x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2010.

 

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO __________

NEVADA		98-0655634
(STATE OR OTHER JURISDICTION OF		(I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION

 

Large accelerated filer o	Accelerated filer o
Non-accelerated filer o	Smaller reporting company x

RONGFU AQUACULTURE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

(UNAUDITED)

Note 1 – ORGANIZATION –(CONTINUED)

The Company, through its subsidiaries, and Contractual Agreements, is engaged in integrated business of aquaculture including Tilapia brood stock, Tilapia fry, Tilapia farming, and marketing for Tilapia. It is specializing in the production of the Hengsheng Brand Nile Tilapia and the new licensed New Jifu Tilapia.

In the opinion of the management of the Company, the accompanying consolidated interim financial statements contain all material adjustments (consisting only of normal recurring adjustments) necessary to present fairly the consolidated financial position of the Company at September 30, 2010 and the results of its operations for the nine and three month periods ended September 30, 2010 and 2009 and its cash flows for the nine month periods September 30, 2010 and 2009. Actual results may differ from these estimates as a result of different assumptions or conditions.

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and represent the pro forma historical results of the consolidated group. The Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (the “Codification”) on July 1, 2009. For the nine months ended September 30, 2010, all reference for periods subsequent to January 1, 2010 is based on the Codification. The Company's functional currency is the Chinese Renminbi, however the accompanying consolidated financial statements have been translated and presented in United States Dollars.

Principles of Consolidation

The consolidated financial statements include the accounts of Rongfu Aquaculture, Inc. and its wholly owned subsidiaries, Hong Kong Rongfu, Guangzhou Flourishing, Nanhai Ke Da Heng Sheng, and Hainan Ke Da Heng Sheng (collectively referred to herein as the” Company”). All material inter-company accounts, transactions and profits have been eliminated in consolidation. The Company has adopted the Consolidation Topic of the FASB Accounting Standards Codification which requires a variable interest entity (“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.

Translation Adjustment

As of September 30, 2010 and December 31, 2009, the accounts of the Company were maintained, and its financial statements were expressed, in Chinese Yuan Renminbi (“CNY”). Such financial statements were translated into U.S. Dollars (“USD”) in accordance with the Foreign Currency Matters Topic of the Codification, with the CNY as the functional currency. According to the Codification, all assets and liabilities were translated at the current exchange rate, stockholders’ equity are translated at the historical rates and income statement items are translated at the average exchange rate for the period. The resulting translation adjustments are reported under other comprehensive income in accordance with the Comprehensive Income Topic of the Codification, as a component of shareholders’ equity. Transaction gains and losses are reflected in the income statement.

Statement of Cash Flows

In accordance with the Statement of Cash Flows Topic of the Codification, cash flows from the Company’s operations are based upon the local currencies. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.

 

F-6

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RONGFU AQUACULTURE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

(UNAUDITED)

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Comprehensive Income

The Company follows the Comprehensive Income Topic of the Codification. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income.

Risks and Uncertainties

The Company’s operations are carried out in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, by the general state of the PRC’s economy. The Company’s business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

The Company is subject to substantial risks from, among other things, intense competition associated with the industry in general, other risks associated with financing, liquidity requirements, rapidly changing customer requirements, limited operating history, foreign currency exchange rates and the volatility of public markets.

Contingencies

Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought. There were no contingencies of this type as of September 30, 2010 and December 31, 2009.

If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s financial statements. If the assessment indicates that a potential material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material would be disclosed. There were no contingencies of this type as of September 30, 2010 and December 31, 2009.

Loss contingencies considered to be remote by management are generally not disclosed unless they involve guarantees, in which case the guarantee would be disclosed.

Cash and Cash Equivalents

Cash and cash equivalents include cash in hand and cash in time deposits, certificates of deposit and all highly liquid debt instruments with original maturities of three months or less.

 

F-7

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RONGFU AQUACULTURE, INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

(UNAUDITED)

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Accounts Receivable

The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Reserves are recorded primarily on a specific identification basis. There were no allowances for doubtful accounts as of September 30, 2010 and December 31, 2009.

Inventories

Inventories are valued at the lower of cost (determined on a weighted average basis) or market. As of September 30, 2010 and December 31, 2009, inventories consist of the following:

 

		9/30/2010				12/31/2009
Raw materials		$	20,643			$	47,185
Work in process and finished goods			10,885,334				2,932,568
Total		$	10,905,977			$	2,979,753

Property, Plant & Equipment

Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to earnings as incurred; additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation of property and equipment is provided using the straight-line method for substantially all assets with estimated lives of:

Buildings	10-20 years
Fishing gear	5-10 years
Transportation equipment	5-10 years
Office equipment	3-5 years

 

F-8

---

 

RONGFU AQUACULTURE, INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

(UNAUDITED)

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

As of September 30, 2010 and December 31, 2009, Property, Plant & Equipment consist of the following:

		9/30/2010				12/31/2009
Buildings		$	214,466			$	73,631
Fishing gear			758,351				424,938
Transportation equipment			37,330				37,330
Office equipment			126,840				40,102
Total			1,136,987				576,001
Accumulated depreciation			(268,539	)			(170,854	)
		$	868,448			$	405,147

Depreciation expense for the nine months ended September 30, 2010 and 2009 was $63,818 and $69,050, respectively.

Long-Lived Assets

The Company adopted the Property, Plant and Equipment Topic of the Codification, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes previous accounting guidance, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” and “Reporting the Results of Operations for a Disposal of a Segment of a Business.” The Company periodically evaluates the carrying value of long-lived assets to be held and used, which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets carrying amounts. In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets. Loss on long-lived assets to be disposed of is determined in a similar manner, except that fair market values are reduced for the cost of disposal. Based on its review, the Company believes that, as of September 30, 2010, there were no impairments of its long-lived assets.

