Item 1. Business
OUR BUSINESS
Overview
We are a holding company whose primary business operations are conducted through our wholly-owned subsidiaries BVI-ACM and China-ACMH, and our variable interest entity XinAo. The Company engages in the production of advanced construction materials for large scale infrastructure, commercial and residential developments. The Company is primarily focused on engineering, producing, servicing, delivering and pumping a comprehensive range of advanced ready-mix concrete materials for highly technical, large scale, and environmentally-friendly construction projects. Ready-mixed concrete products are important building materials that are used in a vast majority of commercial, residential and public works construction projects. We are committed to conducting our operations with an emphasis on the extensive use of recycled waste materials, extending product life, the efficient production of our concrete materials with minimal energy usage, dust and air pollution, and innovative products, methods and practices.
During the year ended June 30, 2013, we supplied materials and provided services to our customers through our network of ready-mixed concrete plants in Beijing (two as of June 30, 2013) and our portable plants (three as of June 30, 2013) in Anhui province. We own one concrete plant and its related equipment, and we lease one additional plant in Beijing. Our manufacturing services are used primarily for our national high speed railway projects; almost all of our general contract contractors on the high speed railway projects supply the needed raw materials, which results in higher gross margins for us and reduces our upfront capital investments needed to purchase raw materials. We also produce ready-mix concrete at portable plants, which can be dismantled and moved to new sites for new projects. Our management believes that we may have the ability to capture a greater share of the Beijing market and further expand our footprint in China via expanding relationships and networking, signing new contracts, and continually developing market-leading innovative and eco-friendly ready-mix concrete products.
According to the Investment Research Institute of China’s State Development and Reform Commission, during the 12th Five year plan (FYP), which runs from 2011 to 2015, the Chinese government will invest $460 billion (RMB3.05 trillion) in rural infrastructure.
Our Corporate Structure
We own all of the issued and outstanding capital stock of XinAo Construction Materials, Inc., or BVI-ACM, a British Virgin Islands corporation, which in turn owns 100% of the outstanding capital stock of Beijing Ao Hang Construction Materials Technology Co., Ltd., or China-ACMH, a company incorporated under the laws of China. On November 28, 2007, China-ACMH entered into a series of contractual agreements with Beijing XinAo Concrete Group Co., Ltd., or XinAo, a company incorporated under the laws of China, and its two shareholders, in which China-ACMH effectively took over management of the business activities of XinAo and has the right to appoint all executives and senior management and the members of the board of directors of XinAo. The contractual arrangements are comprised of a series of agreements, including an Exclusive Technical Consulting and Services Agreement and an Operating Agreement, through which China-ACMH has the right to advise, consult, manage and operate XinAo for an annual fee in the amount of XinAo’s yearly net profits after tax. Additionally, XinAo’s shareholders have pledged their rights, titles and equity interest in XinAo as security for China-ACMH to collect technical consulting and services fees provided to China-ACMH through an Equity Pledge Agreement. In order to further reinforce China-ACMH’s rights to control and operate XinAo, XinAo’s shareholders have granted China-ACMH the exclusive right and option to acquire all of their equity interests in XinAo through an Option Agreement.
The following chart reflects our organizational structure as of the date of this report.
Our Corporate History
China Advanced Construction Materials Group, Inc. was founded as an unincorporated business on September 1, 2005, under the name TJS Wood Flooring, Inc., and became a C corporation in the State of Delaware on February 15, 2007. On April 29, 2008, we changed our name to China Advanced Construction Materials Group, Inc. in connection with a reverse acquisition transaction with BVI-ACM as described below.
On April 29, 2008, we completed a reverse acquisition transaction with BVI-ACM whereby we issued to the stockholders of BVI-ACM 8,809,583 shares of our common stock in exchange for all of the issued and outstanding capital stock of BVI-ACM. BVI-ACM thereby became our wholly owned subsidiary and the former stockholders of BVI-ACM became our controlling stockholders.
On August 1, 2013, we consummated a reincorporation merger pursuant to which we merged with and into our wholly-owned subsidiary, China Advanced Construction Materials Group, Inc., a newly formed Nevada corporation and the surviving entity in the merger, pursuant to the terms and conditions of an Agreement and Plan of Merger entered into as of August 1, 2013. As a result of the reincorporation the Company is now governed by the laws of the state of Nevada.
Background and History of BVI-ACM and China-ACMH
BVI-ACM was established on October 9, 2007, under the laws of British Virgin Islands. The majority shareholders of BVI-ACM are Chinese citizens who own 100% of XinAo, a limited liability company formed under laws of China. BVI-ACM was established as a “special purpose vehicle” for foreign fund raising for XinAo. China State Administration of Foreign Exchange, or SAFE, requires the owners of any Chinese companies to obtain SAFE’s approval before establishing any offshore holding company structure for foreign financing as well as subsequent acquisition matters. On September 29, 2007, BVI-ACM was approved by local Chinese SAFE as a “special purpose vehicle” offshore company.
On November 23, 2007, BVI-ACM established a subsidiary, China-ACMH, in China as a wholly owned foreign limited liability company with registered capital of $5 million. Through China-ACMH and its variable interest entity XinAo, we are engaged in producing general ready-mixed concrete, customized mechanical refining concrete, and some other concrete-related products which are mainly sold in China. On September 20, 2010, China ACM established a 100% owned subsidiary, Advanced Investment Holdings Co., Inc., or AIH, in the State of Nevada. AIH never engaged in operations and the Company subsequently dissolved AIH on August 30, 2011.
In March and April 2010, XinAo established five 100% owned subsidiaries in China: Beijing Heng Yuan ZhengKe Technical Consulting Co., Ltd (“Heng Yuan ZhengKe”), Beijing Hong Sheng An Construction Materials Co., Ltd (“Hong Sheng An”), Beijing Heng Tai Hong Sheng Construction Materials Co., Ltd (“Heng Tai”), Da Tong Ao Hang Wei Ye Machinery and Equipment Rental Co., Ltd (“Da Tong”) and Luan Xian HengXin Technology Co., Ltd (“Luan Xian HengXin”). Total registered capital for these five subsidiaries is approximately $2.1 million (RMB 14 million) and none of these XinAo subsidiaries had actual operation as of June 30, 2013. The purpose of these subsidiaries is to support the Company’s future growth.
Business Segment Information
During the year ended June 30, 2013, our operations were comprised of two reportable segments: selling concrete and manufacturing concrete.
For financial information relating to our business segments, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 18 of the Consolidated Financial Statements appearing elsewhere in this annual report.
Concrete Sales Business
Our concrete sales business segment is comprised of the formulation, production and delivery of the Company’s line of C10-C100 concrete mixtures primarily through our current fixed plant network of two ready mix concrete batching plants in Beijing. The ready-mixed concrete sales business engages principally in the formulation, preparation and delivery of ready-mixed concrete to the job sites of our customers. For this segment of our business, we procure all of our own raw materials, mix them according to our measured mixing formula, ship the final product in mounted transit mixers to the destination work site, and, for more sophisticated structures, will pump the mixture and set it into structural frame molds as per structural design parameters. The process of delivering and setting the ready mix concrete mixture cannot exceed 90 minutes due to the chemistry of the concrete mixture which hardens thereafter. The deliverable radius of a concrete mixture from any one of our two ready mix plants in Beijing is approximately 25 kilometers. Traffic conditions are considerations which affect the timing and shipment of our concrete mixtures. Since the 2008 Olympics, there are alternating license plate traffic restrictions on many traffic routes in Beijing to ease traffic congestion and associated exhaust pollution. Due to the large amounts of working capital required for the acquisition of raw materials associated for this business segment, a supply shortage or degradation of supplier accounts payable credit terms would pose a potential risk to our business.
Our principal market, Beijing, has enjoyed stronger economic growth and a higher demand for construction than other regions of China. As a result, we believe that competitors will try to expand their sales and build up their distribution networks in our principal market. We anticipate that this trend will continue and likely accelerate. Increased competition may have a material adverse effect on our financial condition and results of operations.
Manufacturing Services Business
Our manufacturing services business segment is comprised of the formulation, production and delivery of project-specific concrete mixtures primarily through our current portable plant network of 4.5 rapid assembly and deployment batching plants, located in An’hui province. In this segment, we provide services intended to reduce our customers’ overall construction costs by lowering the installed, or “in-place,” cost of concrete. These services include the formulation of mixtures for specific design uses, on-site and lab-based product quality control, and customized delivery programs to meet our customers’ needs. Our clients will purchase and provide the raw materials in volume on a separate account which we will then proportion and mix according to our formulation for a given project’s specifications. At present, our manufacturing services business segment is primarily dedicated to various high-speed rail projects in China which demand very high quality standards on a time sensitive work schedule. Our high speed rail clients are primarily state-owned conglomerate construction contractors whose business practices follow closely with government policy.
Our ready-mixed concrete plants consist of fixed and portable facilities that produce ready-mixed concrete in batches. Our fixed-plant facilities produce ready-mixed concrete that we transport to job sites by mixer trucks. Our portable plant operations deploy to produce ready-mixed concrete at the job site that we direct into place using a series of conveyors. We use our portable plants to service high-volume projects or projects in remote locations.
Any future decisions we make regarding the construction of additional plants will be impacted by market factors, including the expected production demand for the plant, the expected types of projects the plant will service, and the desired location of the plant.
Mixer trucks slowly rotate their loads en route to job sites in order to maintain product consistency. Our central dispatch system, where available, tracks the status of each mixer truck as to the whereabouts of a particular truck, whether the truck is en route to a particular job site.
Our Industry
Our Industry was influenced by the decline in the macro economy in recent periods. The concrete products industry experienced a slowdown in industry production and economic growth since September 2011. In 2012 and 2013, the slowdown in the industry became more obvious month by month, with profit generally being squeezed by the greater pressure to maintain stable level of production and operation.
