Attached files

file filename
EXCEL - IDEA: XBRL DOCUMENT - SHARING ECONOMY INTERNATIONAL INC.Financial_Report.xls
EX-32.1 - CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT - SHARING ECONOMY INTERNATIONAL INC.f10q0911ex32i_cleantech.htm
EX-31.2 - CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT - SHARING ECONOMY INTERNATIONAL INC.f10q0911ex31ii_cleantech.htm
EX-31.1 - CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT - SHARING ECONOMY INTERNATIONAL INC.f10q0911ex31i_cleantech.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2011

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________

COMMISSION FILE NUMBER: 001-34591

CLEANTECH SOLUTIONS INTERNATIONAL, INC.
 (Name of Registrant as specified in its charter)

DELAWARE
(State or other jurisdiction of incorporation of organization)
74-2235008
(I.R.S. Employer Identification No.)
 
No. 9 Yanyu Middle Road
Qianzhou Township, Huishan District, Wuxi City
Jiangsu Province, China 150090
 (Address of principal executive office)

(86) 51083397559
 (Registrant’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
(Do not check if smaller reporting company)
o
Smaller reporting company
x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o No x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.  20,206,313 shares of common stock are issued and outstanding as of November 11, 2011.
 
 
 

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
FORM 10-Q
September 30, 2011

TABLE OF CONTENTS

   
Page No.
PART I. - FINANCIAL INFORMATION
Item 1.
Financial Statements
 
  Consolidated Balance Sheets as of September 30, 2011 (Unaudited) and December 31, 2010 (Audited) 3
 
Consolidated Statements of Income and Comprehensive Income for the Three and Nine Months Ended September 30, 2011 and 2010 (unaudited)
4
  Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010 (unaudited) 5
  Notes to Unaudited Consolidated Financial Statements. 6
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
25
Item 3
Quantitative and Qualitative Disclosures About Market Risk.
42
Item 4
Controls and Procedures.
42
PART II - OTHER INFORMATION
Item 2.
Unregistered Sales of Equity Securities and Use Of Proceeds.
44
Item 6.
Exhibits.
44

FORWARD LOOKING STATEMENTS

This report contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements as denoted in this report. Additionally, statements concerning future matters are forward-looking statements.
 
Although forward-looking statements in this report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the headings “Risks Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our annual report on Form 10-K, in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-Q and information contained in other reports that we file with the SEC. You are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.
 
We file reports with the SEC. The SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
 
We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this report, except as required by law. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this quarterly report, which are designed to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.
 
 
2

 
 
PART 1 - FINANCIAL INFORMATION

Item 1.                                Financial Statements.
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
 
             
   
September 30, 2011
   
December 31, 2010
 
   
(Unaudited)
       
ASSETS
           
             
CURRENT ASSETS:
           
    Cash and cash equivalents
  $ 518,274     $ 947,177  
    Restricted cash
    468,618       -  
    Notes receivable
    150,230       50,593  
    Accounts receivable, net of allowance for doubtful accounts
    8,153,522       8,207,797  
    Inventories, net of reserve for obsolete inventory
    5,448,324       3,371,128  
    Advances to suppliers
    848,256       333,923  
    Prepaid VAT on purchases
    2,022,059       2,759,763  
    Prepaid expenses and other
    176,093       36,338  
                 
        Total Current Assets
    17,785,376       15,706,719  
                 
PROPERTY AND EQUIPMENT - net
    60,127,451       54,742,993  
                 
OTHER ASSETS:
               
   Deposit on equipment
    781,030       -  
   Land use rights, net
    3,821,480       3,767,159  
                 
        Total Assets
  $ 82,515,337     $ 74,216,871  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
CURRENT LIABILITIES:
               
    Short-term bank loans
  $ 2,343,091     $ 1,814,937  
    Bank acceptance notes payable
    468,618       -  
    Accounts payable
    5,124,255       7,660,768  
    Accrued expenses
    599,634       526,006  
    Capital lease obligations- current portion
    242,850       -  
    VAT and service taxes payable
    -       81,614  
    Advances from customers
    2,113,577       236,004  
    Income taxes payable
    651,310       1,331,713  
 
               
        Total Current Liabilities
    11,543,335       11,651,042  
                 
OTHER LIABILITIES:
               
    Capital lease obligations- net of current portion
    419,233       -  
                 
         Total Liabilities
    11,962,568       11,651,042  
                 
STOCKHOLDERS' EQUITY:
               
    Preferred stock $0.001 par value (60,000,000 shares authorized, all of which  were designated
               
       as series A convertible preferred, 13,375,983 and 16,205,268 shares issued and outstanding
               
       at September 30, 2011 and December 31, 2010, respectively)
    13,376       16,205  
    Common stock ($0.001 par value; 150,000,000 shares authorized;
               
       20,168,813 and 18,751,128 shares issued and outstanding
               
       at September 30, 2011 and December 31, 2010, respectively)
    20,169       18,751  
    Additional paid-in capital
    27,451,299       26,579,053  
    Retained earnings
    33,847,632       29,264,152  
    Statutory reserve
    2,044,826       1,658,197  
    Accumulated other comprehensive gain - foreign currency translation adjustment
    7,175,467       5,029,471  
                 
        Total Stockholders' Equity
    70,552,769       62,565,829  
                 
        Total Liabilities and Stockholders' Equity
  $ 82,515,337     $ 74,216,871  
                 
See notes to unaudited consolidated financial statements
 
 
 
3

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
 
(Unaudited)
 
                         
`
 
For the Three Months Ended
   
For the Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
                         
REVENUES
  $ 11,676,696     $ 21,262,054     $ 41,851,257     $ 57,080,010  
                                 
COST OF REVENUES
    9,046,015       15,840,889       31,617,025       42,264,893  
                                 
GROSS PROFIT
    2,630,681       5,421,165       10,234,232       14,815,117  
                                 
OPERATING EXPENSES:
                               
     Depreciation
    84,531       78,478       505,326       239,493  
     Selling, general and administrative
    913,198       1,206,058       2,773,694       3,502,239  
                                 
        Total Operating Expenses
    997,729       1,284,536       3,279,020       3,741,732  
                                 
INCOME FROM OPERATIONS
    1,632,952       4,136,629       6,955,212       11,073,385  
                                 
OTHER INCOME (EXPENSE):
                               
     Interest income
    110       490       940       3,212  
     Interest expense
    (60,452 )     (23,923 )     (122,980 )     (117,336 )
     Foreign currency loss
    (1,476 )     (6,172 )     (4,817 )     (13,073 )
     Grant income
    -       132       -       49,278  
     Other income
    14,266       -       91,379       -  
                                 
        Total Other Income (Expense)
    (47,552 )     (29,473 )     (35,478 )     (77,919 )
                                 
INCOME BEFORE INCOME TAXES
    1,585,400       4,107,156       6,919,734       10,995,466  
                                 
INCOME TAXES
    450,410       1,133,566       1,949,625       3,051,682  
                                 
NET INCOME
  $ 1,134,990     $ 2,973,590     $ 4,970,109     $ 7,943,784  
                                 
COMPREHENSIVE INCOME:
                               
      NET INCOME
  $ 1,134,990     $ 2,973,590     $ 4,970,109     $ 7,943,784  
                                 
      OTHER COMPREHENSIVE INCOME:
                               
           Unrealized foreign currency translation gain
    655,213       908,803       2,145,996       1,124,886  
                                 
      COMPREHENSIVE INCOME
  $ 1,790,203     $ 3,882,393     $ 7,116,105     $ 9,068,670  
                                 
NET INCOME PER COMMON SHARE:
                               
    Basic
  $ 0.06     $ 0.16     $ 0.26     $ 0.45  
    Diluted
  $ 0.05     $ 0.12     $ 0.20     $ 0.32  
                                 
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
                               
    Basic
    19,976,741       18,177,405       19,370,281       17,671,530  
    Diluted
    24,621,594       25,312,979       25,126,373       24,904,210  
                                 
See notes to unaudited consolidated financial statements
 
 
 
4

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(Unaudited)
 
   
   
For the Nine Months Ended
 
   
September 30,
 
   
2011
   
2010
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 4,970,109     $ 7,943,784  
Adjustments to reconcile net income from operations to net cash
               
provided by operating activities:
               
Depreciation
    3,651,168       2,145,463  
Amortization of debt discount to interest expense
    -       44,993  
Amortization of land use rights
    68,145       65,042  
Increase in allowance for doubtful accounts
    389,120       550,006  
Stock-based compensation expense
    282,259       478,390  
Changes in assets and liabilities:
               
Notes receivable
    (96,409 )     (16,598 )
Accounts receivable
    (70,783 )     (2,966,377 )
Inventories
    (1,935,112 )     (1,918,385 )
Prepaid value-added taxes on purchases
    814,967       (1,564,513 )
Prepaid and other current assets
    (48,340 )     174,823  
Advances to suppliers
    (495,317 )     (1,028,678 )
Accounts payable
    (2,741,480 )     3,345,974  
Accrued expenses
    58,098       (212,262 )
VAT and service taxes payable
    (82,941 )     62,311  
Income taxes payable
    (712,490 )     148,220  
Advances from customers
    1,839,882       89,848  
                 
NET CASH PROVIDED BY OPERATING ACTIVITIES
    5,890,876       7,342,041  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Payments for deposit on equipment
    (768,520 )     -  
Purchase of property and equipment
    (6,413,874 )     (9,212,125 )
                 