Derivative Liability

The Company issued warrants in connection with the Share Exchange Agreement and Series A Preferred Stock Purchase Agreement dated March 29, 2010 (the “Stock Purchase Agreement”).

The Company determined that the warrants did not qualify for a scope exception under ASC 815 as they were determined to not be indexed to the Company’s stock as prescribed by ASC 815.  The warrants, under ASC 815, were classified as derivative liability for the then relative fair market value of $3,267,797 and marked to market. For the nine months ended September 30, 2010, the Company recorded a loss on change in fair value of derivative liability of $6,251,254 to mark to market for the increase in fair value of the warrants through September 30, 2010.   Under ASC 815, the warrants will be carried at fair value and adjusted at each reporting period.

 

F-9

---

 

RONGFU AQUACULTURE, INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

 (UNAUDITED)

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Fair Value of Financial Instruments

In accordance with FASB ASC 820, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

In determining fair value, the Company uses various valuation approaches.  In accordance with GAAP, a fair value hierarchy for inputs is used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.  Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company.  Unobservable inputs reflect the Company’s assumptions about the inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.  The fair value hierarchy is categorized into three levels based on the inputs as follows:

·

Level 1 — inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

·

Level 2 — inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.

·

Level 3 — inputs to the valuation methodology are unobservable and significant to the fair value.

As of September 30, 2010 and December 31, 2009, the derivative liabilities amounted to $9,519,051 and $0. In accordance with the accounting standards, the Company determined that the carrying value of these derivatives approximated the fair value using the level 1 inputs.

Revenue Recognition

The Company records revenues for goods shipped at the time of shipment.  For goods delivered by the Company to a customer’s site, revenues are recognized at time of delivery.

The Company believes that recognizing revenue at these times is appropriate because the Company’s sales policies meet the four criteria of the SEC’s staff Accounting Bulletin No. 104, which are: (i) persuasive evidence that an arrangement exists, (ii) service has occurred, (iii) the seller’s price to the buyer is fixed and determinable and (iv) collection is reasonably assured.

Research and development cost

Research and development costs are expensed in the period when they are incurred. During the nine months ended September 30, 2010 and 2009, research and development costs were $104,255 and $56,437, respectively. During the three months ended September 30, 2010 and 2009, research and development costs were $65,612 and $21,295, respectively.

Advertising

Advertising expense consists primarily of costs of promotion for corporate image and product marketing and costs of direct advertising. The Company expenses all advertising costs as incurred. Advertising expense for the nine months ended September 30, 2010 and 2009 was $34,537 and $41,106, respectively. Advertising expense for the three months ended September 30, 2010 and 2009 was $18,849 and $32,470, respectively.

 

F-10

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RONGFU AQUACULTURE, INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

(UNAUDITED)

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Shipping and handling fees

The Company follows ASC 605-45, “Handling Costs, Shipping Costs”.  The Company does not charge its customers for shipping and handling. The Company classifies shipping and handling costs as part of general and administrative expense. Shipping and handling fees for the nine months ended September 30, 2010 and 2009 were $442,591 and $118,035, respectively. Shipping and handling fees for the three months ended September 30, 2010 and 2009 were $198,997 and $70,449, respectively.

Advances from Clients

The Company records deposits received by customers prior to the completion of the sale as deferred revenues and included as a component of advances from clients.  At such time as the revenue cycle is complete, these monies will be recognized into revenues.

Income Taxes

The Company utilizes the accounting guidance, “Accounting for Income Taxes,” which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. It is the Company’s intention to permanently reinvest earnings from activity with PRC. And thereby indefinitely postpone repatriation of these funds to the US. Accordingly, no domestic deferred income tax provision has been made for US income tax which could result from paying dividend to the Company.

There were no deferred taxes at September 30, 2010 and December 31, 2009.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk are cash, accounts receivable and other receivables arising from its normal business activities. The Company places its cash in what it believes to be credit-worthy financial institutions. The Company has a diversified customer base, all are in China. The Company controls credit risk related to accounts receivable through credit approvals, credit limits and monitoring procedures. The Company routinely assesses the financial strength of its customers and, based upon factors surrounding the credit risk, establishes an allowance, if required, for uncollectible accounts and, as a consequence, believes that its accounts receivable credit risk exposure beyond such allowance is limited.

Note 3 –OTHER RECEIVABLES

Other receivables mainly consist of prepayment of fish equipment amounting to $1,194,030. As of September 30, 2010 and December 31, 2009, the other receivables excluding the prepayment of fish equipment were $127,326 and $21,208, respectively.

 

F-11

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RONGFU AQUACULTURE, INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

 (UNAUDITED)

 Note 4 – BIOLOGICAL ASSETS

As of September 30, 2010 and December 31, 2009, Biological assets at cost consist of the following:

		9/30/2010				12/31/2009
Carp		$	28,101			$	20,562
Tilapia			959,561				959,561
Yellow bone fish			55,385				-
California bass			15,999				-
Snakeheads			265,368				178,204
Total			1,324,414				1,158,327
Accumulated amortization			(1,075,603	)			(725,519	)
		$	248,811			$	432,808

Amortization expense for the nine months ended September 30, 2010 and 2009 was $ 350,084 and $ 306,613 respectively.

