and accrued expenses. We base our estimates on historical experience, known trends and events and various other factors 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. Actual results may differ from these estimates under different assumptions or conditions. Changes in estimates are recorded in the period in which they become known.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue recognition

In accordance with the ASC Topic 605, "Revenue Recognition", the Company recognizes revenue when persuasive evidence of an arrangement exists, transfer of title has occurred or services have been rendered, the selling price is fixed or determinable and collectability is reasonably assured.

The Company's revenue is principally derived from two primary sources: sales of energy saving flow control equipment and provision of energy project management and sub-contracting services.

(a) Sale of products

The Company derives a majority of its revenues from the sale of energy saving flow control equipment. Generally, the energy saving flow control equipment is manufactured and configured to customer requirements. The Company typically produces the energy saving flow control equipment for customers during a period from one to six months. When the Company completes the production in accordance with the customer's specification, the customer is required to inspect the finished products for quality and suitability, to its full satisfaction, then the Company makes delivery to the customer

The Company recognizes revenue from the sale of such finished products upon delivery to the customers, when the title and risk of loss are fully transferred to the customers. The Company records its revenues, net of value added taxes ("VAT"). The Company is subject to VAT which is levied on the majority of the products at the rate of 17% on the invoiced value of sales. As of December 31, 2013 and 2012, there were no refunds regarding our products.

(b)Service revenue

Service revenue is derived from energy-saving technical services, project management or sub-contracting services that are not an element of the arrangement for the sale of products. These services are generally billed on a time-cost plus basis, for the period of service which is generally from two to three months.

Revenue is recognized, net of business taxes when the service is rendered and accepted by the customers.

(c) Interest income

Interest income is recognized on a time apportionment basis, taking into account the principal amounts outstanding and the interest rates applicable.

Accounts receivable and allowance for doubtful accounts

Accounts receivable are recorded at the invoiced amount, do not bear interest and are due within the contractual payment terms, generally 30 to 90 days from shipment. Credit is extended based on evaluation of a customer's financial condition, the customer's credit-worthiness and their payment history. Accounts receivable outstanding longer than the contractual payment terms are considered past due. Past due balances over 90 days and those over a specified amount are reviewed individually for collectability. At the end of each period, the Company specifically evaluates each individual customer's financial condition, credit history, and the current economic conditions to monitor the progress of the collection of accounts receivable. The Company will consider an allowance for doubtful accounts for any estimated losses resulting from the inability of its customers to make required payments. For the receivables that are past due or not being paid according to payment terms, the appropriate actions are taken to exhaust all means of collection, including seeking legal resolution in a court of law.

The payment terms for our accounts receivable from each source of revenue is set forth below:

    Revenue items       General payment terms:

1.  Sales of products   (a)   10% of the contract value will be paid by the customer
                              upon signing the contract.
                        (b)   50% of the contract value will be paid by the customer
                              after the physical inspection (with a credit term from
                              30 to 90 days).
                        (c)   30% to 35% of the contract value will be paid upon the
                              delivery to the customer (with a credit term from 30 to
                              90 days).
                        (d)   5% to 10% of the contract value will be paid within 12
                              to 24 months (from the delivery date) as warranty
                              retention for the product.

2.  Services            (a)   10% to 15 % of the contract value will be paid by the
                              customer upon signing the contract.
                        (b)   The remaining contract value will be paid by the
                              customer upon the completion of the service (with a
                              credit term from 30 to 90 days).

In general, accounts receivable with aging within 90 days, between 91 and 180 days, and between 181 and 360 days represent approximately 30-40%, 50-60%, and 5%-15%, respectively, of the total accounts receivable. The Company is highly aware of the risk of default, and as a result, we actively monitor accounts receivable with aging above 1 year and those accounting for at least 1% of the total accounts receivable.

For most of our contracts, our customers are generally large or state-owned construction contractors or developers mainly engaged in government-sponsored infrastructure projects such as large hydraulic/aqua-engineering projects, power plants and urban sewage network projects in the PRC. Usually, these infrastructure projects are undertaken in a number of phrases over a certain period of time. Our flow control equipment components are generally considered as major or significant components in the development phase of these infrastructure projects. In our industry practice, we are paid by these construction contractors and/or developers when they have been paid by the local government or state-owned enterprises after the full inspection of each milestone during the construction phrase. Given that the construction of these infrastructure projects are complex, very large in size and require a high of quality in completion, the inspection process may take a considerable amount of time. Therefore, we may not collect the accounts receivable on a timely manner or only after a period longer than our agreed payment terms.