NET CASH USED IN INVESTING ACTIVITIES
    (7,182,394 )     (9,212,125 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Principal payments on capital lease
    (143,545 )     -  
Proceeds from loans payable
    2,612,969       1,320,345  
Repayment of loans payable
    (2,151,857 )     (2,090,460 )
Increase in restricted cash
    (461,112 )     -  
Increase in bank acceptance notes payable
    461,112       -  
Proceeds from sale of preferred stock, net
    125,000       -  
Proceeds from exercise of warrants
    400,000       2,100,000  
                 
NET CASH PROVIDED BY FINANCING ACTIVITIES
    842,567       1,329,885  
                 
EFFECT OF EXCHANGE RATE ON CASH AND CASH EQUIVALENTS
    20,048       35,270  
                 
NET DECREASE IN CASH AND CASH EQUIVALENTS
    (428,903 )     (504,929 )
                 
CASH AND CASH EQUIVALENTS - beginning of year
    947,177       2,278,638  
                 
CASH AND CASH EQUIVALENTS - end of period
  $ 518,274     $ 1,773,709  
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
               
Cash paid for:
               
Interest
  $ 122,980     $ 74,486  
Income taxes
  $ 2,662,115     $ 2,903,462  
                 
NON-CASH INVESTING AND FINANCING ACTIVITIES:
               
Security deposit and leased property in exchange for capital lease obligations
  $ 795,022     $ -  
Series A preferred converted to common shares
  $ 3,536     $ 2,911  
Common stock issued for future service
  $ 63,576     $ 3,900  
                 
See notes to unaudited consolidated financial statements.
 
 
 
5

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

Cleantech Solutions International, Inc. (the “Company”) was incorporated in Delaware on June 24, 1987 under the name of Malex, Inc.  On December 18, 2007, the Company’s corporate name was changed to China Wind Systems, Inc., and on June 13, 2011, the Company’s corporate name was changed to Cleantech Solutions International, Inc. Through its affiliated companies and subsidiaries, the Company manufactures and sells forged products and fabricated products to a range of clean technology customers including high precision forged rolled rings and related products for the wind power industry and other industries.  The Company also makes textile dyeing and finishing machines.  The Company is the sole owner of Fulland Limited (“Fulland”), a Cayman Island limited liability company, which was organized on May 9, 2007.  Fulland owns 100% of the capital stock of Green Power Environment Technology (Shanghai) Co., Ltd. (“Green Power”) and Wuxi Fulland Wind Energy Equipment Co., Ltd. (“Fulland Wind Energy”), which are wholly foreign-owned enterprises (“WFOE”) organized under the laws of the People’s Republic of China (“PRC” or “China”).  Green Power is a party to a series of contractual arrangements, as fully described below, dated October 12, 2007 with Wuxi Huayang Electrical Power Equipment Co., Ltd. (“Electrical”) and Wuxi Huayang Dyeing Machinery Co., Ltd. (“Dyeing”), both of which are limited liability companies organized under the laws of, and based in, the PRC.   Electrical and Dyeing are sometimes collectively referred to as the “Huayang Companies.”

Fulland was organized by the owners of the Huayang Companies as a special purpose vehicle for purposes of raising capital, in accordance with requirements of the PRC State Administration of Foreign Exchange (“SAFE”). On May 31, 2007, SAFE issued an official notice known as Hui Zong Fa [2007] No. 106 (“Circular 106”), which requires the owners of any Chinese company to obtain SAFE’s approval before establishing any offshore holding company structure for foreign financing as well as subsequent acquisition matters in China. Accordingly, the owners of the Huayang Companies, Mr. Jianhua Wu and Ms. Lihua Tang, submitted their application to SAFE in early September 2007. On October 11, 2007, SAFE approved their application, permitting these Chinese citizens to establish Fulland as a special purpose vehicle for any foreign ownership and capital raising activities by the Huayang Companies.

Electrical was formed on May 21, 2004, and Fulland Wind Energy was formed on August 27, 2008.  Beginning in April 2007, Electrical began to produce large-scaled forged rolled rings that are up to three meters in diameter for the wind-power and other industries.  In 2009, the Company began to produce and sell forged products through Fulland Wind Energy. The Company manufactures and machines all forged products, including wind products such as shafts, rolled rings, gear rims, gearboxes, bearings and other components and finished products and assemblies for the wind power industry, electro-slag re-melted (“ESR”) products used in the steel industry, and other sectors, and solar products, including any type of large-scale equipment used in the manufacturing process for the solar industry, through Fulland Wind Energy.  The Company refers to this segment of its business as the forged rolled rings and related components division.  

Dyeing, which was formed on August 17, 1995, produces and sells a variety of high and low temperature dyeing and finishing machinery for the textile industry.  The Company refers to this segment as the dyeing division.

Basis of presentation; management’s responsibility for preparation of financial statements

Management acknowledges its responsibility for the preparation of the accompanying interim consolidated financial statements which reflect all adjustments, consisting of normal recurring adjustments, considered necessary in its opinion for a fair statement of its consolidated financial position and the results of its operations for the interim period presented.

These consolidated financial statements should be read in conjunction with the summary of significant accounting policies and notes to consolidated financial statements included in the Company’s Form 10-K annual report for the year ended December 31, 2010.
 
 
6

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Basis of presentation; management’s responsibility for preparation of financial statements (continued)

The accompanying unaudited consolidated financial statements for Cleantech Solutions International, Inc., its subsidiaries and variable interest entities, have been prepared in accordance with accounting principles generally accepted in the United States of America (the “U.S.”) for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X. Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole.

The Company’s consolidated financial statements include the financial statements of its wholly-owned subsidiaries, Fulland, Greenpower and Fulland Wind Energy, as well as the financial statements of Huayang Companies, Dyeing and Electric.  All significant intercompany accounts and transactions have been eliminated in consolidation.

The Huayang Companies are considered variable interest entities (“VIE”), and the Company is the primary beneficiary.  The Company’s relationships with the Huayang Companies and their shareholders are governed by a series of contractual arrangements between Green Power, the Company’s wholly foreign-owned enterprise in the PRC, and each of the Huayang Companies, which are the operating companies of the Company in the PRC. Under PRC laws, each of Green Power, Huayang Dye Machine and Huayang Electrical Power Equipment is an independent legal entity and none of them is exposed to liabilities incurred by the other parties. The contractual arrangements constitute valid and binding obligations of the parties to such agreements. Each of the contractual arrangements and the rights and obligations of the parties thereto are enforceable and valid in accordance with the laws of the PRC. On October 12, 2007, the Company entered into the following contractual arrangements with each of Huayang Dye Machine and Huayang Electrical Power Equipment:

Consulting Services Agreement. Pursuant to the exclusive consulting services agreements between Green Power and the Huayang Companies, Green Power has the exclusive right to provide to the Huayang Companies general business operation services, including advice and strategic planning, as well as consulting services related to the technological research and development of dye and finishing machines, electrical equipments and related products (the “Services”). Under this agreement, Green Power owns the intellectual property rights developed or discovered through research and development, in the course of providing the Services, or derived from the provision of the Services. The Huayang Companies shall pay a quarterly consulting service fees in Renminbi (“RMB”) to Fulland that is equal to all of the Huayang Companies’ profits for such quarter.

Operating Agreement. Pursuant to the operating agreement among Green Power, the Huayang Companies and all shareholders of the Huayang Companies, Green Power provides guidance and instructions on the Huayang Companies’ daily operations, financial management and employment issues. The Huayang Companies shareholders must designate the candidates recommended by Green Power as their representatives on the boards of directors of each of the Huayang Companies. Green Power has the right to appoint senior executives of the Huayang Companies. In addition, Green Power agrees to guarantee the Huayang Companies’ performance under any agreements or arrangements relating to the Huayang Companies’ business arrangements with any third party. The Huayang Companies, in return, agree to pledge their accounts receivable and all of their assets to Green Power. Moreover, each of the Huayang Companies agrees that, without the prior consent of Green Power, it will not engage in any transactions that could materially affect its assets, liabilities, rights or operations, including, without limitation, incurrence or assumption of any indebtedness, sale or purchase of any assets or rights, incurrence of any encumbrance on any of their assets or intellectual property rights in favor of a third party or transfer of any agreements relating to their business operation to any third party. The term of this agreement, as amended on November 1, 2008, is 20 years from October 12, 2007 and may be extended only upon Green Power’s written confirmation prior to the expiration of the this agreement, with the extended term to be mutually agreed upon by the parties.

 
7

 

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011

 
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Basis of presentation; management’s responsibility for preparation of financial statements (continued)

Equity Pledge Agreement. Under the equity pledge agreement between the Huayang Companies’ shareholders and Green Power, the Huayang Companies’ shareholders pledged all of their equity interests in the Huayang Companies to Green Power to guarantee the Huayang Companies’ performance of their respective obligations under the consulting services agreement. If the Huayang Companies or the Huayang Companies’ shareholders breach their respective contractual obligations, Green Power, as pledgee, will be entitled to certain rights, including the right to sell the pledged equity interests. The Huayang Companies’ shareholders also agreed that, upon occurrence of any event of default, Green Power shall be granted an exclusive, irrevocable power of attorney to take actions in the place and stead of the Huayang Companies’ shareholders to carry out the security provisions of the equity pledge agreement and take any action and execute any instrument that Green Power may deem necessary or advisable to accomplish the purposes of the equity pledge agreement. The Huayang Companies’ shareholders agreed not to dispose of the pledged equity interests or take any actions that would prejudice Green Power’s interest. The equity pledge agreement will expire two years after the Huayang Companies’ obligations under the consulting services agreements have been fulfilled.