Biological assets are amortized using the straight-line method over their estimated period of benefit, ranging from three to five years. Management evaluate the recoverability of biological assets periodically and take into account events or circumstances that warrant revised estimates of useful lives or that indicate that any changes exists. All of the Company’s biological assets are subject to amortization with estimated lives of:

Carp	5 years
Tilapia	3 years
Snakeheads	3 years
California bass	3 years
Yellow bone fish	3 years

Note 5 – RELATED PARTIES

One of the Company’s vendors is a related party. As of and for the nine months ended September 30, 2010, such vendor accounted for approximately 19% of the Company’s purchases and 38% of accounts payable. As of and for the nine months ended September 30, 2009, such vendor accounted for approximately 53% of the Company’s purchases and 87% of accounts payable.

For the nine months ended September 30, 2010, the Company collected all amounts previously due from the shareholder.

Note 6 – DUE FROM/TO SHAREHOLDER

As of September 30, 2010, due from shareholder was $0.

During the fourth quarter of 2009, the Company loaned an aggregate of RMB 21,900,000 ($3,201,343 translated at $1=RMB 6.8372) to a shareholder. The shareholder invested the entire proceeds of the loan in the construction of Foshan Nanhai Guanyao Processing Industrial Park, which has a total area of 108,000 square meters with the construction area of 85,000 square meters. The loan bears interest and may be paid off by deducting the shareholder’s allocation of shareholders’ dividends or other means. After the construction has been completed, the Company has a first option to rent Foshan Nanhai Guanyao Processing Industrial Park on terms to be determined. This amount is included in the Due from shareholders of $4,008,659 as of December 31, 2009. During the nine months ended September 30, 2010 this loan was repaid.

No interest was levied from the related transaction. The facilities are constructed in progress and third parties have rented part of the facilities. The Company has not rented the facilities yet.

Note 7 – CONCENTRATIONS

As of September 30, 2010, three customers accounted for 65% of accounts receivable. As of September 30, 2009, two customers accounted for 99% of accounts receivable.

For the nine months ended September 30, 2010, the Company had three vendors who accounted for 56% of total purchases. As of December 31, 2009, two customers accounted for 20% of accounts receivable. For the nine months ended September 30, 2009, the Company had two vendors who accounted for 66% of total purchases and one related party vendor who accounted for 60%. For the three months ended September 30, 2009, the Company had two vendors who accounted for 39% of total purchases and one related party vendor who accounted for 16%. At September 30, 2010, 87% of accounts payable was due to related parties. For the three months ended September 30, 2009, the Company had two vendors who accounted for 77% of total purchases and one related party vendor who accounted for 70% of total purchases.

 

F-12

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RONGFU AQUACULTURE, INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

 (UNAUDITED)

Note 8 – COMPENSATED ABSENCES

Regulation 45 of the local labor law of PRC entitles employees to annual vacation leave after 1 year of service. In general, all leave must be utilized annually, with proper notification. Any unutilized leave is cancelled. The management estimated that there is insignificant unutilized leave as at September 30, 2010 and September 30, 2009.

Note 9 – COMMON STOCK

On March 29, 2010, the Company entered into the Share Exchange Agreement. Pursuant to the Share Exchange Agreement, on March 29, 2010, 9 Rongfu Stockholders transferred 100% of the outstanding shares of common stock and 100% of the warrants to purchase common stock of Rongfu held by them, in exchange for an aggregate of 18,623,889 newly issued shares of our Common Stock and warrants to purchase an aggregate of 666,666 shares of our Common Stock. In connection with the closing of the Share Exchange Agreement, the former principal stockholder agreed to and did cancel 1,150,000 of the 1,200,000 shares of Rongfu Aquaculture, Inc. Common Stock held by her.

 

F-13

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RONGFU AQUACULTURE, INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

 (UNAUDITED)

Note 10 – SERIES A CONVERTIBLE PREFERRED STOCK AND WARRANTS

On March 29, 2010, the Company entered into the Stock Purchase Agreement with eighteen investors. The Company authorized and issued to Investors $7,700,000, of the Company’s convertible, redeemable Series A Preferred Stock, $0.001 par value per share (the “Series A Stock”) at a price of $2.78 per share (the “Series A Issue Price”). The shares are convertible into shares of the Company’s common stock, par value $0.001 per share. In connection with the Stock Purchase Agreement the Company incurred offering costs of $1,038,923, which are subtracted from the total proceeds and recorded in additional paid in capital.

 

The Series A Stock, in preference to the holders of common stock, shall be entitled to receive, when and as declared by the Board of Directors out of funds that are legally available therefore, cumulative dividends at the rate of six percent (6%) per annum of the original Series A Issue Price on each outstanding of Series A Preferred payable semi-annually on each February 28 and August 31.  Payment of these dividends shall be made, at the Company’s option, in cash or shares of common stock.  Each holder of the Series A Stock shall be entitled to one vote for each whole share of common stock into which such shares of Series A Stock could be converted in accordance with the agreement.

The Company has agreed to pay liquidated damages to its warrant holders if the Registration Statement is not filed by May 13, 2010 and/or not declared effective by the SEC on or before October 25, 2010. The liquidated damages are equal to 1% of the purchase price of the purchased shares owned by investors. The maximum aggregate liquidated damages payable to the investors under this Agreement shall be 6% of the aggregated purchase price paid by the investors pursuant to this Purchase Agreement. The Company must pay the liquidated damages in cash. Liquidated damages of $207,900 have been accrued as a component of other payables.

Pursuant to the Purchase Agreement the holders of Series A Stock also received 3,460,902 5 year warrants to purchase common shares. The warrants have an exercise price of $3.47 for 1,730,451 warrants and $4.17 for the remaining 1,730,451 warrants.

Assuming a valuation of $3.10 per share and the conversion of the Series A Stock into 4,221,389 shares of common stock at an effective conversion price of approximately $1.52 per share which is obtained by dividing the amount to be allocated to the BCF by the 2,768,721 common shares.