China averaged annual GDP growth exceeding 10% over the past 30 years. China has become the world’s second largest economy, both in nominal GDP and purchasing power parity terms, after the United States. In line with this macroeconomic growth the Chinese construction and building material industry has grown tremendously. China uses half of the world’s concrete output and one third of its steel output in construction according to an article in China Orbit published in January 2011. The Chinese market, however, faces some uncertainty going forward in the face of projects initiated under the 2008-2009 Government stimulus package which are coming to an end, macro-economic credit tightening measures by the Government to combat inflation, suspended approval of new high speed railway construction projects by the State Planning Commission and the Ministry of Rail, and increasing industry consolidation pressure for more energy efficient, environmentally conscious and quality consistent cement and concrete.
China is already among the world’s largest construction materials producers, ranking first in the world’s annual output of cement, flat glass, building ceramic and ceramic sanitary ware. The construction materials market includes all manufacturers of sand, gravel, aggregates, cement, concrete and bricks. The market does not include other finished or semi-finished building materials. The performance of the market is forecast to decelerate, with an anticipated CAGR of 6.4% for the five year period 2010-2015, which is still expected to drive the market to a value of $335.5 billion by the end of 2015.
According to Nomura Research, in order to meet a possibly higher energy-saving target during 12th FYP period, China has given high priority to industry consolidation to curb capacities and energy consumption. According to one news report (Source: China Cement Net, Cement Industry Restructuring Set to Start, Sept 13, 2010), China aims to increase the market share of the Top 10 cement producers from 25% (as of 2009) to above 35% by 2015, the end of the 12th FYP period, in terms of cement capacity. The government has a two pronged approach to industry consolidation: phasing out outdated capacity and encouraging merger and acquisition activity in the industry.
On August 9, 2010, China announced that it was closing down 19 metric tons (mt) of outdated cement capacity and 88.3mt of outdated clinker capacity, impacting a total of 762 cement producers across the country. In addition, it was reported that China will eliminate all of its outdated capacity by end of the 12th FYP period. (Source: China Cement Net, Cement Industry Restructuring Set to Start, September 13, 2010). On the other hand, China has issued various policies to encourage industry consolidation since 2005, and the latest one, entitiled “Advice to Promote Company M&A and Industry Restructuring” by China’s State Council on September 6, 2010, stipulates that the government will remove rules that limit cross-regional mergers and acquisitions and that local governments may sign agreements on splitting revenue from companies formed through cross-regional mergers and acquisitions, which removes the biggest obstacle for cross-region mergers and acquisitions. Nomura Research expects industry mergers and acquisitions to speed up in the next few years driven by both governments’ efforts and cement producers’ growth needs.
Construction Demand in China
China’s gross national construction output is expected to increase by 15% during the country’s 12th FYP period (2011-2015), according to a statement from China’s Ministry of Housing and Urban-Rural Development of China on August 18, 2011. During the same period consumption of C60 concrete in China is also expected to increase by 10%.
According to the Summary of Construction Outlook in China (the “Summary”), published in August 6, 2013 by the Freedonia Group, an industry research firm, construction expenditures in China are expected to increase 8.5 percent per year in real terms through 2017. Ongoing urbanization and industrialization, rising income levels, further population and household growth, and the government’s continuing efforts to expand and upgrade physical infrastructure in the country will support healthy growth in construction spending.
Construction expenditures in China are nearly equally split among residential buildings, nonresidential buildings, and nonbuilding structures. Each of these segments accounted for around one-third of the total construction market in 2012. Nonbuilding construction will see the fastest growth (in real terms) through 2017. Our industry will benefit from stated efforts to expand and upgrade the country’s transportation infrastructure, such as the “7918” highways network, subway systems in major cities, and several airports. Utilities construction will also contribute to nonbuilding construction spending gains, particularly in fast growing urban areas, as the government continues to expand and improve access to such infrastructure as water supply, sewage treatment, rubbish disposal, and gas distribution. Further efforts to increase the country’s power generation capacity and improve electricity transmission networks will also drive spending on nonbuilding construction.
China’s Cement & Concrete Demand
According to the Summary, demand for cement in China is forecast to rise 6.0% annually through 2012 to 1.8 billion mt. Growth will be driven by rising, but decelerating, construction expenditures in China. Further advances in cement manufacturing technology are also expected to help stimulate sales by improving the quality of the product, reflecting the versatility of these types across a range of construction applications, as well as their performance and/or price benefits over other types of cement. Regional cement markets reflect differences in construction expenditures, which in turn are driven by local trends in demographics, industrial output and economic activity. The cement markets in Northwest and Southwest China are expected to grow at a faster pace, as a result of the government’s Great Western Development strategy, which aims to promote investment in these areas. Consumption of cement in Central and Northern China is also expected to perform above the national average, supported by high levels of transportation infrastructure construction and booming urban markets in Beijing and Tianjin. (Summary of the Freedonia Group's January 2009 "Cement in China" report, from Business Wire).
Residential and non-residential buildings in China are increasingly requiring much more concrete due to, among other reasons, the short supply of wood. China is currently the largest consumption market of cement worldwide at over $200 billion annually. At the present rate, it is presumed that China will continue to be an important player in the global construction materials marketplace for at least the next two decades.
Demand for Ready-Mixed Concrete
Construction contractors are expected to continue to represent the largest market for cement. Economic downturns or reductions in government funding of infrastructure projects could significantly reduce our revenues. However, we believe that the ready-mix concrete market could exhibit the strongest growth in the cement industry. Gains are expected to benefit from government regulations banning on-site concrete and mortar mixing. Demand for cement used in concrete products is expected to be driven by the increasing popularity of precast concrete with many construction contractors. In addition, the phase-out of clay bricks will heighten demand for concrete blocks. Recognizing the significant environmental impact created from the large-scale construction activities undertaken in the past few decades, China’s government implemented Decree #341 in 2004 which bans onsite concrete production in over 200 major cities across China in order to reduce environmental damage from onsite cement mixing and improve the quality of concrete used in construction.
Our Competitive Strengths
Ready-mixed concrete is a highly versatile construction material that results from combining coarse and fine aggregates, such as gravel, crushed stone and sand, with water, various chemical admixtures and cement. We manufacture ready-mixed concrete in variations, which in each instance may reflect a specific design use. We generally maintain inventory of raw materials for a short period of time to coordinate our daily materials purchases with the time-sensitive delivery requirements of our customers.
The quality of ready-mixed concrete is time-sensitive as it becomes difficult to place within hours after mixing. Consequently, the market for a permanently installed ready-mixed concrete plant is usually limited to an area within certain radius of such plant’s location. We produce ready-mixed concrete in batches at our plants and use mixer and other trucks to complete the production process, distribute and deliver the concrete to the job sites of our customers.
Concrete has many attributes that make it a highly versatile construction material. In recent years, industry participants have developed various uses for concrete products.
We generally obtain contracts through local sales and marketing efforts directed at concrete sub-contractors, general contractors, property owners and developers, governmental agencies and home builders.
Our competition includes a number of state-owned and large private PRC-based manufacturers and distributors that produce and sell products similar to ours. We compete primarily on the basis of quality, technological innovation and price. Essentially all of the contracts on which we bid are awarded through a competitive bid process, with awards often being made to the lowest bidder, though other factors such as shorter schedules or prior experience with the customer are often just as important. Within our markets, we compete with many national, regional and local state-owned and private construction firms some of which have achieved greater market penetration or have greater financial and other resources than us. In addition, there are a number of larger national companies in our industry that could potentially establish a presence in our markets and compete with us for contracts. If we are unable to compete successfully in our markets, our relative market share and profits could be reduced.
We believe that the following competitive strengths enable us to compete effectively and to capitalize on the remaining growth potential of the market for construction materials in China:
• Large Scale Contractor Relationships. We have contracts with major construction contractors which are constructing key infrastructure, commercial and residential projects. Our sales efforts focus on large-scale projects and large customers which place large recurring orders and present less credit risk to us. For the year ended June 30, 2013, five customers accounted for approximately 22% of the Company’s sales and 8.15% of the Company’s account receivables as of June 30, 2013.
Should we lose these customers in the future and are unable to obtain additional customers, our revenues will suffer.
• Experienced Management. Management’s technical knowledge and business relationships gives us the ability to secure major infrastructure projects, which provides us with leverage to acquire less sophisticated operators, increase production volumes, and implement quality standards and environmentally sensitive policies. If there is any significant turnover in our senior management, it could significantly deplete the institutional knowledge held by our existing senior management team.
• Innovation Efforts. We strive to produce the most technically and scientifically advanced products for our customers and maintain close relationships with Tsinghua University, Xi’an University of Architecture and Technology and Beijing DongfangJianyu Institute of Concrete Science &Technology which assist us with our research and development activities. During our five year agreement with the Institute, we have realized an advantage over many of our competitors by gaining access to a wide array of resources and knowledge. In the year ended June 30, 2013, $2.3 million was paid under the agreement to the Institute. The Company incurred research & development expenses of approximately $2.2 million and $2.9 million for the years ended June 30, 2013 and 2012, respectively.
Our Growth Strategy
We are committed to enhancing profitability and cash flows through the following strategies:
• Focusing on High Capacity Utilization. We intend to focus on achieving high capacity utilization in order to operate our plants efficiently, by increasing capacity utilization at existing plants or expanding capacity by building new plants to meet existing contracts and anticipated increase in demand and by retiring under-utilized plants in the face of reduced demand. We increased capacity utilization at our four Beijing-based concrete plants significantly in fiscal 2011 when demand was increasing. During fiscal 2012 we retired ten portable stations in view of lower anticipated demand. We may begin to selectively sell or retire portable plant assets in fiscal year 2013 based on slowing demand for railway construction in connection with the suspension of new and ongoing high speed railway projects stemming from a changing policy announced by China’s Ministry of Rail and State Planning Commission.
• Mergers and Acquisitions. When capital permits, we intend to capitalize on the challenges that smaller companies are encountering in our industry by acquiring complementary companies at favorable prices. We believe that buying rather than building capacity is an option that may be attractive to us if replacement costs are higher than purchase prices. We continue to look into acquiring smaller concrete manufacturers in China as part of our expansion plans. We have not identified specified targets or entered into any Letters-of-Intent at this time.
