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CLNT > SEC Filings for CLNT > Form 10-Q on 15-May-2014All Recent SEC Filings

Show all filings for CLEANTECH SOLUTIONS INTERNATIONAL, INC.,

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


15-May-2014

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, 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 March 31,
                                                    2014                        2013
                                            Dollars          %          Dollars          %
Forged rolled rings and related
components:
  Wind power industry                      $   3,755          21.3 %   $   3,696          26.6 %
  Other industries                             4,502          25.5 %       2,831          20.4 %
   Total forged rolled rings and related
components                                     8,257          46.8 %       6,527          47.0 %
Dyeing and finishing equipment                 9,378          53.2 %       7,358          53.0 %
Total                                      $  17,635         100.0 %   $  13,885         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.

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.

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 $2.0 million, or 27.5%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 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. Our gross margin from our dyeing segment increased to 23.3% for the three months ended March 31, 2014, from 22.7% for the three months ended March 31, 2013.

The factors that affected our revenue, gross margin and net income in both of our segments during the three months ended March 31, 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.

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 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. Four major suppliers provided approximately 47% of our purchases of raw materials for the three months ended March 31, 2014. One major supplier provided approximately 16% of our purchases of raw materials for the three months ended March 31, 2013.

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 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 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 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 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
                                  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 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 March 31, 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 revenue 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 months ended March 31, 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 months ended March 31, 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 revenue will be 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.


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.

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.


RESULTS OF OPERATIONS

Comparison of Results of Operations for the Three Months Ended March 31, 2014
and 2013

The following table sets forth the results of our operations for the three
months ended March 31, 2014 and 2013 indicated as a percentage of net revenues
(dollars in thousands):

                                                          Three Months Ended March 31,
                                                      2014                            2013
                                            Dollars       Percentage        Dollars       Percentage
Revenues                                   $  17,635            100.0 %    $  13,885            100.0 %
Cost of revenues                              13,362             75.8 %       10,755             77.5 %
Gross profit                                   4,273             24.2 %        3,130             22.5 %
Operating expenses                               997              5.6 %          845              6.1 %
Income from operations                         3,276             18.6 %        2,285             16.4 %
Other income (expenses)                          (21 )           (0.1 )%         (76 )           (0.5 )%
Income before provision for income taxes       3,255             18.5 %        2,209             15.9 %
Provision for income taxes                       859              4.9 %          586              4.2 %
Net income                                     2,396             13.6 %        1,623             11.7 %
Other comprehensive income (loss):
 Foreign currency translation adjustment        (782 )           (4.4 )%         428              3.1 %
Comprehensive income                       $   1,614              9.2 %    $   2,051             14.8 %

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 March 31, 2014 and 2013 (dollars in thousands).

                                                      Forged rolled
                                                        rings and          Dyeing and
                                                         related           finishing
                                                        products           equipment          Total
                                                            Three Months ended March 31, 2014
Revenues                                             $         8,257     $        9,378     $  17,635
Cost of revenues                                     $         6,167     $        7,195     $  13,362
Gross profit                                         $         2,090     $        2,183     $   4,273
Gross margin                                                    25.3 %             23.3 %        24.2 %



                                                      Forged rolled
                                                        rings and          Dyeing and
                                                         related           finishing
                                                        products           equipment          Total
                                                            Three Months ended March 31, 2013
Revenues                                             $         6,527     $        7,358     $  13,885
Cost of revenues                                     $         5,065     $        5,690     $  10,755
Gross profit                                         $         1,462     $        1,668     $   3,130
Gross margin                                                    22.4 %             22.7 %        22.5 %


Revenues

For the three months ended March 31, 2014, we had revenues of $17,635,000, as compared to revenues of $13,885,000 for the three months ended March 31, 2013, an increase of $3,750,000 or approximately 27.0%. The increase in revenue for the three months ended March 31, 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):

. . .

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