The Company measured and recognized an aggregate of $3,267,797 of the fair value of warrants to additional paid in capital upon issuance of these warrants. The terms of the warrants provide for an adjustment to the exercise price of these warrants if the company closes on the sale or issuance of common stock at a price which is less than the exercise price then in effect for these warrants.  The Company determined that the warrants did not qualify for a scope exception under SFAS No. 133 as they were determined to not be indexed to the Company’s stock. On March 29, 2010, the warrants were classified as a derivative liability for the then fair market value and marked to market.

											Aggregate
						Exercise			Remaining		Intrinsic
		Total				Price			Life		Value
Outstanding, December 31, 2009			-
Granted in 2010
- in connection with exchange agreement			666,666			$	2.44-2.93		4.5 years
- in connection with Series A preferred			3,460,902			$	3.47-4.17		4.5 years
Exercised in 2010
Outstanding, September 30, 2010			4,127,568

Note 11-DERIVATIVE FINANCIAL INSTRUMENTS

The balance sheet caption derivative liabilities consist of warrants to purchase 4,127,568 shares of the Company’s common stock, issued to consultants and investor relations in connection with the merger agreements and in connection with the Stock Purchase Agreement. These derivative financial instruments are indexed to an aggregate of 2,768,721 and 0 shares of the Company’s common stock as of September 30, 2010 and December 31, 2009, respectively, and are carried at fair value. The following tabular presentations sets forth information about the derivative instruments for the periods September 30, 2010 and December 31, 2009:

Derivative income (expense)		Nine Months Ended September 30, 2010				Three Months Ended  September 30, 2010
Warrant derivative		$	(6,251,054	)		$	(943,266	)

Liabilities		September 30, 2010			December 31, 2009
Warrant derivative			9,519,051		0-

Freestanding derivative instruments, consisting of warrants are valued using the Black-Scholes-Merton valuation methodology because that model embodies all of the relevant assumptions that address the features underlying these instruments. Significant assumptions used in the Black Scholes models included: conversion or strike prices ranging from $2.44-$4.17; volatility 73.27%  based upon forward terms of instruments; terms-remaining life of 4.5 years ; and a risk free rate ranging from 1.79%-2.5%.

Note 12 - INCOME TAXES

The Company operates in more than one jurisdiction with complex regulatory environments subject to different interpretations by the taxpayer and the respective governmental taxing authorities, we evaluate our tax positions and establish liabilities, if required. For uncertain tax position which may be challenged by local tax authorities and may not be fully sustained despite our belief that the underlying tax positions maybe be fully supportable. At this time the Company is not able to make a reasonable estimate of the impact on the effective tax rate related these items which could be challenged.

 

F-14

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RONGFU AQUACULTURE, INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

 (UNAUDITED)

Note 12 - INCOME TAXES – (CONTINUED)

Pursuant to the PRC Income Tax Laws, the Enterprise Income Tax (“EIT”) is at a statutory rate of 25%. The Company is an agriculture enterprise and under PRC Income Tax Laws, it is entitled to have new PRC tax policy for the agriculture enterprise. The Company’s derived from three areas including fish breeding, fish cultivation and selling adult fish. For income from fish breeding, it is entitled to an exemption. For income from fish cultivation, EIT is a discount rate of 12.5%. For income from selling adult fish, EIT is a rate of 25%.

 

The following is a reconciliation of income tax expense:

September 30, 2010		International				Total
Current		$	790,416			$	790,416
September 30, 2009		International				Total
Current		$	446,572			$	446,572

		Nine Months Ended September 30,								Three Months Ended September 30,
		2010				2009				2010				2009
Reconciliation of Effective tax rate
Statutory tax rate			25	%			25	%			25	%			25	%
Non deductibility of permanent items			26	%			0	%			9	%			0	%
Tax benefits from discounts and exemption			(18	)%			(18	)%			(20	)%			(54	)%
Others			4	%			0	%			11	%			35	%
Effective tax rate			37	%			7	%			25	%			6	%

If the Company were subject to the standard 25% EIT, it would have incurred $1,587,300 and $1,193,111 of income tax expense for the nine months ended September 30, 2010 and 2009, respectively.  The standard income tax rate would have caused the Company to incur an additional expense of $0.08 and $0.06 per share for the nine months ended September 30, 2010 and 2009, respectively.

If the Company were subject to the standard 25% EIT, it would have incurred $422,316 and $577,110 of income tax expense for the three months ended September 30, 2010 and 2009, respectively.  The standard income tax rate would have caused the Company to incur an additional expense of $0.02 and $0.03 per share for the three months ended September 30, 2010 and 2009, respectively.

Note 13– COMMITMENTS & CONTINGENCIES

The Company leases facilities under operating leases, which expire on different dates. It pays for on an annual basis and accrues for throughout the year. For the nine months ended September 30, 2010 and 2009, rent expense was $ 232,379 and $ 315,059. Future payments under these leases are as follows as of September 30:

2011		$	382,899
2012		$	365,660
2013		$	334,234
2014		$	268,287
2015		$	111,825
Thereafter		$	439,246
Total		$	1,902,151

 

F-15

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RONGFU AQUACULTURE, INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

 (UNAUDITED)

Note 14– EARNINGS PER SHARE

In accordance with FASB ASC Topic 260-1-50, “Earnings per Share”, and SEC Staff Accounting Bulletin No. 98, basic net income or loss per common share is computed by dividing net income or loss for the period by the weighted - average number of common shares outstanding during the period.  Under FASB ASC 260-10-50, diluted income or loss per share is computed by dividing net income or loss for the period by the weighted - average number of common and common equivalent shares, such as stock options, warrants and convertible securities outstanding during the period. 