• Vertical Integration. When capital permits, we plan to acquire smaller companies within the construction industry, develop more material recycling centers, and hire additional highly qualified employees. In order to accomplish this, we may be required to offer additional equity or debt securities. Certain of the companies we may seek to acquire are suppliers of the raw materials we purchase to manufacture our products. If we do acquire such companies we will have greater control over our raw material costs.
• Supply Chain Efficiencies and Scale. We intend to streamline our supply chain process and leverage our economies of scale.
• New Product Offering. We plan to produce a lightweight aggregate concrete for use in projects and to expand product offerings to include pre-cast concrete.
Our Operations
We provide materials and services through our network of ready-mixed concrete plants in Beijing (two as of June 30, 2013) and portable plants (three as of June 30, 2013) located in Anhui province. We own one concrete plant and its related equipment, and we lease one additional plant in Beijing.
Our manufacturing services are used primarily for our national high speed railway projects; almost all of our general contract contractors on the high speed railway projects supply the needed raw materials, which results in higher gross margins for us and reduces our upfront capital investments needed to purchase raw materials.
We also produce ready-mix concrete at portable plants, which can be dismantled and moved to new sites for new projects in less than a few weeks. The plants are currently located between railway stations and each of these plants is directly tied to contracts we have recently won and are expected to operate near capacity. Almost all of our general contractors supply raw materials for the projects, which results in higher gross margins for the Company and reduces our upfront capital investment on raw material purchases. The one time start-up cost for each portable plant and associated equipment is approximately $3 million, with cost optimization initiatives underway to bring the average cost down below $2.5 million per plant. Each plant is capable of generating approximately $2 million in revenue per year.
Products and Services
As architectural designs have become more complex, challenging, and modern in scope, the need for technology driven companies to provide high-end specialty concrete mixtures has been rapidly accelerating. Increasing demand for state-of-the-art cement mixtures has spurred our technological innovation and our ability to provide advanced mixtures of building materials that meet project specific engineering and environmental specifications. We produce a range of C10 to C100 concrete materials and specialize in an array of specialized ready-mixed concretes tailored to each project’s technical specifications and environmental standards. Our High Speed Rail clients require our concrete products be held to 100 year strength and survivability standard as tested by the local Ministry of Construction authority.
We specialize in “ready-mixed concrete”, a concrete mixture made at our facility with complete computerized operating systems. Such concrete accounts for nearly three-fourths of all concrete produced. Ready-mixed concrete is mixed on demand and is shipped to worksites by concrete mixer trucks.
Our ready-mixed concrete products consist of proportioned mixes we prepare and deliver in an unhardened plastic state for placement and shaping into designed forms at the job site. Selecting the optimum mix for a job entails determining not only the ingredients that will produce the desired permeability, strength, appearance and other properties of the concrete after it has hardened and cured, but also the ingredients necessary to achieve a workable consistency considering the weather and other conditions at the job site. We believe we can achieve product differentiation for the mixes we offer because of the variety of mixes we can produce, our volume production capacity and our scheduling, delivery and placement reliability.
We produce ready-mixed concrete by combining the desired type of cement, other cementitious materials and gravel and crushed stone with water and, typically, one or more admixtures. These admixtures, such as chemicals, minerals and fibers, determine the usefulness of the product for particular applications.
We use a variety of chemical admixtures to relieve internal pressure and increase resistance to cracking in subfreezing weather, retard the hardening process to make concrete more workable in hot weather, strengthen concrete by reducing its water content, accelerate the hardening process and reduce the time required for curing, and facilitate the placement of concrete having low water content.
We frequently use various mineral admixtures as supplements to cement, which we refer to as cementitious materials, to alter the permeability, strength and other properties of concrete.
The ready-mixed concrete sector in the concrete market is growing at a fast rate, largely due to the Chinese government’s implementation of Decree #341 in 2004. This law bans on-site concrete production in over 200 cities across China, with the goal of reducing environmental damages from onsite concrete mixing and improving the quality of concrete used in construction. The use of ready-mix concrete minimizes worksite noise, dirt and congestion, and most additives used in ready-mix concrete are environmentally safe. Our goal is to continue to use at least 30% recyclable components in our concrete mixtures.
We are building a comprehensive product portfolio that serves the diverse needs of our developing customer base and its unique construction and infrastructure projects. While we mainly specialize in ready-mix concrete formulations from controlled low-strength material to high-strength concrete, each specifically formulated to meet the individual needs of each project. We provide both industry standard and highly innovative products, including:
Our Customers
For the fiscal year ended June 30, 2013, we had no customer, whose sales accounted for more than 10% of our total sales. Five customers accounted for approximately 22% and 11% of the Company’s sales for the years ended June 30, 2013 and 2012, respectively. The total accounts receivable from these customers amounted to approximately $7.8 million and $9.2 million as of June 30, 2013 and 2012, respectively.
Developing New Relationships
Our business will be damaged if project contracts with the Chinese government, for which we may act as a subcontractor are cancelled. Our sales strategy balances these risks focusing on building new long-term cooperative relationships with some of China’s top construction companies in order to benefit from their reputations and to enter new markets. Our sales representatives are actively building relationships with the Chinese government, general contractors, architects, engineers, and other potential sources of new business in our target markets. Our sales efforts are further supported by our executive officers and engineering personnel, who have substantial experience in the design, formulation and implementation of advanced construction and concrete materials projects.
Our Suppliers
We rely on third party suppliers of the raw materials to manufacture our products. Our top five suppliers accounted for approximately 27% and 12% of the Company’s purchases for the years ended June 30, 2013 and 2012, respectively. The total accounts payable to these suppliers amounted to approximately $5.5 million and $7.3 million as of June 30, 2013 and 2012, respectively.
Sales and Marketing
General contractors typically select their suppliers of ready-mixed concrete and precast concrete. In large, complex projects, an engineering firm or division within a state transportation or public works department may influence the purchasing decision, particularly if the concrete has complicated design specifications. In connection with large, complex projects and in government-funded projects generally, the general contractor or project engineer usually awards supply orders on the basis of either direct negotiation or a competitive bidding process. Our marketing efforts target general contractors, developers, design engineers, architects and homebuilders whose focus extends beyond the price of our product to quality, consistency and reducing the in-place cost.
Our marketing efforts are geared towards advancing China-ACMH as the supplier of choice for building China’s most modern and challenging projects. The Company is constantly seeking ways to raise its profile and leverage additional publicity. To this end, the Company plans to expand its presence at leading construction industry events and in periodicals to build on its successful reputation. The primary goal when expanding into new markets is to reinforce the sales effort by promoting positive testimonials and success stories from the Company’s strong base of high profile clients and projects. Our marketing and sales strategy emphasizes the sale of value-added products and solutions to customers.
Research and Development
Construction materials companies are under extreme pressure to respond quickly to industry demands with new designs and product innovations that support rapidly changing technical demand and regulatory requirements. We devote a substantial amount of attention to the research and development of advanced construction materials that meet the demands of project specific needs while striving to lead the industry in value, materials and processes. We have sophisticated in house R&D and testing facilities, a highly technical onsite team, access to highly specialized market research, cooperation with a leading research institution, experienced management and advisory board, and close relationships with leading concrete materials experts. Our research and development expense was approximately $2.2 million in the year ended June 30, 2013, as compared to $2.9 million for the year ended June 30, 2012.
University Relationships & Cooperation Agreements
We have strong relationships with Tsinghua University and the Xi’an University of Architecture and Technology. We signed a ten-year cooperation agreement with Xi’an University on June 10, 2007. Xi’an University is a top university in the fields of building and material science research and education and works with the Company to follow the advancements of the cement and concrete industries globally.
Beijing Concrete Institute Partnership
The Beijing DongfangJianyu Institute of Concrete Science & Technology, or Beijing Concrete Institute, has 40 employees, with five senior research fellows, and 15 mid-level researchers. The Institute and its staff have participated and collaborated with national and local government agencies to establish the following industry standards:
Specification For Mix Proportion Design of Ordinary Concrete JGJ55-2000
Code for Acceptance of Constructional Quality Of Concrete Structures GB 50204-2002
Applied Technical Specification of Mineral Admixtures In Concrete DBJ/T01-64-2002
Ready-Mixed Concrete GB/T 14902-2003
Practice Code for Application of Ready-Mixed Mortar DBJ 01-99-2005
Management Specification of Quality for Ready-Mixed Concrete
Technical Requirement for Environmental Labeling Products Ready-Mixed Concrete HJ/T412-2007
We have a close association with the Beijing Concrete Institute and have been able to incorporate many of these research findings into our operations, products, and procedures. We work closely with the institute and, in return for sponsoring multiple research initiatives, have been granted exclusive work space for the development of the materials used for our existing plants’ regional projects.
We are able to use the Research Findings & Technical Publication and Procedures of the Beijing Concrete Institute in our business, which provides us with an advantage over many of our competitors. Because of our five year exclusive contract with the institute, our competitors are unable to benefit from the same findings for commercial use. Some of these findings include:
Research on Compound Admixture HPC; 3rd Class Award for China Building Materials Science& Technology Progress.
Research and Application of C100 HPC; 3rd Class Award for Beijing Science & Technology Progress.
Research on pumping Light Aggregate Concrete; Innovation Award for China Building Materials Science& Technology.
Research and Application of Green (nontoxic) HPC; First Prize for Beijing Science & Technology Progress.
Construction Technology of HPC for the Capital International Airport
Research on Production and Construction Technology of Phase Change Energy-saving Thermostat Concrete and Mortar
Polycarboxylate Series High Performance Water Reducing Agent Compositing Technique
State Swimming Center for Concrete Cracking Control Technology
In addition, we are able to collaborate closely with the institute and its executives who play a strong role recommending industry standards, advising on major infrastructure developments, and creating and maintaining strong connections with leading developers, construction companies, and governmental officials.