Option Agreement. Under the option agreement between the Huayang Companies’ shareholders and Green Power, the Huayang Companies’ shareholders irrevocably granted Green Power or its designated person an exclusive option to purchase, to the extent permitted under PRC law, all or part of the equity interests in the Huayang Companies for the cost of the initial contributions to the registered capital or the minimum amount of consideration permitted by applicable PRC law. Green Power or its designated person has sole discretion to decide when to exercise the option, whether in part or in full. The term of this agreement, as amended on November 1, 2008, is 20 years from October 12, 2007 and may be extended prior to its expiration by written agreement of the parties.

Pursuant to Accounting Standards Codification (“ASC”) Topic 810 and related subtopics related to the consolidation of variable interest entities, the accounts of the Huayang Companies are consolidated in the accompanying financial statements.  As VIEs, the Huayang Companies’ sales are included in the Company’s total sales, its income from operations is consolidated with the Company’s, and the Company’s net income includes all of the Huayang Companies net income. The Company does not have any non-controlling interest and, accordingly, did not subtract any net income in calculating the net income of the VIEs that is attributable to the Company. Because of the contractual arrangements, the Company  has a pecuniary interest in the Huayang Companies that requires consolidation of the Company’s and the Huayang Companies’ financial statements.

Use of estimates

The preparation of the financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures at the date of the financial statements and during the reporting period. Actual results could materially differ from these estimates. Significant estimates in the nine months ended September 30, 2011 and 2010 include the allowance for doubtful accounts, the allowance for obsolete inventory, the useful life of property and equipment and intangible assets, assumptions used in assessing impairment of long-term assets and valuation of deferred tax assets, accruals for taxes due, and the value of stock-based compensation.

Cash and cash equivalents

For purposes of the consolidated statements of cash flows, the Company considers all highly liquid instruments purchased with a maturity of three months or less and money market accounts to be cash equivalents. The Company maintains cash and cash equivalents with various financial institutions mainly in the PRC and the U.S. Balances in the U.S are insured up to $250,000 at each bank.  Balances in banks in the PRC are uninsured.
 
 
8

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Fair value of financial instruments

The Company adopted the guidance of ASC Topic 820 for fair value measurements which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.
 
Level 2-Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data.
 
Level 3-Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.

The carrying amounts reported in the balance sheets for cash, accounts receivable, loans payable, accounts payable and accrued expenses, customer advances, and amounts due from related parties approximate their fair market value based on the short-term maturity of these instruments. The Company did not identify any assets or liabilities that are required to be presented on the consolidated balance sheets at fair value in accordance with the accounting guidance.

ASC Topic 825-10 “Financial Instruments,” allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, unrealized gains and losses for that instrument should be reported in earnings at each subsequent reporting date. The Company did not elect to apply the fair value option to any outstanding instruments.

Concentrations of credit risk

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 environment in the PRC, and by the general state of the PRC’s economy. The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America. The Company's results may be adversely affected 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.

Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. Substantially all of the Company’s cash is maintained with state-owned banks within the PRC, and no deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts. A significant portion of the Company’s sales are credit sales which are primarily to customers whose ability to pay is dependent upon the industry economics prevailing in these areas; however, concentrations of credit risk with respect to trade accounts receivables is limited due to generally short payment terms.  The Company also performs ongoing credit evaluations of its customers to help further reduce credit risk. At September 30, 2011 and December 31, 2010, the Company’s cash balances by geographic area were as follows:

   
September 30, 2011
   
December 31, 2010
 
Country:
                       
United States
  $ 3,849       0.7 %   $ 97,188       10.3 %
China
    514,425       99.3 %     849,989       89.7 %
Total cash and cash equivalents
  $ 518,274       100.0 %   $ 947,177       100.0 %
 
 
9

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Restricted cash

Restricted cash consists of cash deposits held by a bank to secure bank acceptance notes payable.

Notes receivable

Notes receivable represents trade accounts receivable due from various customers where the customers’ bank has guaranteed the payment of the receivable. This amount is non-interest bearing and is normally paid within three to nine months.   Historically, the Company has experienced no losses on notes receivable. The Company‘s notes receivable totaled $150,230 and $50,593 at September 30, 2011 and December 31, 2010, respectively.

Accounts receivable

Accounts receivable are presented net of an allowance for doubtful accounts. The Company maintains allowances for doubtful accounts for estimated losses. The Company reviews the accounts receivable on a periodic basis and makes general and specific allowances when there is doubt as to the collectability of individual balances. In evaluating the collectability of individual receivable balances, the Company considers many factors, including the age of the balance, a customer’s historical payment history, its current credit-worthiness and current economic trends. Accounts are written off after exhaustive efforts at collection. At September 30, 2011 and December 31, 2010, the Company has established, based on a review of its outstanding balances, an allowance for doubtful accounts in the amounts of $2,270,516 and $1,815,508, respectively.

Inventories

Inventories, consisting of raw materials, work in process and finished goods related to the Company’s products 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, the Company will record reserves for the difference between the cost and the market value. These reserves are recorded based on estimates.  The Company recorded an inventory reserve of $171,557 and $166,108 at September 30, 2011 and December 31, 2010, respectively.

Advances to suppliers
 
Advances to suppliers represent the cash paid in advance for the purchase of raw material from suppliers. The advance payments are intended to ensure preferential pricing and delivery. The amounts advanced under such arrangements totaled $848,256 and $333,923 as of September 30, 2011 and December 31, 2010, respectively.

Property and equipment

Property and equipment are carried at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized.  When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition. The Company examines 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.

 
10

 

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Property and equipment (continued)

Included in property and equipment is construction-in-progress which consisted of factory improvements and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation of the assets. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use. Property purchased from a related party is recorded at the cost to the related party and any payment to or on behalf of the related party in excess of the cost is reflected as a distribution to a related party.

Impairment of long-lived assets

In accordance with ASC Topic 360, the Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable, or at least annually. The Company recognizes 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. The Company did not record any impairment charges for the nine months ended September 30, 2011 and 2010.
 
Advances from customers

Advances from customers at September 30, 2011 and December 31, 2010 amounted to $2,113,577 and $236,004, respectively, and consist of prepayments from customers for merchandise that had not yet been shipped. The Company will recognize the deposits as revenue as customers take delivery of the goods in accordance with its revenue recognition policy.

Revenue recognition

Pursuant to the guidance of ASC Topic 605 and ASC Topic 360, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the purchase price is fixed or determinable and collectability is reasonably assured. The Company accounts for the product sale as a multiple element arrangement. Revenue from multiple element arrangements is allocated among the separate accounting units based on the residual method. Under the residual method, the revenue is allocated to undelivered elements based on fair value of such undelivered elements and the residual amounts of revenue allocated to delivered elements. The Company recognizes revenues from the sale of dyeing equipment, forged rolled rings and other components 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. Grant income is recognized when funds have been received and all significant terms of the grant have been fulfilled by the Company. Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period.  For the nine months ended September 30, 2011 and 2010, amounts allocated to warranty revenues were not material. Based on historical experience, warranty service calls and any related labor costs have been minimal.
 
All other product sales with customer specific acceptance provisions, including the forged rolled rings, 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.

 
11

 

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Income taxes

The Company is governed by the Income Tax Law of the PRC and the U.S. The Company accounts for income taxes using the liability method prescribed by ASC Topic 740, “Income Taxes.” Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the year in which the differences are expected to reverse. The Company records a valuation allowance to offset deferred tax assets if based on the weight of available evidence, it is more-likely-than-not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized as income or loss in the period that includes the enactment date.
 
The Company applied the provisions of ASC 740-10-50, “Accounting For Uncertainty in Income Taxes,” which provides clarification related to the process associated with accounting for uncertain tax positions recognized in our financial statements. Audit periods remain open for review until the statute of limitations has passed. The completion of review or the expiration of the statute of limitations for a given audit period could result in an adjustment to the Company’s liability for income taxes. Any such adjustment could be material to the Company’s results of operations for any given quarterly or annual period based, in part, upon the results of operations for the given period. As of September 30, 2011 and December 31, 2010, the Company had no uncertain tax positions, and will continue to evaluate for uncertain positions in the future.

Stock-based compensation

Stock-based compensation is accounted for based on the requirements of the Share-Based Payment topic of ASC Topic 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 (presumptively, the vesting period). The Financial Accounting Standards Board (“FASB”) ASC 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 vesting period of the award. Until the measurement date is reached, the total amount of compensation expense remains uncertain. The Company records 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.

Shipping costs

Shipping costs are included in selling expenses and totaled $933,465 and $1,120,177 for the nine months ended September 30, 2011 and 2010 and $262,747 and $426,753 for the three months ended September 30, 2011 and 2010, respectively.

Employee benefits

The Company’s operations and employees are all located in the PRC.  The Company makes mandatory contributions to the PRC government’s health, retirement benefit and unemployment funds in accordance with the relevant Chinese social security laws, equal to approximately 25% of salaries. The costs of these payments are charged to income in the same period as the related salary costs and are not material.

Advertising

Advertising is expensed as incurred and is included in selling, general and administrative expenses on the accompanying consolidated statements of income and comprehensive income and was not material.
 