The following table sets forth the computation of basic and diluted earnings per share of common stock:

		Nine Months Ended September 30,								Three Months Ended September 30,
		2010				2009				2010				2009
Basic and diluted earnings per share:
Numerator:
(Loss)/Income  used in computing		$	(3,846,017	)		$	6,025,171			$	826,560			$	1,003,709
Denominator:
Weighted average common shares outstanding			20,756,854				19,623,889				21,286,789				19,623,889
Basic and diluted earnings per share		$	(0.19	)		$	0.31			$	0.04			$	0.05

Note 15 – STATUTORY RESERVE

In accordance with the laws and regulations of the PRC, a WFOE’s income, after the payment of the PRC income taxes, shall be allocated to the statutory surplus reserves and statutory public welfare fund. Prior to January 1, 2006 the proportion of allocation for reserve was 10 percent of the profit after tax to the surplus reserve fund and additional 5-10 percent to the public affair fund. The public welfare fund reserve was limited to 50 percent of the registered capital. Effective January 1, 2006, there is now only one fund requirement. The reserve should be 10 percent of income after tax, not to exceed 50 percent of registered capital. Statutory Reserve funds are restricted for set off against losses, expansion of production and operation or increase in register capital of the respective company. Statutory public welfare fund is restricted to the capital expenditures for the collective welfare of employees. These reserves are not transferable to the Company in the form of cash dividends, loans or advances. These reserves are therefore not available for distribution except in liquidation. As of September 30, 2010 and December 31, 2009, the Company had allocated $1,076,310 and $1,051,089, to these non-distributable reserve funds.

 

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RONGFU AQUACULTURE, INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

(UNAUDITED)

Note 16- OTHER COMPREHENSIVE INCOME

Balances of related after-tax components comprising accumulated other comprehensive income, included in stockholders’ equity, at September 30, 2010 and December 31, 2009, are as follows:

		Foreign Currency Translation Adjustment				Accumulated Other Comprehensive Income
Balance at December 31, 2008		$	861,166			$	861,166
Change for 2009			5,533				5,533
Balance at December 31, 2009		$	866,699			$	866,699
Change for nine months ended 9/30/2010			399,260				399,260
Balance at September 30, 2010		$	1,265,959				1,265,959

Note 17- RESTATEMENT

The accompanying consolidated balance sheet and statement of stockholders’ equity as of, and for the year ended, December 31, , 2009 have been restated for the following matter:

The number of shares of the Company’s common stock outstanding at December 31, 2009 was overstated in such financial statements.

Therefore, we have restated the financial statements to correct this error. The net effect of this reclassification is as follows:

A decrease in the Company’s common stock by $1,187 from $20,811 to $19,624 and an increase of additional paid in capital by the same amount.

Note 18- SUBSEQUENT EVENTS

For the nine months ended September 30, 2010, the Company has evaluated subsequent events for potential recognition and disclosure through the date of issuance of these financial statements.. Based upon this evaluation management has concluded that no subsequent events requiring recognition or disclosure existed.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the consolidated financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes of Rongfu Aquaculture, Inc. appearing elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Actual results may differ materially from those anticipated in these forward-looking statements.

Overview

The Company is engaged in commercial freshwater aquaculture in the PRC. It sells fish and fish fry and also acts as a freshwater fish dealer (generating trading profits from the purchase of fish from third party farmers and the immediate sale of such fish to wholesalers).

The Company operates 13 adult fish breeding farms, covering a total area of 8,249 mu Three of the Company’s farms are located in Hainan Province, two in the town of Wenchang and one in Nanling. The other 10 farms are located in Guangdong Province in the towns or villages of Nanhai, Qinyuan, Taishan, Yangdong  and Gaoyao. 9 of the farms consist of a series of man-made ponds. Each pond is outfitted with one or more oxygen aeration machines which float on the surface and one or more feeding machines which provide food to the fish twice per day. The aeration machines provide oxygen to the fish and enable the natural removal of fish wastes so that the water does not become toxic for the fish.

4 of the Company’s farms are each comprised of a single lake created by damming a river. Oxygen aeration equipment is not needed since the lakes have a much larger area than the ponds dug by the Company. The land on which the farms are located is leased by the Company from the village under leases for terms of 4 to 30 years.

In addition to its adult fish breeding farms, the Company operates a breeding farm in Wenchang, Hainan Province in which tilapia fry are produced from brood stock.

At its facilities in Nanhai (at which the Company’s fish clinic is also located) and Wenchang, the Company also has constructed and maintains concrete tanks where the Company incubates tilapia. The Company also incubates snakehead and crucian carp fry in its tank in Nanhai. After the incubation period the Company sells approximately 95% of the fry to distributors.

 

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Comparison of three months ended September 30, 2010 and September 30, 2009

The following table presents the Company’s consolidated net sales for its lines of business for the three months ended September 30, 2010 and three months ended September 30, 2009, respectively:

 

Three Months Ended September 30, 2010 and 2009										%
		2010				2009				Change
Farm growing		$	7,112,859			$	2,230,948				219	%
Breeding		$	1.107.114			$	837,051				32	%
Trading		$	4,596,302			$	1,695,651				171	%
Consolidated		$	12,816,275			$	4,763,650				169	%

Revenue for the three months ended September 30, 2010 were $12,816,275, an increase of $8,052,625 or 169%, when compared to the same period in 2009. Such increase was attributed to the increase in sales of the trading business of adult fish by $2.9 million, particularly snakehead which contributed an increasing proportion of revenues of the trading business (60%) for the current quarter, and the increase in farm growing of adult fish by $4.9 million attributable to the increase in farm growing of snakehead compared to the same period of 2009. The opening in May 2010 of our logistics center greatly facilitated the distribution of snakehead to Guangzhou Province and other regions in the PRC.  For the three months ended September 30, 2010, sales of fish fry increased $270,063 compared to the same period of the prior year, due to sales of fry of our two new fish – yellow catfish and California perch.