Successful Innovations
Some of our more advanced products and processes developed through our relationships with research institutes and universities include:
C100 High Performance Concrete
High Strength Concrete is often defined as concrete with a compressive strength greater than 6000 psi (41 MPa). The primary difference between high-strength concrete and normal-strength concrete relates to the compressive strength that refers to the maximum resistance of a concrete sample to applied pressure. Manufacturing high-strength concrete involves making optimal use of the basic ingredients that constitute normal-strength concrete.
Through our collaborative efforts, we have developed a high performance concrete which can be produced at an impermeable grade above P35, and can be used as self-waterproofing concrete for structural engineering, as the water-cement (W/C) ratio and carbonized shrinking is minimal and the structure is close-grained.
Only a limited number of firms in the Beijing area have the expertise to produce C100 High Performance Concrete.
Compound Admixture Concrete
This compound mineral mixture is a composite of coal powder, mineral powder and mineral activators blended to specific proportions. This mixture improves activity, filling, and super-additive effects of the concrete and also improves the compatibility between cement and aggregate.
Lightweight Aggregate Concrete & Innovative Pumping Technology
This procedure involves a pumping technology of lightweight aggregate. It is a pretreatment method of lightweight aggregate. Setting appropriate times and pressure, lightweight aggregate will reach an appropriate saturation state under pressure once it is put into a custom designed sealed pressure vessel. Lightweight aggregate concrete prepared using the above pretreatment method, will dry quicker under pumping pressure, and maintain consistency. Accordingly, lightweight aggregate concrete will be easily pumped which can shorten construction time.
Energy-saving Technologies of Phase Change Thermostat Concrete
Energy conservation concrete may adjust and reflect process temperature, and temperature self-control may solve cracking brought about by cement heat of hydration in large-scale concrete pours.
Polycarboxylate Series High Performance Water Reducing Agent Compositing Technique
The research and production of water reducing admixture would improve performance while lowering pollution and environmental impact. Super plasticizer Polycarboxylate series which reduces water requirements is an attractive additive in that it enables high strength concrete, super-strength concrete, high fluidity and super plasticizer concrete, and self-defense concrete. The water reduction of Polycarboxylate may reach 20% to 25%, which is higher than the Naphthaline water reducing agent, which is the current industry standard. The cost of the water reducing agent is competitve, and it may be used to prepare high strength and high performance concrete instead of Naphthaline.
Application of Reused Water in Concrete
The re-use of waste water of a concrete plant to mix concrete is significant as it can reduce production costs, minimize fresh water use and represent an efficient approach to address industrial waste. The practical application of this effort is a further step towards the goal of minimal pollution and emissions.
Our Competition
Our principal market, Beijing, has enjoyed stronger economic growth and a higher demand for construction than other regions of China. As a result, we believe that competitors will try to expand their sales and build up their distribution networks in Beijing. Our future success depends on our ability to establish and maintain a competitive position in the marketplace.
We compete primarily on the basis of quality, technological innovation and price. Our main competitors include JiangongShanggong Center, Jinyu Group Concrete, ZhuzongShanggong Center and ZhonghangKonggang Concrete.
Essentially all of the contracts on which we bid are awarded through a competitive bid process, with awards generally being made to the lowest bidder, though other factors such as shorter schedules or prior experience with the customer are often just as important. Within our markets, we compete with many national, regional and local construction firms. Some of these competitors have achieved greater market penetration or have greater financial and other resources than we do. In addition, we compete with a number of state-owned enterprises, which have significantly greater financial resources than we do and which may have a competitive advantage over us.
There are approximately 163 concrete mixture stations in the Beijing area. The concrete production industry is highly segmented, with no single supplier having greater than a 10% market share.
Intellectual Property
We currently own the following intellectual property rights:
C100 High Performance Concrete: Patent #2007102011320 Lightweight Pre-Processing Method and Device: Patent#200710201131.6 Compound mineral mixture with: Patent #200710107881.7
Lightweight Aggregate Pressure Pre-Heating Equipment: Utility Model# ZL200720200683.0
Environmental Matters
We are required to comply with environmental protection laws and regulations promulgated by the Ministry of Construction and the State Environmental Protection Administration. Some specific environmental regulations apply to sealed transportation of dust materials and final products, closed storage of sand and gravel, as well as reduction of noise and dust pollution on production sites and encouragement of the use of waste materials. The governmental regulatory authorities conduct periodic inspections. We have met all the requirements in the past inspections. We are one of 10 companies in the industry that have been awarded the honor of “Green Concrete Producer” by the PRC government.
Regulation
The company has been in compliance with all registrations and requirements for the issuance and maintenance of all licenses and certificates required by the applicable governing authorities, including the Ministry of Construction and the Beijing Administration of Industry & Commerce. The Ministry of Construction awards Level II and Level III qualifications to concrete producers in the PRC construction industry, based on criteria such as production capacity, technical qualification, registered capital and capital equipment, as well as performance on past projects. Level II companies are licensed to produce concrete of all strength levels as well as special concretes, and Level III producers are licensed to produce concrete with strength level C60 and below. We are a Level II concrete producer.
Additionally, to make improvements at our currently existing plants, we do not need to apply for regulatory approval. However, in order to build a new concrete plant, we will need to (i) apply for a business license from the local Administration of Industry and Commerce, (ii) receive environmental approval from the local Environmental Protection Bureau in the relevant district area, and (iii) apply for an Industry Qualification Certificate from the local Municipal Construction Committee. The time estimated to receive each of these approvals is approximately one month. In the past, we have not been rejected by any of these three regulators for approval.
Our Labor Force
As of June 30, 2013, we employed 453 full-time employees. The following table sets forth the number of our full-time employees by function as of June 30, 2013.
Employees/Independent Contractors and their Functions
As required by applicable PRC law, we have entered into employment contracts with all of our officers, managers and employees. We believe that we maintain a satisfactory working relationship with our employees and we have not experienced any significant labor disputes or any difficulty in recruiting staff for our operations.
In addition, we are required by PRC law to cover employees in China with various types of social insurance and believe that we are in material compliance with the relevant PRC laws.
Insurance
We believe our insurance coverage is customary and standard for companies of comparable size in comparable industries in China.
Item 1A.
Item 1A. Risk Factors
An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below, together with all of the other information included in this report, before making an investment decision. If any of the following risks actually occurs, our business, financial condition or results of operations could suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.
RISKS RELATED TO OUR BUSINESS
Our plans to build additional plants and to improve and upgrade our internal control and management system will require capital expenditures in fiscal year 2014.
Our plans to build additional plants and to maintain and continually upgrade our internal control and management systems in line with our growing scale will require significant capital expenditures in fiscal year 2014. We may also need further funding for working capital, investments, potential acquisitions and joint ventures and other corporate requirements. We cannot assure you that cash generated from our operations will be sufficient to fund these development plans, or that our actual capital expenditures and investments will not significantly exceed our current planned amounts. If either of these conditions arises, we may have to seek external financing to satisfy our capital needs. Our ability to obtain external financing at reasonable costs is subject to a variety of uncertainties. Failure to obtain sufficient external funds for our development plans could adversely affect our business, financial condition and operating performance.
Our business is subject to the risk of supplier concentration.
Our top five suppliers provide approximately 27% of the sourcing of the raw materials for our concrete production business. As a result of this concentration in our supply chain, our business and operations would be negatively affected if any of our key suppliers were to experience significant disruption affecting the price, quality, availability or timely delivery of their products. The partial or complete loss of one of these suppliers, or a significant adverse change in our relationship with any of these suppliers, could result in lost revenue, added costs and distribution delays that could harm our business and customer relationships. In addition, concentration in our supply chain can exacerbate our exposure to risks associated with the termination by key suppliers of our distribution agreements or any adverse change in the terms of such agreements, which could have an adverse impact on our revenues and profitability.
We may experience major accidents in the course of our operations, which may cause significant property damage and personal injuries.
Significant industry-related accidents and natural disasters may cause interruptions to various parts of our operations, or could result in property or environmental damage, increase in operating expenses or loss of revenue. The occurrence of such accidents and the resulting consequences may not be covered adequately, or at all, by the insurance policies we carry. In accordance with customary practice in China, we do not carry any business interruption insurance or third party liability insurance for personal injury or environmental damage arising from accidents on our property or relating to our operations other than our automobiles. Losses or payments incurred may have a material adverse effect on our operating performance if such losses or payments are not fully insured.
Our planned expansion and technical improvement projects could be delayed or adversely affected by, among other things, failures to receive regulatory approvals, difficulties in obtaining sufficient financing, technical difficulties, or human or other resource constraints.
We intend to expand new production facilities during the next few years. The costs projected for our planned expansion and technical improvement projects and expansion may exceed those originally contemplated. Costs savings and other economic benefits expected from these projects may not materialize as a result of any such project delays, cost overruns or changes in market circumstances.
To make improvements at our currently existing plants, we do not need to apply for regulatory approval. However, in order to build a new concrete plant, we will need to (i) apply for a business license from the local Administration of Industry and Commerce, (ii) apply for an Industry Qualification Certificate from the local Municipal Construction Committee, and (iii) receive environmental approval from the local Environmental Protection Bureau in the relevant district area. There is no guarantee that we will be able to obtain these regulatory approvals in a timely manner or at all.
Additionally, in order to construct a new concrete plant, we may need to apply for a short term loan from a local commercial bank to be used for working capital. Because the lending policies of the local commercial banks are subject to change, there is no guarantee that we will be able to obtain approval for such a loan with conditions favorable to us in a timely manner or at all.
Failure to obtain intended economic benefits from these new plants and technical improvements projects, either due to cost overruns, our failure to obtain the necessary regulatory approvals or our failure to obtain necessary loan financing on terms favorable to us could adversely affect our business, financial condition and operating performances.
We cannot assure you that our growth strategy will be successful.