We have a high level of assurance on the recoverability of these accounts receivable, based on our ongoing assessment of the customer's credit-worthiness and their payment history. These customers are usually large state-owned corporations with good credit ratings. At the end of each period, we specifically evaluate the structure and collectability of accounts receivable and for receivables that are past due or not being paid according to the payment terms, and we take appropriate actions to exhaust all means of collection, including seeking legal resolution in a court of law. For customers with a large accounts receivable balance, we may take other steps, such as limiting sales and changing payment terms and requesting forms of security. We will consider an adjustment to the allowance for doubtful accounts for any estimated losses resulting from the inability of our customers to make required payments.

Account balances are charged off against the allowance for doubtful accounts after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance sheet credit exposure related to its customers.

Inventories

Inventories are stated at the lower of cost or market value (net realizable value), cost being determined on a weighted average method. Costs include material, labor and manufacturing overhead costs. The Company reviews historical sales activity quarterly to determine excess, slow moving items and potentially obsolete items and also evaluates the impact of any anticipated changes in future demand. The Company provides inventory allowances based on excess and obsolete inventories determined principally by customer demand.

Property, Plant and Equipment

Plant and equipment are stated at cost less accumulated depreciation and
accumulated impairment losses, if any. Depreciation is calculated on the
straight-line basis over the following expected useful lives from the date on
which the asset becomes fully operational and after taking into account its
estimated residual values:

                                    Expected useful
                                         life          Residual value
Building                                 30 years                    5 %
Plant and machinery                    10-20 years                   5 %
Furniture, fixture and equipment        5-8 years                    5 %

Expenditure for repairs and maintenance is expensed as incurred. When assets have been retired or sold, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in the results of operations.

Land use right

All land in the PRC is owned by the PRC government. The government in the PRC, according to the relevant PRC law, may sell the right to use the land for a specified period of time. Thus, the Company's land purchase in the PRC is considered to be leasehold land and is stated at cost less accumulated amortization and any recognized impairment loss. Amortization is provided over the term of the land use right agreement on a straight-line basis, which is 50 years and will expire in 2059.

Stock based compensation

The Company adopts ASC Topic 718, "Stock Compensation", ("ASC 718") using the fair value method. Under ASC 718, stock-based compensation is measured using the Black-Scholes Option-Pricing model on the date of grant. For non-employee stock based compensation, the Company adopts ASC Topic 505-50, "Equity-Based Payments to Non-Employees", stock based compensation related to non-employees is accounted for based on the fair value of the related stock or options or the fair value of the services on the grant date, whichever is more readily determinable in accordance with ASC 718.

Income taxes

Income taxes are determined in accordance with the provisions of ASC Topic 740, "Income Taxes"("ASC 740"). Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Any effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

ASC 740 prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. Under ASC 740, tax positions must initially be recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions must initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts.

As at December 31, 2013 and 2012, the Company had no benefit or penalties regarding its income taxes. As of December 31, 2013, there are also no any significant uncertain tax items.

The main operations of the company are located in the PRC and have jurisdiction under the local tax law. As a result of these operations, the company's tax returns are subject to examination by a foreign tax authority. As of December 31, 2013, the Company filed and cleared the tax returns of 2013 with the appropriate local PRC tax authority.

Foreign currencies translation

Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency using the applicable exchange rates at the balance sheet dates. The resulting exchange differences are recorded in the statement of operations. The reporting currency of the Company is the United States Dollar ("US$"). The Company's subsidiaries in the PRC maintain their books and records in their local currency, the Renminbi Yuan ("RMB"), which is the functional currency as being the primary currency of the economic environment in which these entities operate.

In general, for consolidation purposes, assets and liabilities of its subsidiaries whose functional currency is not the US$ are translated into US$, in accordance with ASC Topic 830-30, "Translation of Financial Statement", using the exchange rate on the balance sheet date. Revenues and expenses are translated at average rates prevailing during the period. The gains and losses resulting from translation of financial statements of foreign subsidiaries are recorded as a separate component of accumulated other comprehensive income within the statement of stockholders' equity.