Cost of goods sold for the three months ended September 30, 2010 were $9,129,968, an increase of $5,994,211 or 191%, when compared to the same sales period of the prior year, which consisted of an increase of $3,380,015 for breeding adult fish , an increase of $2,563,000 for the trading business, and a slight increase of $51,196 for breeding fish fry. The percentage increase in cost of goods sold is higher than that of the percentage increase in revenue mainly because the revenues of the farm growing segment, with relatively higher costs of sales increased proportionately more than revenues of the breeding segment.

Gross profit for the three months ended September 30, 2010 was $3,686,307, an increase of $2,058,414 or 126%, when compared to the same period in 2009. The increase in gross profit is comprised of an increase of $1,501,897 for breeding adult fish, an increase of $337,650 for the Company’s trading business and an increase of $218,867 for breeding fish fry. The percentage increase in gross profit for the three months ended September 30, 2010 over the three months ended September 30, 2009 is lower than the percentage increase in revenues for the same periods due to higher costs of goods sold in the three months ended September 30, 2010 as a result of changes in the product mix.

Selling, general and administrative expenses for the three months ended September 30, 2010 were $1,473,963, an increase of $1,010,787 or 218%, when compared to the same period in 2009, mainly attributable to the increase in selling expenses of $256,284 relating to the increase in sales and the increase in general and administrative expenses of $754,503 mainly due to an increase in professional fees associated with being a public company, expenses associated with the expansion of our business and the accrual for liquidated damages to certain investors who hold registration rights as a result of the failure to have a registration statement related to the resale of our common stock underlying the Series A Preferred Stock and warrants held by such investors declared effective by October 25, 2010.

Research and development expenses for the three months ended September 30, 2010 were $65,612, an increase of $44,317 or 208%, when compared with $21,295 in the same period in 2009.

Income from operations for the three months ended September 30, 2010 was $2,147,002, an increase of $1,003,310 or 88%, when compared to the same period in 2009. The main reason for the increase in income from operations was the increase in revenues, offset by the increase in selling, general and administrative expenses.

Interest income for the three months ended September 30, 2010 was $3,970, a decrease of $10,700 or 73%, when compared to the same period in 2009, primarily because the Company used a part of its interest earning funds to pay dividends and income tax in the fourth quarter in 2009, which decreased the Company’s interest income as a consequence.  Interest expense for the three months ended September 30, 2010 was $837, a decrease of $86,149 due to the repayment of the Company’s short term bank loans, when compared to the same period in 2009.

 Income taxes for the three months ended September 30, 2010 was $301,832, an increase of $234,165, or 346%, when compared to the same period in 2009.  In 2010 less proportion of fry was sold and fry was tax exempt while farmed fish was subject to a 12.5% income tax. Trading revenue from grown fish was taxed at a rate of 25%. In 2010 more revenue was contributed by farming and trading and therefore the income taxes were higher than that of 2009.

The Company recorded a loss on fair value of derivative liability of $943,266 for the three months ended September 30, 2010.

 

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Net income for the three months ended September 30, 2010 was $905,037 as compared to net income of $1,003,709 for the three months ended September 30, 2009 due to the increase in revenue offset by the increase in selling, general and administrative expenses and the non-cash item of loss on fair value of derivative liability of $943,266 in the third quarter of fiscal year 2010.  On March 29, 2010, the Company completed a private placement of its preferred stock and five year warrants to purchase an aggregate of 4,127,268 shares of common stock. The warrants are required to be recorded as a derivative instrument liability, carried at fair value and marked-to-market at the end of each period, with changes in the fair value each period charged or credited to net income on the income statement.

Comparison of nine months ended September 30, 2010 and September 30, 2009

The following table presents the Company’s consolidated net sales for its lines of business for the nine months ended September 30, 2010 and nine months ended September 30, 2009, respectively:

 

Nine Months Ended September 30, 2010 and 2009										%
		2010				2009				Change
Farm growing		$	21,128,289			$	13,407,185				58	%
Breeding		$	5,094,679			$	4,369,794				17	%
Trading		$	9,146,731			$	3,954,949				131	%
Consolidated		$	35,369,699			$	21,731,927				63	%

Revenue for the nine months ended September 30, 2010 were $35,369,699, an increase of $13,637,772 or 63%, when compared to the same period in 2009. Such increase was mainly attributed to the increase in sales of adult fish purchased by farmers, which increased $5,191,782, and the sales of adult fish from farm growing, which increased $7,721,705 compared to the same period of 2009 following the opening in May, 2010 of our logistics center which facilitated the distribution of snakehead to Guangzhou Province and other regions in the PRC. For the nine months ended September 30, 2010, sales of fish fry increased $724,885 compared to the same period of the prior year, due to sales of fry of our two new fish – yellow catfish and California perch.

Cost of goods sold for the nine months ended September 30, 2010 were $23,576,353, an increase of $10,252,589 or 77%, when compared to the same sales period of the prior year, which consisted of an increase of $5,551,304 for breeding adult fish, an increase of $4,595,380 for trading business, and an increase of $105,905 for breeding fish fry The percentage increase in cost of goods sold is higher than that of the percentage increase in revenue mainly because the revenues of the farm growing segment, with relatively higher costs of sales, increased proportionately more than revenues of the breeding segment.