One of our strategies is to grow through increasing the distribution and sales of our products by penetrating existing markets in China and entering new geographic markets in China. However, many obstacles to entering such new markets exist including, but not limited to, competition from established companies in such existing markets in the China. We cannot, therefore, assure you that we will be able to successfully overcome such obstacles and establish our products in any additional markets. Our inability to implement this growth strategy successfully may have a negative impact on our growth, future financial condition, results of operations or cash flows.
If we fail to effectively manage our growth and expand our operations, our business, financial condition, results of operations and prospects could be adversely affected.
Our future success depends on our ability to expand our business to address growth in demand for our products and services. In order to maximize potential growth in our current and potential markets, we believe that we must expand our manufacturing and marketing operations. Our ability to accomplish these goals is subject to significant risks and uncertainties, including:
• the need for additional funding to construct additional manufacturing facilities, which we may be unable to obtain on reasonable terms or at all;
• delays and cost overruns as a result of a number of factors, many of which may be beyond our control, such as problems with equipment vendors and manufacturing services provided by third-party manufacturers or subcontractors;
• our receipt of any necessary government approvals or permits that may be required to expand our operations in a timely manner or at all;
• diversion of significant management attention and other resources; and
• failure to execute our expansion plan effectively.
To accommodate our growth, we will need to implement a variety of new and upgraded operational and financial systems, procedures, and controls, including improvements to our accounting and other internal management systems, by dedicating additional resources to our reporting and accounting function, and improvements to our record keeping and contract tracking system. We will also need to recruit more personnel and train and manage our growing employee base. Furthermore, our management will be required to maintain and expand our relationships with our existing customers and find new customers for our services. There is no guarantee that our management can succeed in maintaining and expanding these relationships.
If we encounter any of the risks described above, or if we are otherwise unable to establish or successfully operate additional capacity or increase our output, we may be unable to grow our business and revenues, reduce our operating costs, maintain our competitiveness or improve our profitability and, consequently, our business, financial condition, results of operations, and prospects will be adversely affected.
If we are unable to accurately estimate the overall risks or costs associated with a project on which we are bidding on, we may achieve a profit lower than anticipated or even incur a loss on the contract.
Substantially all of our revenues and contract backlog are typically derived from fixed unit price contracts. Fixed unit price contracts require us to perform the contract for a fixed unit price irrespective of our actual costs. As a result, we realize a profit on these contracts only if we successfully estimate our costs and then successfully control actual costs and avoid cost overruns. If our cost estimates for a contract are inaccurate, or if we do not execute the contract within our cost estimates, then cost overruns may cause the contract not to be as profitable as we expected, or may cause us to incur losses. This, in turn, could negatively affect our cash flow, earnings and financial position.
The costs incurred and gross profit realized on those contracts can vary, sometimes substantially, from the original projections due to a variety of factors, including, but not limited to:
onsite conditions that differ from those assumed in the original bid;
delays caused by weather conditions;
later contract start dates than expected when we bid the contract;
contract modifications creating unanticipated costs not covered by change orders;
changes in availability, proximity and costs of materials, including steel, concrete, aggregate and other construction materials (such as stone, gravel and sand), as well as fuel and lubricants for our equipment;
availability and skill level of workers in the geographic location of a project;
our suppliers’ or subcontractors’ failure to perform;
fraud or theft committed by our employees;
mechanical problems with our machinery or equipment;
citations issued by governmental authorities
difficulties in obtaining required governmental permits or approvals;
changes in applicable laws and regulations; and
claims or demands from third parties alleging damages arising from our work or from the project of which our work is part.
Economic downturns or reductions in government funding of infrastructure projects could significantly reduce our revenues.
Our business is highly dependent on the amount of infrastructure work funded by various governmental entities, which, in turn, depends on the overall condition of the economy, the need for new or replacement infrastructure, the priorities placed on various projects funded by governmental entities and national or local government spending levels. Decreases in government funding of infrastructure projects could decrease the number of civil construction contracts available and limit our ability to obtain new contracts, which could reduce our revenues and profits.
The worldwide recession and credit crisis could impact our business.
The tightening of credit in financial markets and the general economic downturn could adversely affect the ability of our customers, and suppliers to obtain the financing they need to make purchases from us, to perform their obligations under agreements with us or even to continue their operations. The credit tightening and decreased cash availability could also result in an increase in cancellation of orders for our products and services and/or a decrease in demand for our products and services in the markets in which we operate. While we believe that the effects of the recession and credit crisis have abated, we are unable to predict potential future economic conditions and disruptions in financial markets or their effect on our business and results of operations, but the consequences may be materially adverse.
Our concrete production plants in Beijing may be subject to a general city rezoning plan which, if implemented in the future, may require us to relocate or possibly permanently shut down certain of these plants.
Certain of our concrete production plants in Beijing may be subject to a general city rezoning plan which has been prepared by the Beijing municipal government. Under the rezoning plan, it is intended that the properties where these plants are located will be rezoned from industrial to commercial use. If and when implemented in respect of those properties, the rezoning plan may require us to vacate these properties and relocate the plants. In the event we are required to vacate the above properties, we would implement certain strategies to minimize any loss of production capacity during relocation. There can be no assurance that our strategies to deal with the relocation of the facilities can be implemented, or that such strategies can be implemented before we are required to vacate the above properties due to the proposed general city rezoning plan. If we are required to relocate the facilities, our results of operation and financial condition may be materially and adversely affected.
Our exposure to financially troubled customers or suppliers could harm our business, financial condition and operating results.
We provide manufacturing services to companies, and rely on suppliers, that have in the past and may in the future experience financial difficulty, particularly in light of recent conditions in the credit markets and the overall economy that affected access to capital and liquidity. As a result, we devote significant resources to monitor receivables and inventory balances with certain of our customers. If our customers experience financial difficulty, we could have difficulty recovering amounts owed to us from these customers, or demand for our services from these customers could decline. We have experienced delays in payment on our projects from China’s Ministry of Railways, or MOR. After the Minster of MOR was arrested for corruption charges, the MOR conducted payment chain audits; in addition, the MOR was under pressure to repay its debts incurred during the years of expansion. As a result, the MOR has delayed payments to construction companies, including us. Furthermore, the government tightened monetary policy in order to regulate inflation, which in turn led to delayed payment on our housing construction projects. Due to concern over inflation, the Chinese government began to tighten its monetary policy from October of 2010, which affected the real estate and construction industries adversely. As a result, our accounts receivable increased and the provision for doubtful accounts also increased. Some of our customers appeared to have the problems of declining business and shortage in cash. The allowance for doubtful accounts increased to approximately $36.5 million at June 30, 2013, compared to approximately $24.9 million at June 30, 2012. In fact, our provision for doubtful accounts, as a percentage of our overall accounts receivable, has decreased from approximately 46.6% as of June 30, 2012, to approximately 37.9% as of June 30, 2013. The inability to collect on our outstanding accounts receivable could adversely affect our operating cash flows and reduce our working capital. As a result, we may suffer material write-offs on our accounts receivable to bad debt expense. The inability of our suppliers to supply us with needed raw material could adversely affect our production process and therefore, we may not be able to fulfill our contract arrangements with customers.
We rely on internal models to manage risk, to provide accounting estimates and to make other business decisions. Our results could be adversely affected if those models do not provide reliable estimates or predictions of future activity.
We rely heavily on internal models in making a variety of decisions crucial to the successful operation of our business, including allowances for doubtful accounts and other accounting estimates. It is therefore important that our models are accurate, and any failure in this regard could have a material adverse effect on our results. Models are inherently imperfect predictors of actual results because they are based on historical data available to us and our assumptions about factors such as credit demand, payment rates, default rates, delinquency rates and other factors that may overstate or understate future experience. Our models could produce unreliable results for a number of reasons, including the limitations of historical data to predict results due to unprecedented events or circumstances, invalid or incorrect assumptions underlying the models, the need for manual adjustments in response to rapid changes in economic conditions, incorrect coding of the models, incorrect data being used by the models or inappropriate application of a model to products or events outside of the model’s intended use. In particular, models are less dependable when the economic environment is outside of historical experience, as has been the case recently. Due to the factors described above and in "Management’s Discussion and Analysis of Financial Condition and Results of Operations", we may, among other things, experience actual charge-offs that exceed our estimates and which are possibly greater than our allowance for doubtful accounts, or which require material adjustments to the allowance. Unanticipated and excessive default and charge-off experience can adversely affect our profitability and financial condition and adversely affect our ability to finance our business.
Our business will be damaged if project contracts with the Chinese government, for which we may act as a subcontractor are cancelled.
We do not enter into any contracts directly with the Chinese government. For contracts that are funded by the Chinese government, we place bids and enter into subcontracts with the private entity prime contractor. A sudden cancellation of a prime contract, and in turn our subcontract, could cause our equipment and work crews to remain idle for a significant period of time until other comparable work becomes available. This idle time could have a material adverse effect on our business and results of operations.
Our industry is highly competitive, with numerous larger companies with greater resources competing with us, and our failure to compete effectively could reduce the number of new contracts awarded to us or adversely affect our margins on contracts awarded.
Our competition includes a number of state-owned and large private PRC-based manufacturers and distributors that produce and sell products similar to ours. We compete primarily on the basis of quality, technological innovation and price. Essentially all of the contracts on which we bid are awarded through a competitive bid process, with awards generally being made to the lowest bidder, though other factors such as shorter schedules or prior experience with the customer are often just as important. Within our markets, we compete with many national, regional and local state-owned and private construction firms. Some of these competitors have achieved greater market penetration or have greater financial and other resources than us. In addition, there are a number of larger national companies in our industry that could potentially establish a presence in our markets and compete with us for contracts. As a result, we may need to accept lower contract margins in order to compete against these competitors. If we are unable to compete successfully in our markets, our relative market share and profits could be reduced.
We could face increased competition in our principal market.
Our principal market, Beijing, has enjoyed stronger economic growth and a higher demand for construction than other regions of China. As a result, we believe that competitors will try to expand their sales and build up their distribution networks in our principal market. We anticipate that this trend will continue and likely accelerate. Increased competition may have a material adverse effect on our financial condition and results of operations.