 
12

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Research and development

Research and development costs are expensed as incurred. For the nine and three months ended September 30, 2011 and 2010, research and development costs were not material.

Foreign currency translation

The reporting currency of the Company is the U.S. dollar. The functional currency of the parent company is the U.S. dollar and the functional currency of the Company’s operating subsidiaries is the Chinese Renminbi (“RMB”). For the subsidiaries and affiliates whose functional currencies are the RMB, results of operations and cash flows are translated at average exchange rates during the period, assets and liabilities are translated at the unified exchange rate at the end of the period, and equity is translated at historical exchange rates. As a result, amounts relating to assets and liabilities reported on the statements of cash flows may not necessarily agree with the changes in the corresponding balances on the balance sheets.  Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive income.  The cumulative translation adjustment and effect of exchange rate changes on cash for the nine months ended September 30, 2011 and 2010 was $20,048 and $35,270, respectively. Transactions denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing on the transaction dates. Assets and liabilities denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing at the balance sheet date with any transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

All of the Company’s revenue transactions are transacted in the functional currency of the operating subsidiaries and affiliates. Other than for the purchase of equipment from non-Chinese suppliers, the Company does not enter into any material transaction in foreign currencies.  Transaction gains or losses have not had, and are not expected to have, a material effect on the results of operations of the Company.

Asset and liability accounts at September 30, 2011 and December 31, 2010 were translated at 6.4018 RMB to $1.00 and at 6.6118 RMB to $1.00, respectively, which were the exchange rates on the balance sheet dates. Equity accounts were stated at their historical rate. The average translation rates applied to the statements of income for the nine months ended September 30, 2011 and 2010 were 6.50601 RMB and 6.8164 RMB to $1.00, respectively.  Cash flows from the Company’s operations are calculated based upon the local currencies using the average translation rate. 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 consolidated balance sheets.

Income per share of common stock
 
ASC Topic 260 “Earnings Per Share,” requires dual presentation of basic and diluted earnings per share (“EPS”) with a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.
 
Basic net income per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted income per share is computed by dividing net income by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. Potentially dilutive common stock consist of common stock issuable upon the conversion of series A convertible preferred stock (using the if-converted method) and common stock purchase warrants (using the treasury stock method). 
 
 
13

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Income per share of common stock (continued)

The following table presents a reconciliation of basic and diluted net income per share:
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Net income available to common stockholders for basic and diluted net income per share of common stock
  $ 1,134,990     $ 2,973,590     $ 4,970,109     $ 7,943,784  
Weighted average common stock outstanding – basic
    19,976,741       18,177,405       19,370,281       17,671,530  
Effect of dilutive securities:
                               
Series A convertible preferred stock
    4,644,853       4,752,421       5,088,566       4,752,421  
Warrants
    -       2,383,153       667,526       2,480,259  
Weighted average common stock outstanding – diluted
    24,621,594       25,312,979       25,126,373       24,904,210  
Net income per common share - basic
  $ 0.06     $ 0.16     $ 0.26     $ 0.45  
Net income per common share - diluted
  $ 0.05     $ 0.12     $ 0.20     $ 0.32  

The Company's total common stock equivalents at September 30, 2011 and December 31, 2010 include the following:

   
September 30, 2011
   
December 31, 2010
 
Warrants
    2,201,582       2,524,654  
Series A convertible preferred stock
    4,458,662       5,401,756  
Total
    6,660,244       7,926,410  

Deemed preferred stock dividend

When we issue shares of convertible preferred stock at a price that is, on an “as if converted” basis, less than the market price of the underlying shares of common stock, the difference between the value of the underlying shares of common stock and the purchase price of the convertible preferred stock is treated as a deemed preferred stock dividend.  In connection with the issuance of shares of preferred stock upon exercise of warrants, as a result of board approval of the issuance of series A preferred stock instead of common stock, the Company does not record a deemed preferred stock dividend since the Company issues the equivalent number of preferred shares which are convertible into the number of common shares that would have been issued upon exercise.

Accumulated other comprehensive income
 
Comprehensive income is comprised of net income and all changes to the statements of stockholders' equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders. For the Company, comprehensive income for the nine and three months ended September 30, 2011 and 2010 included net income and unrealized gains from foreign currency translation adjustments.

 
14

 

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Related parties

Parties are considered to be related to the Company if the parties, directly or indirectly, through one or more intermediaries, control, are controlled by, or are under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of principal owners of the Company and its management and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. The Company discloses all related party transactions. All transactions shall be recorded at fair value of the goods or services exchanged. Property purchased from a related party is recorded at the cost to the related party and any payment to or on behalf of the related party in excess of the cost is reflected as a distribution to related party.

Recent accounting pronouncements

In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs,” which is not expected to have a material impact on the consolidated financial statements upon adoption.

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income.” Under the amendments in this ASU, an entity has two options for presenting its total comprehensive income: to present total comprehensive income and its components along with the components of net income in a single continuous statement, or in two separate but consecutive statements. The amendments in this ASU are required to be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The adoption of ASU No. 2011-05 will not have any material impact on the Company’s consolidated financial position and results of operations.


In September 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-08, Intangibles — Goodwill and Other (Topic 350). This Accounting Standards Update amends FASB ASC Topic 350. This amendment specifies the change in method for determining the potential impairment of goodwill. It includes examples of circumstances and events that the entity should consider in evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption does not have any material impact on the Company’s consolidated financial position and results of operations.

Accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

Proposed reverse stock split

On November 4, 2011, the Company’s board of directors approved for a one-for-five reverse split of its common stock and a reduction in the number of authorized shares of common stock from 150,000,000 to 50,000,000 and preferred stock from 60,000,000 to 30,000,000. These changes will be reflected in an amendment to the Company's certificate of incorporation and are subject to stockholder approval. The Company plans to call a special meeting of stockholders at which it will seek stockholder approval for an amendment to the Company's certificate of incorporation that effects the reverse split and the reduces the authorized capital stock. This action by the board of directors superseded previous authorization for a one-for-three reverse split. All share and per share information has not been retroactively adjusted to reflect the reverse split since the reverse stock split has not been approved by stockholders as of the filing date of this report.

 
15

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 2 – ACCOUNTS RECEIVABLE

At September 30, 2011 and December 31, 2010, accounts receivable consisted of the following:

   
September 30, 2011
   
December 31, 2010
 
Accounts receivable
  $ 10,424,038     $ 10,023,305  
Less: allowance for doubtful accounts
    (2,270,516 )     (1,815,508 )
    $ 8,153,522     $ 8,207,797  

NOTE 3 - INVENTORIES

At September 30, 2011 and December 31, 2010, inventories consisted of the following:
   
September, 2011
   
December 31, 2010
 
Raw materials
  $ 1,750,906     $ 1,573,841  
Work in process
    2,244,411       1,302,015  
Finished goods
    1,624,564       661,380  
      5,619,881       3,537,236  
Less: reserve for obsolete inventory
    (171,557 )     (166,108 )
    $ 5,448,324     $ 3,371,128  
NOTE 4 - PROPERTY AND EQUIPMENT

At September 30, 2011 and December 31, 2010, property and equipment consist of the following:

   
Useful Life
   
September 30, 2011
   
December 31, 2010
 
Office equipment and furniture
 
5 Years
    $ 187,890     $ 127,522  
Manufacturing equipment
 
5 – 10 Years
      53,583,966       42,473,873  
Vehicles
 
5 Years
      123,491       119,569  
Construction in progress
    -       1,490,189       3,837,975  
Building and building improvements
 
20 Years
      17,556,259       16,998,647  
              72,941,795       63,557,586  
Less: accumulated depreciation
            (12,814,344 )     (8,814,593 )
            $ 60,127,451     $ 54,742,993  

For the nine months ended September 30, 2011 and 2010, depreciation expense amounted to $3,651,168 and $2,145,463, of which $3,145,842 and $1,905,970 is included in cost of sales, for the nine months ended September 30, 2011 and 2011, respectively.  For the three months ended September 30, 2011 and 2010, depreciation expense amounted to $1,147,409 and $944,821, of which $1,062,878 and $866,343 is included in cost of sales, for the three months ended September 30, 2011 and 2011, respectively.

Construction in progress includes capital leased equipment which is currently being installed (see note 12). Depreciation is not taken during the period of construction or during the period of equipment.  Upon completion of the installation of equipment or any construction in progress, construction in progress balances will be classified to their respective property and equipment categories.
 
