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CLNT > SEC Filings for CLNT > Form 10-Q on 12-Aug-2016All Recent SEC Filings

Show all filings for CLEANTECH SOLUTIONS INTERNATIONAL, INC.,

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


12-Aug-2016

Quarterly Report


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

Overview

Historically we were engaged in two business segments - the dyeing and finishing equipment segment, in which we manufacture and sell textile dyeing and finishing machines, and 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. As a result of a significant decline in revenues in the forged rolled rings and related components segment, revenue from the dyeing and finishing segment represented 96.5% of our revenue in the three months ended June 30, 2016 and 94.0% of our revenue in the six months ended June 30, 2016.

In 2015, we entered a third segment, the petroleum and chemical equipment segment, in which we manufacture and sell equipment, such as reaction kettle, heat exchangers, separators, tanks, towers and other components, to the petroleum and chemical industries. Sales in this segment commenced in the first quarter of 2015. However, we had no revenue from this segment in the second quarter of 2016 and nominal revenue from this segment in the six months ended June 30, 2016, and in 2015, because of claims made by our largest customer, which was a customer for this segment, we incurred significant impairment charges in the fourth quarter of 2015.

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

                                                      Three Months Ended June 30,
                                                     2016                     2015
                                             Dollars         %        Dollars         %
Dyeing and finishing equipment               $  3,918        96.5 %   $  8,613        56.7 %
Forged rolled rings and related components        143         3.5 %      2,999        19.7 %
Petroleum and chemical equipment                    -           -        3,579        23.6 %
Total                                        $  4,061       100.0 %   $ 15,191       100.0 %




                                                       Six Months Ended June 30,
                                                     2016                     2015
                                             Dollars         %        Dollars         %
Dyeing and finishing equipment               $  8,445        94.0 %   $ 15,136        49.1 %
Forged rolled rings and related components        405         4.5 %     10,273        33.3 %
Petroleum and chemical equipment                  131         1.5 %      5,428        17.6 %
Total                                        $  8,981       100.0 %   $ 30,837       100.0 %

Recently, difficult economic conditions, a continuing decline in oil prices and limited availability of credit in China, presented numerous challenges for our business. In our dyeing and finishing equipment segment, we experienced softer demand for our low-emission airflow dyeing machines as many of our potential customers already upgraded to newer models and we believe that much of our remaining potential customer base does not have the ability to make significant capital expenditures at this time. Our forged rolled rings and related products segment and petroleum and chemical equipment segment in particular experienced significant reduction in sales and operated at a loss during the six months ended June 30, 2016, with no revenue from the petroleum and chemical equipment segment and nominal revenue from the forged rolled rings and related components segment in the second quarter of 2016.

The key factors that affected our revenue, gross margin and net income (loss) in our segments during the six months ended June 30, 2016, including the factors which resulted in significant declines in revenues in all of our three segments, particularly in our forged rolled rings and related components segment and petroleum and chemical equipment segment, which are described below, are likely to continue to affect our operations in the rest of 2016 and beyond. 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, and we cannot assure you that we will be able to increase our revenues in any segment in the near future, if at all. 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. Further, our petroleum and chemical equipment segment was impacted by the loss of our major customer in that segment following the December 2015 contract termination by our largest customer alleging breach of contract for late delivery and for delivery of product with quality defects and the related write-offs at December 31, 2015.

The Future of the Forged Rolled Rings and Petroleum and Chemical Segments

In view of the sharp decline in revenue from both the forged rolled rings and related products and the petroleum and chemical equipment segments and the lack of any revenue in the petroleum and chemical equipment segment, including the loss of our major customer, which was a customer in the petroleum and chemical segment, the negative gross margin for the forged rolled rings and related components segment, and our anticipation that sales in the forged rolled rings and related products will continue to decline from their current low levels and the absence of any orders for our petroleum and chemical equipment segment during 2016 through the date of this report, we are evaluating, on an ongoing basis, the viability of these segments, and, if we determine that it is not likely that we will be able to operate either or both of these segments profitably, we may discontinue operating in either or both of these segments and seek to sell the associated assets. We are not optimistic about the market for either our forged rolled rings and related products or our petroleum and chemical products. Unless we can show improvement in revenues from these segments, it may be necessary for us to reclassify some or all of the equipment used in these segments which cannot be effectively used for other purposes, as equipment held for sale. We cannot give any assurance that we will be able to improve our revenues from these segments in the near future, if at all, and it may be necessary for us to discontinue operating in one or both of these segments. We cannot assure you that, if we seek to sell the assets related to either or both of these segments, that we will be able to recover the current book value of those assets. In event that we discontinue operations and are unable to recover the current book value, it is likely that we will incur an impairment charge for equipment that is used in these segments but which is not otherwise usable.