Our dependence on subcontractors and suppliers of materials could increase our costs and impair our ability to compete on contracts on a timely basis or at all, which would adversely affect our profits and cash flow.
We rely on third-party subcontractors to perform some of the work on many of our contracts. We do not bid on contracts unless we have the necessary subcontractors committed for the anticipated scope of the contract and at prices that we have included in our bid. Therefore, to the extent that we cannot obtain third-party subcontractors, our profits and cash flow will suffer.
We may be exposed to liabilities under the Foreign Corrupt Practices Act, and any determination that we violated the Foreign Corrupt Practices Act or Chinese anti-corruption law could have a material adverse effect on our business.
We are subject to the Foreign Corrupt Practice Act, or FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute for the purpose of obtaining or retaining business. Chinese anti-corruption law also strictly prohibits bribery of government officials. We have operations, agreements with third parties and make sales in China, where corruption may occur. Our activities in China create the risk of unauthorized payments or offers of payments by one of the employees, consultants, sales agents or distributors of our Company, even though these parties are not always subject to our control. It is our policy to implement safeguards to prevent these practices by our employees. However, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents or distributors of our Company may engage in conduct for which we might be held responsible.
Violations of the FCPA or other anti-corruption laws may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the United States government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.
We depend heavily on key personnel, and turnover of key employees and senior management could harm our business.
Our future business and results of operations depend in significant part upon the continued contributions of our key technical and senior management personnel, including Xianfu Han, our Chairman and Chief Executive Officer and Weili He, our Vice-Chairman and Chief Operating Officer. They also depend in significant part upon our ability to attract and retain additional qualified management, technical, operational and support personnel for our operations. If we lose a key employee, if a key employee fails to perform in his or her current position, or if we are not able to attract and retain skilled employees as needed, our business could suffer. Significant turnover in our senior management could significantly deplete the institutional knowledge held by our existing senior management team. We depend on the skills and abilities of these key employees in managing the reclamation, technical, and marketing aspects of our business, any part of which could be harmed by turnover in the future.
Certain of our existing stockholders have substantial influence over our company, and their interests may not be aligned with the interests of our other stockholders.
Our Chairman, Xianfu Han, owns approximately 32.4% of our outstanding voting securities and our Vice-Chairman, Weili He, owns approximately 17.0% of our outstanding voting securities as of June 30, 2013, in a fully-diluted share base. As a result, each have significant influence over our business, including decisions regarding mergers, consolidations, liquidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. This concentration of ownership may also have the effect of discouraging, delaying or preventing a future change of control, which could deprive our stockholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our shares.
We may require additional capital and we may not be able to obtain it on acceptable terms or at all.
We may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities could result in dilution to our stockholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financing covenants that would restrict our operations. Our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties, including:
investors’ perception of, and demand for, securities of Chinese-based companies involved in construction supply or concrete industries;
conditions of the U.S. and other capital markets in which we may seek to raise funds;
our future results of operations, financial condition and cash flows; and
economic, political and other conditions in China.
Financing may not be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could have a material adverse effect on our business, financial condition and results of operations.
We may be exposed to potential risks relating to our internal controls over financial reporting.
As directed by Section 404 of the Sarbanes-Oxley Act of 2002 or SOX 404, the SEC adopted rules requiring public companies to include a report of management on the company’s internal controls over financial reporting in their annual reports. Under current law, the auditor attestation will not be required as long as our filing status remains as a smaller reporting company, but we may cease to be a smaller reporting company in future years, in which case we will be subject to the auditor attestation requirement. We were subject to management report for the fiscal year ended June 30, 2013, and a report of our management for the 2013 fiscal year is included under Item 9A of this annual report concluding that, as of June 30, 2013, our internal controls over financial reporting were not effective. If we cannot remediate the material weakness identified in a timely manner or, if and when we are subject to the auditor attestation report requirement, we are unable to receive a positive attestation from our independent auditors with respect to our internal controls, investors and others may lose confidence in the reliability of our financial statements, which could adversely affect the price of our common stock.
We have limited insurance coverage for our operations in China.
The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited insurance products. We have determined that the risks of disruption or liability from our business, the loss or damage to our property, including our facilities, equipment and office furniture, the cost of insuring for these risks, and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. As a result, we do not have any business liability, disruption, litigation or property insurance coverage for our operations in China except for insurance on some company owned vehicles. Any uninsured occurrence of loss or damage to property, or litigation or business disruption may result in the incurrence of substantial costs and the diversion of resources, which could have an adverse effect on our operating results.
We may not be current in our payment of social insurance and housing accumulation fund for our employees and such shortfall may expose us to relevant administrative penalties.
The PRC laws and regulations require all employers in China to fully contribute their own portion of the social insurance premium and housing accumulation fund for their employees within a certain period of time. Failure to do so may expose the employers to make rectification for the accrued premium and fund by the relevant labor authority. Also, an administrative fine may be imposed on the employers as well as the key management members. As of June 30, 2013, Xin Ao has fully contributed the social insurance premium and housing accumulation fund according to PRC laws and regulations.
Our operations may incur substantial liabilities to comply with environmental laws and regulations.
Our concrete manufacturing operations are subject to laws and regulations relating to the release or disposal of materials into the environment or otherwise relating to environmental protection. Applicable law required that we obtain an environmental impact report and environmental approval from the environmental protection administration prior to obtaining the business license and construction enterprise qualification certificate for Xin Ao. However, the local administration of industry and commerce and the Beijing Municipal Construction Commission did not require Xin Ao to provide the environmental impact report and environmental approval, and Xin Ao has not received any notice of non-compliance nor has any fine or other penalty been assessed. However, the environmental protection administration may in the future require that Xin Ao provide the applicable report and apply for the required environment approval. Our failure to have complied with the applicable laws regarding delivery of the report may result in the assessment of administrative, civil and criminal penalties, the incurrence of investigatory or remedial obligations and the imposition of injunctive relief. Resolution of these matters may require considerable management time and expense. In addition, changes in environmental laws and regulations occur frequently and any changes that result in more stringent or costly manufacturing, storage, transport, disposal or cleanup requirements could require us to make significant expenditures to reach and maintain compliance and may otherwise have a material adverse effect on our industry in general and on our own results of operations, competitive position or financial condition.
RISKS RELATED TO DOING BUSINESS IN CHINA
In order to comply with PRC regulatory requirements, we operate our businesses through companies with which we have contractual relationships but in which we do not have controlling ownership. If the PRC government determines that our agreements with these companies are not in compliance with applicable regulations, our business in the PRC could be materially adversely affected.
We do not have direct or indirect equity ownership of our variable interest entity, or VIE, Xin Ao, which operates all our businesses in China. At the same time, however, we have entered into contractual arrangements with Xin Ao and its individual owners pursuant to which we received an economic interest in, and exert a controlling influence over Xin Ao, in a manner substantially similar to a controlling equity interest.
Although we believe that our current business operations are in compliance with the current laws in China, we cannot be sure that the PRC government would view our operating arrangements to be in compliance with PRC regulations that may be adopted in the future. There have been recent reports of potential PRC government efforts to regulate or perhaps limit the use of VIE structures for new foreign investment, particularly in the internet and other telecommunications industries. We are monitoring developments in this area and do not believe any adverse impact on our operations is likely.
If we are determined not to be in compliance with future PRC regulations, the PRC government could levy fines, revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, require us to restructure our business, corporate structure or operations, impose additional conditions or requirements with which we may not be able to comply, impose restrictions on our business operations or on our customers, or take other regulatory or enforcement actions against us that could be harmful to our business. As a result, our business in the PRC could be materially adversely affected.
We rely on contractual arrangements with our VIE for our operations, which may not be as effective in providing control over these entities as direct ownership.
Our operations and financial results are dependent on our VIE, Xin Ao, in which we have no equity ownership interest and must rely on contractual arrangements to control and operate the businesses of our VIE. These contractual arrangements are not as effective in providing control over the VIE as direct ownership. For example, the VIE may be unwilling or unable to perform its contractual obligations under our commercial agreements. Consequently, we would not be able to conduct our operations in the manner currently planned. In addition, the VIE may seek to renew its agreements on terms that are disadvantageous to us. Although we have entered into a series of agreements that provide us with substantial ability to control the VIE, we may not succeed in enforcing our rights under them insofar as our contractual rights and legal remedies under PRC law are inadequate. In addition, if we are unable to renew these agreements on favorable terms when these agreements expire or enter into similar agreements with other parties, our business may not be able to operate or expand, and our operating expenses may significantly increase.
If we become directly subject to the recent scrutiny, criticism and negative publicity involving certain U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter which could harm our business operations, stock price and reputation and could result in a loss of your investment in our stock, especially if such matter cannot be addressed and resolved quickly.
Recently, U.S. public companies that have substantially all of their operations in China, particularly companies like us which have completed so-called reverse merger transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, short sellers, financial commentators and regulatory agencies, such as the United States Securities and Exchange Commission. Much of the scrutiny, criticism and negative publicity has centered around financial and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless. Many of these companies are now subject to shareholder lawsuits, SEC enforcement actions and are conducting internal and external investigations into the allegations. It is not clear what affect this sector-wide scrutiny, criticism and negative publicity will have on our company, our business and our stock price. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend our company. This situation could be costly and time consuming and distract our management from growing our company. If such allegations are not proven to be groundless, our company and business operations will be severely impacted and your investment in our stock could be rendered worthless.
Adverse changes in political and economic policies of the PRC government could impede the overall economic growth of China, which could reduce the demand for our products and damage our business.
We conduct all of our operations and generate all of our revenue in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The PRC economy differs from the economies of most developed countries in many respects, including:
the higher level of government involvement;
the early stage of development of the market-oriented sector of the economy;
the rapid growth rate;
the higher level of control over foreign exchange; and
the allocation of resources.
As the PRC economy has been transitioning from a planned economy to a more market-oriented economy, the PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. While these measures may benefit the overall PRC economy, they may also have a negative effect on us.