Translation of amounts from RMB into US$ has been made at the following exchange rates for the respective year:

2013 2012 Year-end RMB:US$ exchange rate 6.1140 6.3161 Annual average RMB:US$ exchange rate 6.1982 6.3198

RESULTS OF OPERATIONS

Year Ended December 31, 2013 compared to Year Ended December 31, 2012

The following discussion should be read in conjunction with the financial statements included in this report and is qualified in its entirety by the foregoing.

REVENUES

Total revenues were $5,674,933 and $9,269,016 for the years ended December 31, 2013 and 2012, respectively. Total revenues decreased $3,594,083, a 39% decrease, for the year ended December 31, 2013 compared to total revenues for the year ended December 31, 2012. Decrease in total revenue was due to the decrease in product revenue and service revenue.

Product Revenues

Product revenues are derived principally from the sale of self-manufactured products and energy saving flow control equipment. Product revenues were $4,693,248 and $6,866,959, or 83% and 74% of total revenues for the years ended December 31, 2013 and 2012, respectively. Product revenues for the year ended December 31, 2013 decreased $2,173,711 or 32%, compared to the product revenue for the year ended December 31, 2012. The decrease in product revenue was mainly attributable to lower demand on sales orders from the customers.

Service Revenues

Service revenues are derived principally from energy-saving technical services and product collaboration processing services. The energy-saving technical services include providing energy saving auditing, conservation plans, and/or related service reports. The product re-processing services are generally billed on a time-cost plus basis. Service revenues were $981,685 and $2,402,057 for the years ended December 31, 2013 and 2012 respectively, a decrease of $1,420,372 or 59%. The decrease in service revenue was primarily due to the Company terminating two casting contracts exported to South Korea because of lower profit margins.

COSTS AND EXPENSES

Cost of Revenues

Cost of revenues consists primarily of material costs, direct labor, depreciation and manufacturing overhead, which are directly attributable to the manufacture of products and the rendering of services. Total cost of revenues was $4,132,139 and $7,423,946, or 73% and 80% of total revenues, for the years ended December 31, 2013 and 2012, respectively. The total cost of revenues decreased by $3,291,807 or 44% for the year ended December 31, 2013 compared to the total cost of revenues for the year ended December 31, 2012. The decrease in total cost of revenues was primarily due to the decrease in product revenue and service revenue by 39% during the year.

The overall gross profit for the Company was $1,542,794 and $1,845,070, or 27% and 20% of total revenues, for the years ended December 31, 2013 and 2012, respectively. The increase of margin was due to the gross profit derived from sales of technologically advanced large diameter electric butterfly valves, which have a higher gross profit than the Company's less advanced valves.

Cost of Products

Total cost of product revenues was $3,468,117 and $5,819,446 for the years ended December 31, 2013 and 2012, respectively. The cost of product revenues decreased by $2,351,329 or 40% for the year ended December 31, 2013 compared to the cost of revenues for the year ended December 31, 2012. The gross profit for products was $1,225,131 and $1,047,513, and the gross profit margin was 26% and 15.25% for the years ended December 31, 2013 and 2012, respectively. The increase in gross margin was due advances in product design and related production efficiencies.

Cost of Service

Total cost of service revenues was $664,022 and $1,604,500 for the years ended December 31, 2013 and 2012, respectively. The cost of service revenues decreased by $940,478 or 59% for the year ended December 31, 2013 compared to the cost of revenues for the year ended December 31, 2012. The gross margin for services was $317,663 and $797,557, or 32.36% and 33.20% for the years ended December 31, 2013 and 2012, respectively.

Operating Expenses

The total operating expenses were $1,156,601 and $1,278,735, or 20.38% and 13.80% of total revenues, for the year ended December 31, 2013 and 2012, respectively. The total operating expenses decreased by 122,134 or 9.55% for the year ended December 31, 2013 compared to the year ended December 31, 2012. The decrease of operating expenses is primarily due to the decrease in sales and marketing expenses.

Sales and marketing expenses

The total sales and marketing expenses were $98,863 and $196,033, or 1.7% and 2.1% of total revenues, for the years ended December 31, 2013 and 2012, respectively. The decrease in sales and marketing expenses is due to the decrease in the expenses related to the Company's marketing activities.