NOTE 5 – DEPOSIT ON EQUIPMENT
 
During the nine months ended September 30, 2011, the Company made cash deposit of $781,030 for deposit for manufacturing equipment. As of the date of this report, the Company has not received the equipment. At September 30, 2011 and December 31, 2010, deposit on equipment is as follows:
 
   
September 30, 2011
   
December 31, 2010
 
Deposit on equipment
  $ 781,030     $ -  
 
 
16

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 6 – LAND USE RIGHTS
 
There is no private ownership of land in China. Land is owned by the government and the government grants land use rights for specified terms.   The Company’s land use rights have terms of 45 and 50 years and expire on January 1, 2053 and October 30, 2053.  The Company amortizes the land use rights over the term of the respective land use right. For the nine months ended September 30, 2011 and 2010, amortization of land use rights amounted to $68,145 and $65,042, respectively. For the three months ended September 30, 2011 and 2010, amortization of land use rights amounted to $23,007 and $21,797, respectively. At September 30, 2011 and December 31, 2010, land use rights consist of the following:
 
 
Useful Life
 
September 30, 2011
   
December 31, 2010
 
Land use rights
45 - 50 years
  $ 4,217,688     $ 4,083,728  
Less: accumulated amortization
      (396,208 )     (316,569 )
      $ 3,821,480     $ 3,767,159  

Amortization of land use rights attributable to future periods is as follows:

Twelve-month periods ending September 30:
     
2012
  $ 92,339  
2013
    92,339  
2014
    92,339  
2015
    92,339  
2016
    92,339  
Thereafter
    3,359,785  
    $ 3,821,480  

NOTE 7 – STOCKHOLDERS’ EQUITY

(a)           Common stock issued for services

During the nine months ended September 30, 2011, the Company issued an aggregate of 7,500 shares of its common stock to a director pursuant to an amended director’s agreement. The shares are valued at the fair value on the grant date and the Company recorded stock-based compensation of $19,025.

During the nine months ended September 30, 2011, the Company issued an aggregate of 22,500 shares of its common stock to its chief financial officer pursuant to the employment agreement between the Company and the chief financial officer. The shares are valued at the fair value on the grant date and the Company recorded stock-based compensation of $57,225.

In March 2011, the Company issued an aggregate of 15,250 shares of its common stock to employees, of which 7,000 shares were granted to the Company’s chief executive officer.  None of the other shares were issued to executive officers or directors.  The shares are valued at the fair value on the grant date and the Company recorded stock-based compensation of $49,594.

On April 1, 2011, the Company issued 1,250 shares of its common stock to an employee pursuant to the engagement agreement between the Company and the employee. The shares are valued at the fair value on the grant date and the Company recorded stock-based compensation of $3,925.

On April 14, 2011, the Company issued 13,000 shares of common stock to an investor relations firm pursuant to an agreement with the firm for the twelve months beginning May 1, 2010.  The shares are valued at the fair value on the grant date. For the nine months ended September 30, 2011, the Company recorded stock-based professional fees of $37,440.
 
 
17

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 7 – STOCKHOLDERS’ EQUITY (continued)

(a)           Common stock issued for services  (continued)

On May 26, 2011, the Company issued 12,500 shares of common stock to an investor relations firm pursuant to an agreement with the firm for the twelve months beginning May 1, 2011. The shares are valued at the fair value on the grant date, and the Company recorded stock-based professional fees of $9,792 and prepaid expenses of $13,708 which will be amortized over the remaining service period.

In June 2011, the Company issued an aggregate of 78,000 shares of its common stock to employees, of which 41,000 shares were granted to the Company’s chief executive officer.  None of the other shares were issued to executive officers or directors.  The shares are valued at the fair value on the grant date and the Company recorded stock-based compensation of $95,572 and prepaid expenses of $46,868 which will be amortized during the rest of service period.

On June 29, 2011, the Company issued 4,526 shares of its common stock to a director pursuant to a director’s agreement. The shares are valued at the fair value on the grant date and the Company recorded stock-based compensation of $4,526.

In July 2011, the Company issued 3,250 shares of its common stock to its employees pursuant to the engagement agreement between the Company and their employees. The shares are valued at the fair value on the grant date and the Company recorded stock-based compensation of $2,160.

On July 7, 2011, the board of directors authorized the issuance of 8,760 shares of common stock to a director pursuant to an agreement with the director, which were issuable in two installments.  The Company issued 4,380 shares of common stock in August 2011 and recorded stock-based compensation of $3,000 and prepaid expense of $3,000 which will be amortized during the rest of service period and the remaining 4,380 shares of common stock are issuable in January.  The 8,760 shares were valued at $12,000, being the fair market value of the shares on the date of the director’s election to the board.

All of the shares issued as compensation, other than the shares issued to the chief financial officer, were issued pursuant to the Company’s long-term incentive plan.

(b) Common stock issued for preferred share conversions

In February 2011, the Company issued 312,000 shares of its common stock upon the conversion of 936,000 shares of series A convertible preferred stock (“series A preferred stock”).

In July and August 2011, the Company issued 866,667 shares of its common stock upon the conversion of 2,600,000 shares of series A preferred stock.

(c)  Common stock sold for cash

On January 18, 2011, the Company sold 35,014 shares of its common stock to its chief financial officer for $125,000, representing the market price on January 18, 2011, the date of the stock purchase agreement.

(d)  Common stock issued on exercise of warrants

In May 2011, the Company issued 41,848 shares of its common stock upon the cashless exercise of warrants.

(e)  Series A preferred stock issued upon exercise of warrants

During the period from February to April 2011, the Company issued a total of 706,715 shares of series A preferred stock upon the exercise of warrants, for which the Company received total cash proceeds of $400,000.  Each share of series A preferred stock is convertible into one-third share of common stock.
 
 
18

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 7 – STOCKHOLDERS’ EQUITY (continued)

(f)  Warrants

Warrant activity for the nine months ended September 30, 2011 is summarized as follows:

   
Nine Months Ended September 30, 2011
   
Number of Warrants
   
Weighted Average Exercise Price
 
Balance at December 31, 2010
    2,524,654     $ 1.57  
Granted
    -       -  
Exercised
    (323,072 )     1.56  
Forfeited
    -       -  
Balance at September 30, 2011
    2,201,582     $ 1.57  
Warrants exercisable at September 30, 2011
    2,201,582     $ 1.57  

The following table summarizes the shares of the Company's common stock issuable upon exercise of warrants outstanding at September 30, 2011:
Warrants Outstanding
   
Warrants Exercisable
 
Range of Exercise Price
   
Number Outstanding at September 30, 2011
   
Weighted Average Remaining Contractual Life (Years)
   
Weighted Average Exercise Price
   
Number
Exercisable at
September 30, 2011
   
Weighted Average Exercise Price
 
$ 1.698       1,649,991       1.12     $ 1.698       1,649,991     $ 1.698  
$ 1.200       551,591       1.12       1.200       551,591       1.200  
          2,201,582       1.12     $ 1.57       2,201,582     $ 1.57  

NOTE 8 – INCOME TAXES

The Company accounts for income taxes pursuant to the accounting standards that requires the recognition of deferred tax assets and liabilities for both the expected impact of differences between the financial statements and the tax basis of assets and liabilities, and for the expected future tax benefit to be derived from tax losses and tax credit carryforwards.  Additionally, the accounting standards require the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Realization of deferred tax assets, including those related to the U.S. net operating loss carryforwards, are dependent upon future earnings, if any, of which the timing and amount are uncertain.

Accordingly, the net deferred tax asset related to the U.S. net operating loss carryforward has been fully offset by a valuation allowance. The Company is governed by the Income Tax Law of the PRC and the U.S.  In 2011 and 2010, under the Income Tax Laws of PRC, Chinese companies are generally subject to an income tax at an effective rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments. The Company’s VIEs (Dyeing and Electric) and the Company’s subsidiary, Fulland Wind Energy, are subject to these statutory rates. The Company’s wholly-owned subsidiary, Fulland Limited was incorporated in the Cayman Islands. Under the current laws of the Cayman Islands, this entity is not subject to income taxes.

 
19

 

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 9 – SHORT-TERM BANK LOANS

Short-term bank loan represents an amount due to a bank that is due within one year. This loan can be renewed with the bank upon maturity. At September 30, 2011 and December 31, 2010, short-term bank loans consisted of the following:

   
September 30,
   
December 31,
 
   
2011
   
2010
 
Loan from Bank of Communications, due on February 1, 2011 with annual interest at December 31, 2010 of 4.86%, the rate being adjusted quarterly based on 120% of People’s Bank of China’s base rate and repaid on due date.
 
    -       756,224  
Loan from Agricultural and Commercial Bank, due on March 31, 2011 with annual interest at December 31, 2010 of 5.75%, secured by certain assets of the Company and repaid on due date.
 
    -       604,979  
Loan from Agricultural and Commercial Bank, due on October 30, 2011 with annual interest at September 30, 2011 and December 31, 2010 of 5.75%, secured by certain assets of the Company and repaid on due date.
    468,618       453,734  
                 
Loan from Agricultural and Commercial Bank, due on March 30, 2012 with annual interest at September 30, 2011 of 7.88%, secured by certain assets of the Company.
    624,824       -  
                 
Loan from China Merchants Bank, due on December 29, 2011 with annual interest at September 30, 2011 of 6.73%.
    468,618       -  
 
Loan from Bank of Communications, due on January 10, 2012 with annual interest being adjusted quarterly based on 120% of People’s Bank of China’s base rate
    468,618       -  
 
Loan from Bank of Communications, due on January 12, 2012 with annual interest being adjusted quarterly based on 120% of People’s Bank of China’s base rate
    312,413       -  
              -  
Total short-term bank loans
  $ 2,343,091     $ 1,814,937  

NOTE 10 – BANK ACCEPTANCE NOTES PAYABLE

Bank acceptance notes payable represents amounts due to a bank which are collateralized and typically renewed. All bank acceptance notes payable are secured by the Company’s restricted cash which is on deposit with the lender. The Company’s bank acceptance notes payables consist of the following:
   
September 30, 2011
   
December 31,
2010
 
Agricultural and Commercial Bank, non-interest bearing, due on October 12, 2011, collateralized by 100% of restricted cash deposited.
  $ 156,206     $ -  
Agricultural and Commercial Bank, non-interest bearing, due on January 15, 2012, collateralized by 100% of restricted cash deposited.
    312,412       -  
Total
  $ 468,618     $ -  
 
 
20

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011

 
NOTE 11 - SEGMENT INFORMATION

For the nine months ended September 30, 2011 and 2010, the Company operated in two reportable business segments - (1) the manufacture of dyeing and finishing equipment segment and (2) the manufacture of forged rolled rings and related components for the wind power and other industries segment, which also includes the manufacture of the Company’s solar industry products. The Company's reportable segments are strategic business units that offer different products. They are managed separately based on the fundamental differences in their operations.  All of the Company’s operations are conducted in the PRC.