Gross profit for the nine months ended September 30, 2010 was $11,793,346, an increase of $3,385,183 or 40%, when compared to the same period in 2009. The increase in gross profit is comprised of an increase of $2,169,801 for breeding adult fish, an increase of $596,402 for the Company’s trading business, and an increase of $618,980 for breeding fish fry. The percentage increase in gross profit for the nine months ended September 30, 2010 over the nine months ended September 30, 2009 is lower than the percentage increase in revenues for the same periods due to higher costs of goods sold in the nine months ended September 30, 2010 as a result of changes in the product mix.

Selling, general and administrative expenses for the nine months ended September 30, 2010 were $3,255,188, an increase of $1,427,131 or 78%, when compared to the same period in 2009.  The increase was mainly attributed to the increase of selling expenses of $807,934 for the expansion of our business and the increase in general and administrative expenses by $619,196, mainly due to increases in professional fees associated with our being a public company, the expenses associated with the expansion of our business and the accrual for liquidated damages to certain investors who hold registration rights as a result of the failure to have a registration statement related to the resale of our common stock underlying the Series A Preferred Stock and warrants held by such investors declared effective by October 25, 2010.

Income from operations for the nine months ended September 30, 2010 was $8,433,903, an increase of $1,910,234 or 29%, when compared to the same period in 2009. The increase was attributable to the increase in gross profit of $3,385,183 due to the expansion in sales of adult fish, fish fry and trading business, offset by the increase in selling, general and administrative expenses by $1,427,131.

 

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Interest income for the nine months ended September 30, 2010 was $10,584, a decrease of $24,926 or 70%, when compared to the same period in 2009, primarily because the Company used a part of its interest earning funds to pay dividends and income tax of the fourth quarter in 2009, which decreased the Company’s interest income as a consequence.  Interest expense for the nine months ended September 30, 2010 was $35,678, a decrease of $51,758 or 59% due to the repayment of the Company’s short term bank loans, when compared to the same period in 2009.

Income taxes for the nine months ended September 30, 2010 were $790,416, an increase of $343,844, or 77%, when compared to the same period in 2009.  In 2010 less proportion of fry was sold and fry was tax exempt while farmed fish was subject to a 12.5% income tax. Trading revenue from grown fish was taxed at a rate of 25%. In 2010 more revenue was contributed by farming and trading and therefore the income taxes were higher than that of 2009.

The Company recorded a loss on fair value of derivative liability of $6,251,254 for the nine months ended September 30, 2010.

Net income for the nine months ended September 30, 2010 was $1,498,039 as compared to net income of $6,025,171 for the nine months ended September 30, 2009 due to the increase in revenue offset by the increase in selling, general and administrative expenses and the non-cash item of loss on fair value of derivative liability of $6,251,254 in the first three quarters in fiscal year 2010 and the professional fee in connection with the services rendered in reverse merger for the issuance of shares in the first quarter in 2010.  On March 29, 2010, the Company completed a private placement of its preferred stock and five year warrants to purchase an aggregate of 4,127,268 shares of common stock. The warrants are required to be recorded as a derivative instrument liability, carried at fair value and marked-to-market at the end of each period, with changes in the fair value each period charged or credited to net income on the income statement.

During the nine months ended September 30, 2010, total assets increased by $10,668,136, or 92%, from $11,629,668 at December 31, 2009 to $22,297,804 at September 30, 2010.  The majority of the increase was in cash, accounts receivable, advance payment and prepayment, and inventories, which was partially offset by a decrease in amount due from shareholders.

During the nine months ended September 30, 2010, cash increased by $3,501,039, or 110%, to $6,695,287 as compared to $3,194,248 at December 31, 2009. This is mainly attributed to the funding from investors of net proceeds amounting to $6,561,077 in second quarter this year, offset by the increase in inventories, payment of dividends to shareholders in 2009.

At September 30, 2010, the accounts receivable balance increased by $1,368,179, or 579%, from the balance at December 31, 2009. The increase is due to the increase in revenue in the nine months ended September 30, 2010. In addition, we have granted our customers a longer credit period as a strategy to increase our market share.

At September 30, 2010, the other receivables increased by $1,300,148, or 6,130%, from the balance at December 31, 2009. The increase is mainly due to the advance payment of $1,194,000 for fish nets.

At September 30, 2010, there were no amounts due from shareholders, as compared to due from shareholders of $4,008,659 at December 31, 2009. This is attributed to the repayment from shareholders during the first quarter of 2010.

The Company’s inventory at September 30, 2010 was $10,905,977, an increase of $7,926,224, or 266%, compared to inventory at December 31, 2009. Inventories mainly consists of adult tilapia, snakehead, crucian carp and other varieties of freshwater fish. The main reason of the increase of inventory is the Company increased its breeding capacity in the nine months ended September 30, 2010.

At September 30, 2010 fixed assets were $868,448, mainly consisting of aerators, feeding machine and other equipments used in fish farms, representing an increase of $463,301, or 114%, compared to fixed assets at December 31, 2009.

At September 30, 2010 biological assets were $248,811, a decrease of $183,997, or 43%, compared to biological assets at December 31, 2009. The decrease in biological assets was due to the amortization for the nine months in 2010, offset by the procurement of certain breeding fish during the 2010.  Biological assets consist of tilapia, snakehead, crucian carp, yellow catfish and black bass.

 

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At September 30, 2010 accounts payable were $5,036,460, as compared to $0 at December 31, 2009. The increase in accounts payable was due to the procurement of fish food used in fish farm and fish fry breeding mainly from related parties.