General and administrative expenses

General and administrative expenses were $1,057,738 and $1,082,702, or 18.64% and 11.68% of total revenue, for the year ended December 31, 2013 and 2012, respectively. The general and administrative expenses decreased by $24,964 or 2%. The decrease in general and administrative expenses was primarily due to a reduction in overall spending (except for an increase in IR fees) in light of the decrease in the total revenues.

Income from Operations

As a result of the foregoing, our income from operations was $386,193 or 6.81% of total revenues, for the year ended December 31, 2013, as compared to $566,335 or 6.11% of total revenues, for the year ended December 31, 2012, a decrease of $180,142 or 31.81%.

Other income (expenses)

For the year ended December 31, 2013, other expense was $519,338, as compared to $435,029 for the year ended December 31, 2012, an increase of $84,309. This increase was primarily the result of an increase in interest expense, partially offset by increases in interest income and other income. For the year ended December 31, 2013, interest income was $36,686 as compared to $33,002 for the year ended December 31, 2012, an increase of $3,684. In 2013, interest expense was $592,528, an increase of $124,497 as compared to $468,031 for the year ended December 31, 2012. The increase of interest was due to the increase in interest rate by 2.5% to 6% on the loan of $1,500,000 from a company controlled by Mr. Li (C.E.O of the company) and Ms. Lihua Wang (C.F.O of the company).

Income Tax Expenses

For the years ended December 31, 2013 and 2012, income tax expenses were $47,020 and $43,272 respectively. The increase of income tax expenses was due to the increase in taxable income, an increase of $3,748 as compared to 2012.

As of December 31, 2013, the Company's operations in the United States of America incurred $2,892,175 of cumulative net operating losses, which can be carried forward to offset future taxable income. The net operating loss carry forwards begin to expire in 2033, if unutilized. The Company has provided for a full valuation allowance against the deferred tax assets of $983,340 on the expected future tax benefits from the net operating loss carry forwards as the management believes it is more likely than not that these assets will not be realized in the future.

Net Income

As a result of the foregoing, we recorded net loss of $180,165, a 3.2% loss margin on revenue for the year ended December 31, 2013, as compared to net income of $88,034, a 0.95% profit margin on revenues, for the year ended December 31, 2012. The net income for the year ended December 31, 2013 decreased by $268,199, a decrease of 305%, compared to the year ended December 31, 2012. The decrease in net income was mainly due to the decrease in revenues and increase in interest expense.

LIQUIDITY AND CAPITAL RESOURCES

Operating activities

For the year ended December 31, 2013, net cash provided by operating activities was $892,708. This was primarily attributable to our net loss of $180,165, adjusted by non-cash items of depreciation and amortization of $831,084, gain on disposal of plant and equipment of $28,891, reversal of allowance for doubtful account of $5,947, non-cash interest expenses of $16,762, and imputed interest instead of shares of $34,836. The increase in operating cash flow in 2013 were due primarily to the decrease in accounts receivable by $2,021,333, the increase in inventories by $1,383,490, increase in prepayments and other receivables by $29,792, decrease in accounts payable by $335,876, increase in income tax payable by $39,072 and decrease in other payables and accrued liabilities by $145,394.

We have followed ASC 230-10-45-28 and choose to provide information about major classes of cash flow items by the indirect method. In the statement of cash flows, we have reported the same amount for net cash flow from operating activities indirectly by adjusting net income to reconcile it to net cash flow from operating activities. The reconciliation has separately reported all major classes of reconciling items, for example, changes during the period in accounts receivables pertaining to operating activities, in inventory, and in payables pertaining to operating activities.

As of December 31, 2013, the increase of inventories was primarily derived from the market fluctuation and delay in construction of some projects such that the product could not be delivered to the customers. It is anticipated that the inventories will be delivered prior to July, 2014.

As of December 31, 2013, accounts and retention receivable was $5,750,069, 83% and 17% of the product revenue and service revenue, respectively.

The Company is highly aware the risk of default, and as a result, we actively monitor accounts receivable with aging above 1 year and those that account for about 20% of the total accounts receivable, thus there is no significant credit risk. The Company will consider an allowance for doubtful accounts for any estimated losses resulting from the inability of its customers to make required payments. The Company's accounts and retention receivable aging was as follows:

                                                                                              Above 365
Items                               Total       1-90 days    91-180 days     181-365 days       days
. . .
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