Information with respect to these reportable business segments for the three and nine months ended September 30, 2011 and 2010 is as follows:
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenues:
                       
       Dyeing and finishing equipment
  $ 4,067,900     $ 5,559,091     $ 12,118,216     $ 15,776,814  
       Forged rolled rings and related components
    7,608,796       15,702,963       29,733,041       41,303,196  
      11,676,696       21,262,054       41,851,257       57,080,010  
Depreciation:
                               
       Dyeing and finishing equipment
    267,443       136,649       665,030       371,751  
       Forged rolled rings and related components
    879,966       808,172       2,986,138       1,773,712  
      1,147,409       944,821       3,651,168       2,145,463  
Interest expense:
                               
       Forged rolled rings and related components
    60,452       23,923       122,980       69,393  
       Other (a)
    -       -       -       47,943  
      60,452       23,923       122,980       117,336  
Net income (loss):
                               
       Dyeing and finishing equipment
    463,156       580,281       1,292,804       1,782,784  
       Forged rolled rings and related components
    838,628       2,580,906       4,329,039       7,068,661  
       Other (a)
    (166,794 )     (187,597 )     (651,734 )     (907,661 )
      1,134,990       2,973,590       4,970,109       7,943,784  
                             
Identifiable long-lived tangible assets by segment:
 
September 30, 2011
   
December 31, 2010
                 
       Dyeing and finishing equipment
  $ 9,892,459     $ 6,033,004                  
       Forged rolled rings and related components
    50,234,992       48,709,989                  
    $ 60,127,451     $ 54,742,993                  
                             
Identifiable long-lived tangible assets by geographical location:
 
September 30, 2011
   
December 31, 2010
                 
       China
  $ 60,127,451     $ 54,742,993                  
       United States
    -       -                  
    $ 60,127,451     $ 54,742,993                  
 
 (a)             The Company does not allocate any general and administrative expenses of its U.S. activities to its reportable segments because these activities are managed at a corporate level and not allocable to any segment.
 
 
21

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 

NOTE 12 - CAPITAL LEASE OBLIGATIONS

The Company has entered into a non-cancelable capital lease agreement with expiration date of June 3, 2014. The asset and liability under the capital lease are recorded at the lower of the present value of the minimum lease payments or the fair value of the asset. Currently, the capital leased equipment is being installed and no provision for depreciation is made on the equipment until the equipment is ready for its intended use. The asset and future obligations related to the capital lease included in the accompanying consolidated balance sheets in property and equipment and capital lease obligations, respectively.

Minimum future lease payments under the capital lease are as follows:

12-month periods ending September 30,
 
Amount
 
2012
  $ 421,143  
2013
    375,089  
2014
    230,664  
Total minimum lease payments
    1,026,896  
Less: amount representing interest
    (196,489 )
Less: security deposit due
    (168,324 )
Present value of net minimum lease payment
    662,083  
Less: current portion
    242,850  
Long-term portion
  $ 419,233  

NOTE 13 – STATUTORY RESERVES

The Company is required to make appropriations to reserve funds, comprising the statutory surplus reserve, statutory public welfare fund and discretionary surplus reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the PRC (the “PRC GAAP”). Appropriation to the statutory surplus reserve should be at least 10% of the after tax net income determined in accordance with the PRC GAAP until the reserve is equal to 50% of the entities’ registered capital or members’ equity. Appropriations to the statutory public welfare fund are at a minimum of 5% of the after tax net income determined in accordance with PRC GAAP. Commencing on January 1, 2006, the new PRC regulations waived the requirement for appropriating retained earnings to a welfare fund. Prior to December 31, 2009, the Company appropriated the required maximum 50% of its registered capital to statutory reserves for Dyeing and Electric.

For the nine months ended September 30, 2011, statutory reserve activity is as follows:

   
Dyeing
   
Electric
   
Wuxi Fulland
   
Total
 
Balance – December 31, 2010
  $ 72,407     $ 1,168,796     $ 416,994     $ 1,658,197  
Additional to statutory reserves
    -       -       386,629       386,629  
Balance –September 30, 2011
  $ 72,407     $ 1,168,796     $ 803,623     $ 2,044,826  

 
22

 

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011


NOTE 14 – CONCENTRATIONS

Customers

No customer accounted for 10% or more of the Company’s revenues during the nine months ended September 30, 2011. During the nine months ended September 30, 2010, one customer of the forged rolled rings and related components segment accounted for 10% or more of the Company’s total sales.  The following table sets forth sales to the customer.

   
Nine Months Ended September 30,
Customer
 
2011
 
2010
A
 
*
 
15%
*           Less than 10%.

Suppliers

The following table sets forth information as to each supplier that accounted for 10% or more of the Company’s purchases for the nine months ended September 30, 2011 and 2010.

   
Nine Months Ended September 30,
Supplier
 
2011
 
2010
A
 
*
 
11%
B
 
13%
 
*
C
 
*
 
15%
D
 
13%
 
21%
E
 
12%
 
*
F
 
11%
 
*
*           Less than 10%.

NOTE 15 – RESTRICTED NET ASSETS

Regulations in the PRC permit payments of dividends by the Company’s PRC VIEs only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Subject to certain cumulative limit, a statutory reserve fund requires annual appropriations of at least 10% of after-tax profit, if any, of the relevant PRC VIE’s and subsidiary. The statutory reserve funds are not distributable as cash dividends. As a result of these PRC laws and regulations, the Company’s PRC VIE’s and its subsidiary are restricted in their abilities to transfer a portion of their net assets to the Company. Foreign exchange and other regulations in PRC may further restrict the Company’s PRC VIEs and its subsidiary from transferring funds to the Company in the form of loans and/or advances.

As of September 30, 2011 and December 31, 2010, substantially all of the Company’s net assets are attributable to the PRC VIE’s and its subsidiary located in the PRC. Accordingly, the Company’s restricted net assets were approximately $69,828,000 and $62,056,000, respectively.

 
23

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 
 
NOTE 16 – SUBSEQUENT EVENTS

On October 11, 2011, the Company issued 7,500 shares of its common stock to its chief financial officer pursuant to the employment agreement between the Company and the chief financial officer. The shares are valued at the fair value on the grant date and the Company recorded stock-based compensation of $2,475.

On November 8, 2011, the Company issued 30,000 shares to a key employee.  The shares, which were issued pursuant to the Company’s long-term incentive plan, were valued at the fair market value on the date of issuance of $11,700.

On October 12, 2011, the Company renewed its loan agreement with Agricultural and Commercial Bank in the amount of $468,618. The loan is due on August 31, 2012 with interest at the annual rate of 7.872% and secured by certain assets of the Company.
 
 
24

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

We are engaged in two business segments – the forged rolled rings and related components segment, in which we manufacture and sell high precision forged rolled rings, shafts, flanges, and other forged components for the wind power and other industries as well as equipment for the solar power industry, and the dyeing and finishing equipment segment, in which we manufacture and sell textile dyeing and finishing machines.

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

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
Dollars
   
%
   
Dollars
   
%
   
Dollars
   
%
   
Dollars
   
%
 
Forged rolled rings and related  components - wind power industry
  $ 4,490       38.5 %   $ 12,425       58.4 %   $ 20,918       50.0 %   $ 28,559       50.0 %
 
Forged rolled rings  and related components- other industries
    3,119       26.7 %     3,278       15.5 %     8,815       21.0 %     12,744       22.4 %
Dyeing and finishing equipment
    4,068       34.8 %     5,559       26.1 %     12,118       29.0 %     15,777       27.6 %
Total
  $ 11,677       100.0 %   $ 21,262       100.0 %   $ 41,851       100.0 %   $ 57,080       100.0 %

Forged rolled rings and related components segment

Prior to 2009, the manufacturing of textile dyeing and finishing machines was our principal source of revenue. We have changed our focus to the manufacture of forged rolled rings, shafts, gear rims and yaw bearings in order to meet the perceived growing demands of China’s wind energy and other industries that require precision-manufactured products. 

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

·  
We produce precision forged rolled rings and other forged components to the wind and other industries.  Forged rolled rings and other forged components for the wind industry are used in wind turbines, which are used to generate wind power.  The government of the PRC continues to expand significantly its goal for installed wind energy capacity.  We also we manufacture shafts and forged rolled rings for gear rims, flanges and other applications in our 108,000 square foot manufacturing facility which became operational in March 2009. In addition to the wind industry, we sell our forged rolled rings and other forged components in other industries, including heavy machinery manufacturing, petrochemical, metallurgical, sea port machinery, defense and radar manufacturing industries, which use our forged rolled rings railway as components in the manufacture of equipment. We produce precision forgings using axial close-die forging technology, which is a new technology for producing rotary precision forgings, using forging equipment which we manufactured for our own use. The axial close-die forging technology reduces the use of raw materials by as much as 35%, provides a high precision and surface flatness, reduces the cutting output, has excellent mechanical strength and high flexibility, and is a fully automatic operation.
 