At September 30, 2010 other payables were $552,475, a decrease of $2,743,960, or 80%, compared to other payables at December 31, 2009. The main item included in other payables is personal income tax payable, and the high personal income tax payable was due to the dividend payable in the fiscal year ended December 31, 2009, which was paid in the first quarter of 2010. On the other hand, at September 30, 2010, there is an accrual of $207,900 for the liquidated damages to warrant holders for the Registration Statement not declared effective by October 25, 2010.

At September 30, 2010, there was no advance from clients, as compared to the advance from clients of $498,785 at December 31, 2009. Because goods were distributed to clients in the first quarter of 2010, there was no advance from clients as of September 30, 2010.

At September 30, 2010, there was no bank loan, as compared to current portion of bank loan of $380,273 at December 31, 2009.  The loan was fully repaid prior to September 30, 2010.

At September 30, 2010, there was no dividend payable, as compared to a dividend payable of $3,466,331 at December 31, 2009 since the dividend was fully paid in the nine months ended September 30, 2010.

At September 30, 2010 income tax payable was $301,419, a decrease of $693,894, or 70%, compared to income tax payable at December 31, 2009. This is mainly because the fourth quarter is the peak season of sales normally, and therefore the income tax for the nine months ended September 30, 2010 is lower than the income tax for the whole 2009 fiscal year.

Liquidity and Capital Resources

The Company has typically financed its operations and expansion from cash flows from operations and loans from its shareholders and banks. The Company consummated a reverse merger transaction and raised approximately $7.7 million in gross proceeds in a private placement financing on March 29, 2010.

Nanhai Ke Da Heng Sheng has entered into two credit line agreements with Foshan Nanhai Allied Rural Credit Union Danzhao Credit Association with credit lines of RMB 7,000,000 (approximately $ 1,044,605 based on the conversion rate as of September 30, 2010) and RMB 5,000,000 (approximately $746,146 based on the conversion rate as of September 30, 2010), respectively. The two credit lines are secured by real estate owned by the sister-in-law of Chen Zhisheng, our Chairman of the Board.  The agreements were entered into on January 14, 2009 and January 13, 2009, respectively, for two-year terms expiring in January 2011. Outstanding loans under the two credit lines bear interest at a rate of 5.4% per year. Interest is payable monthly. As of September 30, 2010, there were no outstanding loans payable

 

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Critical Accounting Policies and Estimates

Management's discussion and analysis of its 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. Our financial statements reflect the selection and application of accounting policies which require management to make significant estimates and judgments. See note 2 to our consolidated financial statements, "Summary of Significant Accounting Policies." Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe that the following reflect the more critical accounting policies that currently affect our financial condition and results of operations.

Principles of Consolidation

The consolidated financial statements include the accounts of Rongfu Aquaculture, Inc (formerly, Granto, Inc.) and its wholly owned subsidiaries, Flourishing HK, the WOFE,  Nanhai Ke Da Heng Sheng, and Hainan Ke Da Heng Sheng (collectively referred to herein as the” Company”). All material inter-company accounts, transactions and profits have been eliminated in consolidation. The Company has adopted the Consolidation Topic of the FASB Accounting Standards Codification which requires a variable interest entity (“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.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Inventories

Inventories are valued at the lower of cost (determined on a weighted average basis) or market.

Derivative Liability

The Company issued warrants in connection with the Purchase Agreement dated March 29, 2010 with certain reset exercise price provisions. 

Adoption of the Derivative and Hedging Topic of the FASB Accounting Standards Codification (“ASC 815”), the Company determined that the warrants did not qualify for a scope exception under ASC 815 as they were determined to not be indexed to the Company’s stock as prescribed by ASC 815.  The warrants, under ASC 815, were classified as derivative liability for the then relative fair market value of $ 3,267,797 and marked to market. For the nine months ended September 30, 2010, the Company recorded a loss on change in fair value of derivative liability of $6,251,254 to mark to market for the increase in fair value of the warrants through ended September 30, 2010.   Under ASC 815, the warrants will be carried at fair value and adjusted at each reporting period.

Fair Value of Financial Instruments

The Financial Instrument Topic of the Codification requires that the Company disclose estimated fair values of financial instruments. The carrying amounts reported in the statements of financial position for current assets and current liabilities qualifying as financial instruments are a reasonable estimate of fair value.

Revenue Recognition

The Company’s revenue recognition policies are in compliance with the Revenue Recognition Topic of the Codification. Sales revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as unearned revenue.

Income Taxes

The Company utilizes the accounting guidance, “Accounting for Income Taxes,” which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

 

It is the Company’s intention to permanently reinvest earnings from activity with China and thereby indefinitely postpone repatriation of these funds to the U.S. Accordingly, no domestic deferred income tax provision has been made for U.S. income tax which could result from paying dividends to the Company.

At September 30, 2010, there were permanent tax differences relating to stock based compensation in conjunction with professional services of $191,141 and the loss on change in fair value of derivative liability of $6,251,254 to mark to market for the increase in fair value of the warrants through ended September 30, 2010.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk are cash, accounts receivable and other receivables arising from its normal business activities. The Company places its cash in what it believes to be credit-worthy financial institutions. The Company has a diversified customer base, all are in China. The Company controls credit risk related to accounts receivable through credit approvals, credit limits and monitoring procedures. The Company routinely assesses the financial strength of its customers and, based upon factors surrounding the credit risk, establishes an allowance, if required, for uncollectible accounts and, as a consequence, believes that its accounts receivable credit risk exposure beyond such allowance is limited.

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements.

 

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Item 3. Quantitative and Qualitative Disclosure About Market Risk

Not applicable.