Although the PRC government has in recent years implemented measures emphasizing the utilization of market forces for economic reform, the PRC government continues to exercise significant control over economic growth in China through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and imposing policies that impact particular industries or companies in different ways.
Any adverse change in the economic conditions or government policies in China could have a material adverse effect on the overall economic growth and the level of new construction investments and expenditures in China, which in turn could lead to a reduction in demand for our services and consequently have a material adverse effect on our business and prospects.
Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.
We conduct substantially all of our business through our operating subsidiary in the PRC. Our operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. In addition, all of our executive officers and almost all of our directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiaries.
The PRC government exerts substantial influence over the manner in which we must conduct our business activities.
The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.
Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
A slowdown or other adverse developments in the PRC economy may materially and adversely affect our customers, demand for our services and our business.
We are a holding company. All of our operations are conducted in the PRC and all of our revenues are generated from sales in the PRC. Although the PRC economy has grown significantly in recent years, we cannot assure you that such growth will continue. A slowdown in overall economic growth, an economic downturn or recession or other adverse economic developments in the PRC may materially reduce the demand for new construction projects and adversely affect our business.
Restrictions on currency exchange may limit our ability to receive and use our sales revenue effectively.
Most of our sales revenue and expenses are denominated in RMB. Under PRC law, the RMB is currently convertible under the “current account,” which includes dividends and trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans. Currently, our PRC operating subsidiary may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, the relevant PRC government authorities may limit or eliminate our ability to purchase foreign currencies in the future. Since a significant amount of our future revenue will be denominated in RMB, any existing and future restrictions on currency exchange may limit our ability to utilize revenue generated in RMB to fund our business activities outside China that are denominated in foreign currencies.
Foreign exchange transactions by PRC operating subsidiaries under the capital account continue to be subject to significant foreign exchange controls and require the approval of or need to register with PRC government authorities, including SAFE. In particular, if our PRC operating subsidiaries borrow foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance the subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the Ministry of Commerce, or MOFCOM, or their respective local counterparts. These limitations could affect their ability to obtain foreign exchange through debt or equity financing.
Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or otherwise materially adversely affect us.
In October 2005, the PRC State Administration of Foreign Exchange, or SAFE, issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75, which required PRC residents to register with the competent local SAFE branch (1) before they establish or gain control of an overseas special purpose vehicle, or SPV, for the purpose of overseas equity financing (including convertible debt financing); (2) when they contribute their assets or equity interests in a domestic enterprise to an SPV or engage in overseas financing after contributing assets or equity interests to an SPV; and (3) when their SPV undergoes a material change outside of China, such as a change in share capital or merger or acquisition. Failure to comply with the requirements of Circular 75, as applied by SAFE in accordance with Notice 106, may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions. Any such failure could also result in the SPV’s subsidiaries being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers of funds into or out of China.
We have asked our stockholders, who are PRC residents as defined in Circular 75, to register with the relevant branch of SAFE, as currently required, in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiaries. Our PRC Residents stockholders, Mr. Han and Mr. He obtained the SAFE registration on September 29, 2007. However, we cannot provide any assurances that they have made all necessary amendments to their registration to fully comply with, all applicable registrations or approvals required by Circular 75. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries’ ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 by our PRC resident beneficial holders.
In addition, such PRC residents may not always be able to complete the necessary registration procedures required by Circular 75. We also have little control over either our present or prospective direct or indirect stockholders or the outcome of such registration procedures. A failure by our PRC resident beneficial holders or future PRC resident stockholders to comply with Circular 75, if SAFE requires it, could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.
We may be unable to complete a business combination transaction efficiently or on favorable terms due to complicated merger and acquisition regulations implemented on September 8, 2006.
The recent PRC Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors also governs the approval process by which a PRC company may participate in an acquisition of its assets or its equity interests. Depending on the structure of the transaction, the new regulation will require the Chinese parties to make a series of applications and supplemental applications to the government agencies. In some instances, the application process may require the presentation of economic data concerning a transaction, including appraisals of the target business and evaluations of the acquirer, which are designed to allow the government to assess the transaction. Government approvals will have expiration dates by which a transaction must be completed and reported to the government agencies. Compliance with the new regulations is likely to be more time consuming and expensive than in the past and the government can now exert more control over the combination of two businesses. Accordingly, due to the new regulation, our ability to engage in business combination transactions has become significantly more complicated, time consuming and expensive, and we may not be able to negotiate a transaction that is acceptable to our stockholders or sufficiently protect their interests in a transaction.
The new regulation allows PRC government agencies to assess the economic terms of a business combination transaction. Parties to a business combination transaction may have to submit to MOFCOM and the other government agencies an appraisal report, an evaluation report and the acquisition agreement, all of which form part of the application for approval, depending on the structure of the transaction. The regulations also prohibit a transaction at an acquisition price obviously lower than the appraised value of the Chinese business or assets and in certain transaction structures, require that consideration must be paid within defined periods, generally not in excess of a year. The regulation also limits our ability to negotiate various terms of the acquisition, including aspects of the initial consideration, contingent consideration, holdback provisions, indemnification provisions and provisions relating to the assumption and allocation of assets and liabilities. Transaction structures involving trusts, nominees and similar entities are prohibited. Therefore, such regulation may impede our ability to negotiate and complete a business combination transaction on financial terms that satisfy our investors and protect our stockholders’ economic interests.
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
The value of our common stock will be indirectly affected by the foreign exchange rate between U.S. dollars and RMB and between those currencies and other currencies in which our sales may be denominated. Because substantially all of our earnings and cash assets are denominated in RMB, fluctuations in the exchange rate between the U.S. dollar and the RMB will affect our balance sheet and our earnings per share in U.S. dollars. In addition, appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars and earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
Currently, some of our raw materials and major equipment are imported. In the event that the U.S. dollars appreciate against RMB, our costs will increase. If we cannot pass the resulting costs on to our customers, our profitability and operating results will suffer.
Under the Current Enterprise Income Tax, or EIT, Law, we may be classified as a "resident enterprise" of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.
We are a holding company incorporated under the laws of Nevada. We conduct substantially all of our business through our wholly-owned and other consolidated entities in China, and we derive all of our income from these entities. Prior to January 1, 2008, dividends derived by foreign enterprises from business operations in China were not subject to the Chinese enterprise income tax. However, such tax exemption ceased as of January 1, 2008 and thereafter with the effectiveness of the new Enterprise Income Tax Law, or EIT Law.
Under the EIT Law, if we are not deemed to be a “resident enterprise” for Chinese tax purposes, a withholding tax at the rate of 10% would be applicable to any dividends paid by our Chinese subsidiaries to us. However, if we are deemed to be a “resident enterprise” established outside of China whose “place of effective management” is located in China, we would be classified as a resident enterprise for Chinese tax purposes and thus would be subject to an enterprise income tax rate of 25% on all of our income, including interest income on the proceeds from this offering on a worldwide basis.
The regulations promulgated pursuant to the EIT Law define the term “place of effective management” as “establishments that carry out substantial and overall management and control over the manufacturing and business operations, personnel, accounting, properties, etc. of an enterprise.” The State Administration of Taxation issued a SAT Circular 82 on April 22, 2009, which provides that the “place of effective management” of a Chinese-controlled overseas-incorporated enterprise is located in China if the following requirements are satisfied: (i) the senior management and core management departments in charge of its daily operations function are mainly located in the PRC; (ii) its financial and human resources decisions are subject to determination or approval by persons or bodies located in the PRC; (iii) its major assets, accounting books, company seals, and minutes and files of its board and shareholders’ meetings are located or kept in the PRC; and (iv) no less than half of the enterprise’s directors or senior management with voting rights reside in the PRC. SAT Circular 82 applies only to overseas registered enterprises controlled by PRC enterprises, not to those controlled by PRC individuals. If the Company’s non-PRC incorporated entities are deemed PRC tax residents, such entities would be subject to PRC tax under the EIT Law. The Company has analyzed the applicability of the EIT Law and related regulations, and for each of the applicable periods presented, the Company has not accrued for PRC tax on such basis.. In addition, although under the EIT Law and the related regulations dividends paid to us by our PRC subsidiaries would qualify as “tax-exempted income,” we cannot assure you that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. As a result of such changes, our historical operating results will not be indicative of our operating results for future periods and the value of our shares of common stock may be adversely affected. We are actively monitoring the possibility of “resident enterprise” treatment and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible.
We may be subject to fines and legal sanctions if we or our Chinese employees fail to comply with PRC regulations relating to employee stock options granted by overseas listed companies to PRC citizens.
On December 25, 2006, the People’s Bank of China issued the Administration Measures on Individual Foreign Exchange Control, and its Implementation Rules were issued by the State Administration of Foreign Exchange (“SAFE”) on January 5, 2007. Both took effect on February 1, 2007. Under these regulations, all foreign exchange matters involved in an employee stock holding plan, stock option plan or similar plan in which PRC citizens’ participation requires approval from the SAFE or its authorized branch. On March 28, 2007, the SAFE issued the Application Procedure for Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plans or Stock Option Plans of Overseas Listed Companies, or Notice 78. Under Notice 78, PRC individuals who participate in an employee stock option holding plan or a stock option plan of an overseas listed company are required, through a PRC domestic agent or PRC subsidiary of the overseas listed company, to register with the SAFE and complete certain other procedures. We and our Chinese employees who have been granted shares or stock options pursuant to our share incentive plan are subject to Notice 78. However, in practice, there are significant uncertainties with regard to the interpretation and implementation of Notice 78. We are committed to complying with the requirements of Notice 78. However, we cannot provide any assurance that we or our Chinese employees will be able to qualify for or obtain any registration required by Notice 78. In particular, if we and/or our Chinese employees fail to comply with the provisions of Notice 78, we and/or our Chinese employees may be subject to fines and legal sanctions imposed by the SAFE or other PRC government authorities, as a result of which our business operations and employee option plans could be materially and adversely affected.
The discontinuation, reduction or delay of any of the preferential tax treatments currently available to us in the PRC could materially and adversely affect our business, financial condition and results of operations.