 
25

 
 
·  
In October 2009, we ordered the initial machinery to expand our completed state-of-the-art forged product facility with a new production line, enabling us to manufacture electro-slag re-melted (“ESR”) forged products for the high performance components market for various industries.  We believe that ESR forged products will be important components in the next generation of larger wind turbines, offshore wind turbines and other high performance components, which will require stronger steel alloy precision forged components than the smaller turbines.  ESR technology is used to increase the durability and quality of steel and to blend specific alloys that are required to meet the anticipated strength requirements of the next generation of wind turbines.  We delivered the initial units from this production line in July 2010 to one customer, which has been our only ESR customer through September 30, 2011. For the nine months ended September 30, 2011, we generated revenue of $1,679,325 from the sale of ESR forged products as compared to $3,111,868 for the comparable period of 2010. This customer is using our ESR products primarily in the steel manufacturing equipment and accordingly revenues from the sale of RSP products are included in forged rolled rings - other industries.  The contract with this customer has expired and we have no new orders for ESR products as of the date of this report.

·  
In 2011, we manufactured and delivered test subassemblies for solar cell manufacturing equipment, which marked our entry into the solar products market.  This equipment is being marketed and manufactured in our forged rolled rings segment. We are leveraging technical expertise to supply solar components used in production of multi crystalline and mono crystalline silicon wafers. Solar industry capabilities include the manufacture of complex pressure vessels and chamber, high temperature vessels, and thick-walled vessels. For the nine months ended September 30, 2011, we generated revenue from the sale of solar industry related products of $126,000.  We had no revenue from solar related products for the comparable period of 2010.  We currently have a backlog of solar related products of approximately $1.89 million, of which about $590,000 have been delivered subsequent to the September 30, 2011.  Our backlog for solar related products as of November 10, 2011 was approximately $1.3 million.  This backlog includes our current solar customer, sample solar customer orders and LED equipment orders.

Our forged rolled rings and other related products are sold for use by manufacturers of industrial equipment.  The demand for products used in manufacturing in general including wind power industries, is uncertain.  Although we believe that over the long term, the forged rolled rings and related components segment will expand, and the government of the PRC has announced its desire to increase the use of wind power as an energy source, in the short term other factors, such as economic factors and the fluctuations in the price of oil and coal, may affect the requirements by our customers and potential customers for our products.  To the extent that the demand for our forged rolled rings and related components declines, our revenue and net income will be affected.

Our revenue, gross margin and net income have declined significantly in the second and third quarters of 2011, following a modest increase in revenues in the first quarter. For the nine months ended September 30, 2011, our revenue declined by 26.7% from the comparable period of 2010.  For the three months ended September 30, 2011, our revenue declined 45.1% from the third quarter of 2010.  The most significant decline was for  forged rolled rings and related products for the wind power industry, which declined $7.9 million, or 63.9%, in the third quarter of 2011 from the third quarter of 2010.  However, we have seen declines in all of our product sales.  We believe that these declines reflect:
 
·  
An apparent decline in the growth rate for the wind industry, following six years of growth during which the total installed capacity doubled each year.
 
·  
Increased competition.
 
·  
The effects of a 2011 decision by the China central bank to tighten the monetary supply, which reduced the availability of bank financing for owners of wind farms who require bank loans to purchase equipment and well as potential purchasers of heavy equipment, including our dying and finishing equipment.
 
·  
Decisions by turbine manufactures to establish vertically integrated operations, then eliminating the need to purchase components from companies such as us.
 
 
26

 
 
·  
Our failure to sell our ESR forged products for the high performance components market for various industries to more than our initial customer.
 
·  
Delays by customers of our dyeing and finishing products in purchasing new equipment designed to meet stricter environmental standards imposed by the Chinese government as textile manufacturers evaluate both their projected business in uncertain economic times and new equipment designed to meet the new standards.
 
Further, although we have entered the solar market in 2011, our revenues from this industry have only been approximately $126,000 for the nine months ended September 30, 2011.

The factors that affected our revenue, gross margin and net income during the third quarter of 2011 are continuing to affect our operations during the fourth quarter.  Since our equipment is capital equipment, which generally requires financing, our ability to expand our operations and increase our revenue is largely affected by the PRC government’s policy on such matters as the availability of credit, which affects all of our operations, and its policies relating to alternative energy such as wind and solar power, which affect our products for these industries.  Our business is also affected by general economic conditions. Because of the nature of our products, our customers’ projection of future economic conditions are an integral part of their decisions as to whether to purchase capital equipment at this time or defer such purchases until a future date.
 
During the nine months ended September 30, 2011, our forging and related components segment inventory increased by approximately $1.6 million and our advances from customers increased by $727,000.  These increases are related.  This increase in inventory was attributable to a) an increase in steel inventory to secure steel pricing for anticipated forging orders, and an increase in inventory related to our solar products.  A significant portion of the inventory increase relates to products for our solar customer, for which we received advance payments.  At the request of the customer we are keeping the products in our warehouse.  This sale will be recognized when the last step of the sale, which is passing Chinese customs, is completed.  Upon the completion of the sale, the advances from this customer will be recognized as revenues and our inventory will be reduced by the products sold.

Dyeing and finishing equipment segment

In connection with our Dyeing and finishing equipment segment, despite the world economic slowdown, for the year 2009, China’s gross output value for textiles rose by 10.3% year on year to RMB 3.8 trillion (approximately $576 billion), while the amount of clothes produced increased by 6.9% year on year to 23.75 billion units, as reported by the China National Textile and Apparel Council (“CNTAC”), Ministry and Industry Information Technology. According to data posted on the CNTAC website at www.english.ctei.gov.cn, in January to June 2011, China's textile industry realized the industrial output value of RMB2,393.8 billion (approximately $374 million), increasing by 30% year over year. We believe weak overseas demand has been more than offset by strong demand within China.
 
During the nine months ended September 30, 2011, our dyeing and finishing equipment segment inventory increased by approximately $300,000 and our advances from customers increased by $1.1 million.  These increases are related.  This increase in inventory was attributable to a) an increase in steel inventory and work in process in order to fulfill current backorders, for which we received advance payments. Upon the completion of the sale, the advances from these customers will be recognized as revenues and our inventory will be reduced by the products sold.

 
27

 
 
Raw materials
 
A major element of our cost of revenues is raw materials, principally steel and other metals. These metals are subject to price fluctuations, and recently these fluctuations have been significant.  In times of increasing prices, we need to try to fix the price at which we purchase raw materials in order to avoid increases in costs which we cannot recoup through increases in sales prices.  Similarly, in times of decreasing prices, we may have purchased metals at prices which are high in terms of the price at which we can sell our products, which also can impair our margins. Four major suppliers provided approximately 49% (13%, 13%, 12% and 11%, respectively) of our purchases of raw materials for the nine months ended September 30, 2011 primarily consisting of steel for the forged rolled rings and related components 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 financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate our estimates, including those related to bad debts, inventories, recovery of long-lived assets, income taxes, and the valuation of equity transactions. We base our estimates on historical experience and on various other assumptions that we believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Any future changes to these estimates and assumptions could cause a material change to our reported amounts of revenues, expenses, assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the financial statements

Variable interest entities

Pursuant to ASC Topic 810 and related subtopics related to the consolidation of variable interest entities, we are required to include in our consolidated financial statements the financial statements of variable interest entities (“VIEs”).  The accounting standards require a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss for the VIE or is entitled to receive a majority of the VIE’s residual returns. VIEs are those entities in which we, through contractual arrangements, bear the risk of, and enjoy the rewards normally associated with ownership of the entity, and therefore we are the primary beneficiary of the entity.

The Huayang Companies are considered VIEs, and we are the primary beneficiary. On November 13, 2007, we entered into agreements with the Huayang Companies pursuant to which we shall receive 100% of the Huayang Companies’ net income. In accordance with these agreements, the Huayang Companies shall pay consulting fees equal to 100% of its net income to our wholly-owned subsidiary, Green Power, and Green Power shall supply the technology and administrative services needed to service the Huayang Companies.

The accounts of the Huayang Companies are consolidated in the accompanying financial statements. As VIEs, the Huayang Companies sales are included in our total sales, their income from operations is consolidated with ours, and our net income includes all of the Huayang Companies’ net income, and their assets and liabilities are included in our consolidated balance sheets. The VIEs do not have any non-controlling interest and, accordingly, we did not subtract any net income in calculating the net income attributable to us. Because of the contractual arrangements, we have pecuniary interest in the Huayang Companies that require consolidation of the Huayang Companies financial statements with our financial statements.

 
28

 
 
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 accurately estimating the likelihood of collection has been established, we consider a number of factors when determining reserves for uncollectable accounts.   We believe that we use a reasonably reliable methodology to estimate the collectability of our accounts receivable. We review our allowances for doubtful accounts on at least a quarterly basis. We also consider whether the historical economic conditions are comparable to current economic conditions. If the financial condition of our customers or other parties that we have business relations with were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventories

Inventories, consisting of raw materials, work-in-process and finished goods, are stated at the lower of cost or market utilizing the weighted average method. An allowance is established when management determines that certain inventories may not be saleable. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, we will record additional reserves for the difference between the cost and the market value. These reserves are recorded based on estimates.  We review inventory quantities on hand and on order and record, on a quarterly basis, a provision for excess and obsolete inventory, if necessary. If the results of the review determine that a write-down is necessary, we recognize a loss in the period in which the loss is identified, whether or not the inventory is retained. Our inventory reserves establish a new cost basis for inventory and are not reversed until we sell or dispose of the related inventory. Such provisions are established based on historical usage, adjusted for known changes in demands for such products, or the estimated forecast of product demand and production requirements.