Dyeing and Finishing Equipment Segment

Revenues from our dyeing and finishing equipment segment decreased $4.7 million, or 54.5%, for the three months ended June 30, 2016 as compared to the three months ended June 30, 2015. Revenues from our dyeing and finishing equipment segment decreased $6.7 million, or 44.2%, for the six months ended June 30, 2016 as compared to the six months ended June 30, 2015. In the three and six months ended June 30, 2016, the dyeing and finishing equipment segment revenues accounted for 96.5% and 94.0%, respectively, of our total revenues. The decrease in revenue was primarily attributable to the challenging economic conditions and limited availability of credit in China. In addition, our business was also affected by government actions requiring textile manufacturers in Zhejiang province to temporarily cease operations in order to improve air quality ahead of the G20 Summit which is scheduled for Hangzhou this September. Further, we experienced a slowdown in shipments of our low-emission airflow dyeing machines as many companies in the dyeing industry had already replaced older dyeing equipment with new equipment, and orders for new low-emission airflow dyeing machines slowed down in 2016.

Currently, we focus on reinvigorating our dyeing equipment business and investing in research and development to improve our competitive position. On June 13, 2016, we entered into an agreement to purchase patent technology use right from a third party, and we purchased the technology use right in August 2016. The patent covers ozone-ultrasonic textile dyeing equipment. We believe this new patent technology will allow us to develop next generation dyeing and finishing equipment that will appeal to textile manufacturers in China as well as Southeast Asia. We expect our revenue from dyeing and finishing equipment segment will remain in its current quarterly level in the near future.

Forged Rolled Rings and Related Components Segment

Through our forged rolled rings and related components 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 components 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.

Revenues from our forged rolled rings and related components segment decreased $2.9 million, or 95.2%, to $143,000 for the three months ended June 30, 2016 as compared to the three months ended June 30, 2015. Revenues from our forged rolled rings and related components segment decreased $9.9 million, or 96.1%, to $405,000 for the six months ended June 30, 2016 as compared to the six months ended June 30, 2015. The significant decrease was mainly attributable to the reduced demand for construction of wind power facilities, which was our principal customer base during the first half of 2016, due to the effects of lower oil and gas prices. We expect that our revenues from forged rolled rings and related components will continue to decrease in the near future. Although we are optimistic about the long-term future of the wind power industry in China, the continued difficulties in generating revenue from this segment in the near term may make it more difficult, if not impossible, for us to continue to operate in this segment without a significant improvement in revenue, which we do not anticipate in the near future.

Petroleum and Chemical Equipment Segment

Through our petroleum and chemical equipment division, we produce and sell equipment such as coal chemical equipment, formaldehyde plant and downstream products, reaction kettle, heat exchangers, separators, tanks, towers to petroleum and chemical industries. We started to sell our petroleum and chemical equipment in February 2015. No revenue was generated from our petroleum and chemical equipment segment during the second quarter of 2016, as compared with $3.6 million for the three months ended June 30, 2015, and, as of the date of this report, we had no orders or pending orders for products from this segment, with the result that we do not anticipate significant, if any, revenue for the balance of 2016. Revenues from our petroleum and chemical equipment segment decreased $5.3 million, or 97.6%, to $131,000 for the six months ended June 30, 2016 as compared to the six months ended June 30, 2015. The market for petroleum products is mainly dominated by three major Chinese petroleum companies, and their capital expenditure and purchasing policy have a significant effect both upon our ability to generate revenue from this segment and the gross margins which we can generate. Furthermore, because we sell our petroleum and chemical equipment products to a very small number of customers, the change in the purchasing policies of one or two customers could have a significant effect on our revenues from this segment. In December 2015, we received a notice of contract termination in writing from our largest customer, which was a customer in this segment, alleging breach of contract for late delivery of product and for delivery of product with quality defects. We did not receive any purchase order and did not generate any revenue from this customer in the first half of 2016 and do not expect any further revenues from this customer. Therefore, our revenues from petroleum and chemical equipment segment significantly decreased in the first half of 2016. We don't anticipate any revenue from petroleum and chemical equipment segment in the near future, and we may not be able to continue in this segment.

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. 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. Two major suppliers provided approximately 23% and 31% of our purchases of inventories for the three and six months ended June 30, 2016, respectively. One major supplier provided approximately 27% of our purchases of inventories for the three months ended June 30, 2015. The supplier and one other major supplier provided approximately 36% of our purchases of inventories for the six months ended June 30, 2015. No other supplier accounted for 10% or more of our purchases during the three and six months ended June 30, 2016 and 2015. Most of our inventory at June 30, 2016 related to our dyeing and finishing segment.

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, 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 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/loss. In accordance with these agreements, the Huayang Companies shall pay consulting fees equal to 100% of its net income/loss 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/loss includes all of the Huayang Companies' net income/loss, 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/loss in calculating the net income/loss 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
Manufacturing equipment              5 - 10 Years
Building and building improvements   5 - 20 Years
Vehicles                               5 Years
Office equipment and furniture         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 the statements of operations in the year of disposition.

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, the purchase price is fixed or determinable and collectability is reasonably assured.

We recognize revenues from the sale of dyeing and finishing equipment, forged rolled rings and other components, petroleum and chemical 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 within a couple days of the delivery of the equipment. Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the three and six months ended June 30, 2016 and 2015, amounts allocated to installation and warranty revenues were minimal. Based on historical experience, warranty service calls and any related labor costs have been minimal.

All other product sales 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 ASC 740 "Accounting for Income Taxes," 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 changed to equity. Deferred tax assets and liabilities are offset when they related to income taxes levied by the same taxation authority and we intend to settle its current tax assets and liabilities on a net basis.

Stock-based Compensation

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

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

Currency Exchange Rates

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

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

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

. . .

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