Advances to suppliers

Advances to suppliers represent the cash paid in advance for the purchase of raw material from suppliers. The advance payments are intended to ensure preferential pricing and delivery.

Property and equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using straight-line method over the estimated useful lives of the assets. The estimated useful lives of the assets are as follows:
   
Useful Life
Building and building improvements
 
20
 
Years
Manufacturing equipment
 
5 – 10
 
Years
Office equipment and furniture
 
5
 
Years
Vehicle
 
5
 
Years
 
The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition.

Included in property and equipment is construction-in-progress which consists of factories and office buildings under construction and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use.
 
 
29

 
 
We examine the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable. We recognize an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value.

Land use rights

There is no private ownership of land in the PRC. All land in the PRC is owned by the government and cannot be sold to any individual or company. The government grants a land use right that permits the holder of the land use right to use the land for a specified period. Our land use rights were granted with a term of 45 or 50 years.  Any transfer of the land use right requires government approval.  We have recorded as an intangible asset the costs paid to acquire a land use right. The land use rights are amortized on the straight-line method over the land use right terms.

Revenue recognition

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the purchase price is fixed or determinable and collectability is reasonably assured. We account for the product sales as a multiple element arrangement. Revenue from multiple element arrangements is allocated among the separate accounting units based on the residual method. Under the residual method, the revenue is allocated to undelivered elements based on fair value of such undelivered elements and the residual amounts of revenue allocated to delivered elements. We recognize revenue from the sale of dyeing and electric equipment upon shipment and transfer of title. The other elements may include installation and generally a one-year warranty.

Equipment installation revenue is valued based on estimated service person hours to complete installation and is recognized when the labor has been completed and the equipment has been accepted by the customer, which is generally close to the date of delivery of the equipment.

Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the nine months ended September 30, 2011 and 2010, amounts allocated to warranty revenues were not material. Based on historical experience, warranty service calls and any related labor costs have been minimal.
 
All other product sales, including the forged rolled rings, with customer specific acceptance provisions, are recognized upon customer acceptance and the delivery of the parts or service. Revenues related to spare part sales are recognized upon shipment or delivery based on the trade terms.

Income taxes

We are governed by the Income Tax Law of the PRC and the United States. Income taxes are accounted for pursuant to accounting standards, which is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. The charge for taxes is based on the results for the year as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.
 
Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences, and deferred tax assets are recognized to the extent that it is probably that taxable profit will be available against which deductible temporary differences can be utilized.
 
 
30

 
 
Deferred tax is calculated using tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it is related to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity.Deferred tax assets and liabilities are offset when they related to income taxes levied by the same taxation authority and the Company intends 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. The Company records compensation expense based on the fair value of the award at the reporting date. The awards to consultants and other third-parties are then revalued, or the total compensation is recalculated based on the then current fair value, at each subsequent reporting date.

Recent accounting pronouncements

In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs,” which is not expected to have a material impact on our consolidated financial statements upon adoption.

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income.” Under the amendments in this ASU, an entity has two options for presenting its total comprehensive income: to present total comprehensive income and its components along with the components of net income in a single continuous statement, or in two separate but consecutive statements. The amendments in this ASU are required to be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. We intend to conform to the new presentation required in this ASU beginning with its Form 10-Q for the three months ended March 31, 2012.

In September 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-08, Intangibles — Goodwill and Other (Topic 350). This Accounting Standards Update amends FASB ASC Topic 350. This amendment specifies the change in method for determining the potential impairment of goodwill. It includes examples of circumstances and events that the entity should consider in evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption does not have any material impact on our consolidated financial position and results of operations.

Other accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on our consolidated financial statements upon adoption.

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.
 
 
31

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

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

RESULTS OF OPERATIONS

Comparison of Results of Operations for the Three and Nine Months ended September 30, 2011 and 2010

The following table sets forth the results of our operations for the periods indicated as a percentage of net revenues (dollars in thousands):

   
Nine Months Ended September 30,
 
   
2011
   
2010
 
   
Dollars
   
Percentage
   
Dollars
   
Percentage
 
Revenues
  $ 41,851       100.0 %   $ 57,080       100.0 %
Cost of revenues
    31,617       75.6 %     42,265       74.0 %
Gross profit
    10,234       24.4 %     14,815       26.0 %
Operating expenses
    3,279       7.8 %     3,742       6.6 %
Income from operations
    6,955       16.6 %     11,073       19.4 %
Other income (expenses)
    (35 )     (0.1 )%     (78 )     (0.1 )%
Income before provision for income taxes
    6,920       16.5 %     10,995       19.3 %
Provision for income taxes
    1,950       4.6 %     3,051       5.3 %
Net income
    4,970       11.9 %     7,944       13.9 %
Other comprehensive income:
                               
  Foreign currency translation adjustment
    2,146       5.1 %     1,125       2.0 %
Comprehensive income
  $ 7,116       17.1 %   $ 9,069       15.9 %

 
32

 
 
   
Three Months Ended September 30,
 
   
2011
   
2010
 
   
Dollars
   
Percentage
   
Dollars
   
Percentage
 
Revenues
  $ 11,677       100.0 %   $ 21,262       100.0 %
Cost of revenues
    9,046       77.5 %     15,841       74.5 %
Gross profit
    2,631       22.5 %     5,421       25.5 %
Operating expenses
    998       8.5 %     1,285       6.0 %
Income from operations
    1,633       14.0 %     4,136       19.5 %
Other income (expenses)
    (48 )     (0.4 )%     (29 )     (0.1 )%
Income before provision for income taxes
    1,585       13.6 %     4,107       19.3 %
Provision for income taxes
    450       3.9 %     1,134       5.3 %
Net income
    1,135       9.7 %     2,973       14.0 %
Other comprehensive income:
                               
  Foreign currency translation adjustment
    655       5.6 %     909       4.3 %
Comprehensive income
  $ 1,790       15.3 %   $ 3,882       18.3 %

The following table sets forth information as to the gross margin for our two business segments for the nine months ended September 30, 2011 and 2010 (dollars in thousands).

   
Forged rolled rings and related products
   
Dyeing and finishing equipment
   
Total
   
Forged rolled rings and related products
   
Dyeing and finishing equipment
   
Total
 
   
Nine Months Ended September 30, 2011
   
Nine Months Ended September 30, 2010
 
Revenues
  $ 29,733     $ 12,118     $ 41,851     $ 41,303     $ 15,777     $ 57,080  
Cost of revenues
  $ 22,097     $ 9,520     $ 31,617     $ 29,767     $ 12,498     $ 42,265  
Gross profit
  $ 7,636     $ 2,598     $ 10,234     $ 11,536     $ 3,279     $ 14,815  
Gross margin %
    25.7 %     21.4 %     24.4 %     27.9 %     20.8 %     26.0 %

The following table sets forth information as to the gross margin for our two business segments for the three months ended September 30, 2011 and 2010 (dollars in thousands).
   
Forged rolled rings and related products
   
Dyeing and finishing equipment
   
Total
   
Forged rolled rings and related products
   
Dyeing and finishing equipment
   
Total
 
   
Three Months Ended September 30, 2011
   
Three Months Ended September 30, 2010
 
Revenues
  $ 7,610     $ 4,067     $ 11,677     $ 15,703     $ 5,559     $ 21,262  
Cost of revenues
  $ 5,875     $ 3,171     $ 9,046     $ 11,471     $ 4,370     $ 15,841  
Gross profit
  $ 1,735     $ 896     $ 2,631     $ 4,232     $ 1,189     $ 5,421  
Gross margin %
    22.8 %     22.0 %     22.5 %     27.0 %     21.4 %     25.5 %

 
33

 

Revenues.

For the nine months ended September 30, 2011, we had revenues of $41,851,000, as compared to revenues of $57,080,000 for the nine months ended September 30, 2010, a decrease of approximately 26.7%. For the three months ended September 30, 2011, we had revenues of $11,677,000, as compared to revenues of $21,262,000 for the three months ended September 30, 2010, a decrease of approximately 45.1%. The decrease in revenue was attributable to the decrease in revenue from both our forged rolled rings and related products segment and dyeing and finishing equipment segment, and is summarized as follows (dollars in thousands):

   
For the Nine Months Ended September 30, 2011
   
For the Nine Months Ended September30, 2010
   
Increase
(Decrease)
   
Percentage Change
 
Forged rolled rings and related products - wind power industry
  $ 20,918     $ 28,559     $ (7,641 )     (26.8 )%
Forged rolled rings and related products – other industries
    8,815       12,744       (3,929 )     (30.8 )%
Dyeing and finishing equipment
    12,118       15,777       (3,659 )     (23.2 )%
  Total net revenues
  $ 41,851     $ 57,080     $ (15,229 )     (26.7 )%

   
For the Three Months Ended September 30, 2011
   
For the Three Months Ended September 30, 2010
   
Increase
(Decrease)
   
Percentage Change
 
Forged rolled rings and related products - wind power industry
  $ 4,490