Prior to January 1, 2008, under the old enterprises income tax law, Xin Ao was subject to a 33% income tax rate, which was subject to certain tax holidays and preferential tax rates. Under the new enterprise income tax law effective January 1, 2008, or the EIT Law, both foreign-invested enterprises and domestic enterprises are subject to a unified 25% income tax rate. Under the EIT Law, preferential tax treatments will be granted to enterprises that conduct business in certain encouraged sectors and to enterprises that qualify as “high and new technology enterprises”, a status reassessed every three years. In addition, an enterprise is entitled to a 0% value-added tax rate if it uses recycled raw materials to manufacture its products. Xin Ao was recognized as a high and new technology enterprise June 2009 and was entitled to a 15% preferential income tax rate for the three-year period ended June 2012. In addition, Xin Ao uses recycled raw materials to manufacture its products and was entitled to a 0% value-added tax rate from June 2010 through June 2013. However, we cannot assure you that Xin Ao will be able to maintain its status as “high and new technology enterprises” and/or as an enterprise for value-added tax exemption. If Xin Ao fails to continue to qualify or fails to receive an updated approvals, our income tax and value-added tax expenses would increase, which would have a material adverse effect on our net income and results of operations.
RISKS RELATED TO THE MARKET FOR OUR COMMON STOCK
Our shares of common stock are very thinly traded, and there can be no assurance that there will be an active market for our shares of common stock in the future.
Our shares of common stock are very thinly traded, and the price if traded may not reflect our value. There can be no assurance that there will be an active market for our shares of common stock in the future. The market liquidity will be dependent on the perception of our operating business and any steps that our management might take to bring us to the awareness of investors. There can be no assurance given that there will be any awareness generated. Consequently, investors may not be able to liquidate their investment or liquidate it at a price that reflects the value of the business. If a more active market should develop, the price may be highly volatile. Because there may be a low price for our shares of common stock, many brokerage firms may not be willing to effect transactions in the securities. Even if an investor finds a broker willing to effect a transaction in the shares of our common stock, the combination of brokerage commissions, transfer fees, taxes, if any, and any other selling costs may exceed the selling price. Further, many lending institutions will not permit the use of such shares of common stock as collateral for any loans.
We do not intend to pay dividends on shares of our common stock for the foreseeable future, but if we intend to do so our holding company structure may limit the payment of dividends to our stockholders.
We have no direct business operations, other than our ownership of our subsidiaries. While we have no current intention of paying dividends, should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in loan agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions as discussed below. If future dividends are paid in RMB, fluctuations in the exchange rate for the conversion of RMB into U.S. dollars may reduce the amount received by U.S. stockholders upon conversion of the dividend payment into U.S. dollars.
Chinese regulations currently permit the payment of dividends only out of accumulated profits as determined in accordance with Chinese accounting standards and regulations. Our subsidiaries in China are also required to set aside a portion of their after tax profits according to Chinese accounting standards and regulations to fund certain reserve funds. Currently, our subsidiaries in China are the only sources of revenues or investment holdings for the payment of dividends. If they do not accumulate sufficient profits under Chinese accounting standards and regulations to first fund certain reserve funds as required by Chinese accounting standards, we will be unable to pay any dividends.
We may be subject to penny stock regulations and restrictions and you may have difficulty selling shares of our common stock.
The SEC has adopted regulations which generally define so-called “penny stocks” to be an equity security that has a market price less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exemptions. If our common stock becomes a “penny stock”, we may become subject to Rule 15g-9 under the Exchange Act, or the “Penny Stock Rule”. This rule imposes additional sales practice requirements on broker-dealers that sell such securities to persons other than established customers and “accredited investors” (generally, individuals with a net worth in excess of $1,000,000 or annual incomes exceeding $200,000, or $300,000 together with their spouses). For transactions covered by Rule 15g-9, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. As a result, this rule may affect the ability of broker-dealers to sell our securities and may affect the ability of purchasers to sell any of our securities in the secondary market.
For any transaction involving a penny stock, unless exempt, the rules require delivery, prior to any transaction in a penny stock, of a disclosure schedule prepared by the SEC relating to the penny stock market. Disclosure is also required to be made about sales commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements are required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stock.
There can be no assurance that our common stock will qualify for exemption from the Penny Stock Rule. In any event, even if our common stock were exempt from the Penny Stock Rule, we would remain subject to Section 15(b)(6) of the Exchange Act, which gives the SEC the authority to restrict any person from participating in a distribution of penny stock, if the SEC finds that such a restriction would be in the public interest.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
There is no private land ownership in China. Individuals and companies are permitted to acquire land use rights for specific purposes. We lease our 44,041 square meter facility located at Jia 1, SanTaiShan, XiaoHongMen County, ChaoYang District, Beijing, China, from Beijing SanTaiShan Chemical Trading & Logistics Co., who was granted land use rights from the PRC government. The lease provides for a five year term beginning on October 1, 2008, with the option to extend following expiration. Annual rent on the property is approximately $197,000. On August 31, 2011, The Company entered a lease agreement to lease office space from a third party, starting from November 1, 2011 to October 31, 2013, with annual payment of approximately $363,000. In addition, on April 30, 2012, the Company entered into a lease agreement to lease 43,000 square feet of office space from a third party, from May 1, 2012 to March 28, 2021, with annual payments of approximately $415,000. The lease agreement is separated into three lease terms, each term has three-year expiration period and will be automatically renewed to next three-year term and so on if the office building would not be acquired or demolished by the city government.
We entered into three different five-year operating lease agreements during the fourth quarter of 2009. We also entered into one four-year operating lease agreement during the second quarter of 2010. One of the lease agreements was terminated early on November 30, 2010. The lease payments for our four manufacturing plants are with different unrelated parties and the aggregate monthly payment is $213,000. Certain lease payments have been pre-paid by transferring the Company’s long-term accounts receivable to the lessors in exchange for agreeing to no increase in the future.
We have an extensive fleet of 115 transit mounted concrete mixers, 17 pump trucks, and we have access to an additional 55 concrete mixers and 3 pump truck vehicles for lease in Beijing and 31 transit mounted concrete mixers and 5 pump trucks at our portable stations depending on specific project requirements. We also anticipate delivery of 40 additional transit mounted concrete mixers and 5 additional pump trucks to our fleet in Beijing by June 30, 2012. More than half of the vehicles are equipped with GPS and tracking devices from the plants central dispatch center in order to optimize capacity utilization, production and delivery schedules.
Item 3.
Item 3. Legal Proceedings
From time to time, we may have disputes that arise in the ordinary course of our business. Currently, there are no material legal proceedings to which we are a party, or to which any of our property is subject, that we expect to have a material adverse effect on our financial condition, results of operations or cash flows.
Since July 29, 2011, multiple class action complaints (the “Stockholder Actions”) were filed against the Company and its Board of Directors in the Court of Chancery of the State of Delaware, generally alleging that the Company and all of our directors breached their fiduciary duties in connection with the receipt by the Company of a preliminary, non-binding offer from Xianfu Han, the Company’s Chairman and Chief Executive Officer, and Weili He, the Company’s Vice Chairman, Chief Operating Officer and Interim Chief Financial Officer (together with Xianfu Han and their affiliates, the “Buyer Group”), to acquire all of the outstanding shares of our common stock not currently owned by them in a going private transaction at a proposed price of $2.65 per share in cash (the “Proposed Transaction”). The Stockholder Actions were consolidated under the caption In re China Advanced Construction Materials Group Litigation, Consolidated C.A. No. 6729-CS.
On July 9, 2012, the Company announced that it and the Buyer Group determined to terminate the merger agreement the parties signed on October 24, 2011,(the “Merger Agreement”) based on the determination by all parties that the conditions to consummate the merger contemplated by the Merger Agreement cannot be satisfied, and the Company and the Buyer Group entered into the Termination of Agreement and Merger Agreement. On August 14, 2012, the plaintiffs in the Stockholder Actions requested that the case be dismissed and the court approved the dismissal.
Item 4.
Item 4. Mine Safety Disclosures
Not Applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock is listed on the NASDAQ Capital Market under the symbol “CADC”. On Febraury 25, 2013, our common stock was transferred from the NASDAQ Global Market to the NASDAQ Capital Market. The following table sets forth the quarterly high and low sales prices of a share of our common stock as reported by NASDAQ for the periods indicated. Effective August 1, 2013 we completed a 1 for 12 reverse stock split, and stock prices prior to such date have been adjusted to reflect the effect of the reverse stock split.
Holders of Common Stock
As of September 24, 2013, there were 378 stockholders of record of our common stock.
Dividends
We have never paid dividends on our common stock. While any future dividends will be determined by our directors after consideration of the earnings, financial condition, and other relevant factors, it is currently expected that available cash resources will be utilized in connection with our ongoing operations.
Item 6.
Item 6. Selected Financial Data
Not Applicable.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a holding company whose primary business operations are conducted through our wholly-owned subsidiaries BVI-ACM and China-ACMH, and our variable interest entity, Xin Ao and its subsidiaries. We engage in the production and supply of advanced construction materials for large scale commercial, residential, and infrastructure developments, and are primarily focused on producing and supplying a wide range of advanced ready-mix concrete materials for highly technical, large scale, and environmentally-friendly construction projects.
During the year ended June 30, 2013, we supplied materials and provided services to our high speed railway projects through our network of ready-mixed concrete plants throughout Beijing (two as of June 30, 2013) and our portable plants (one as of June 30, 2013) located in An Hui province in China. We own one concrete plant and its related equipment.
Our manufacturing services are used primarily for our national high speed railway projects. Typically, the general contractors on the high speed railway projects supply the raw materials required for the project, which results in higher gross margins for us and reduces our upfront capital investments needed to purchase raw materials. We also produce ready-mix concrete at portable plants, which can be dismantled and moved to new sites for new projects. Our management believes that we have the ability to capture a greater share of the Beijing market and further expand our footprint in China via expanding relationships and networking, signing new contracts, and continually developing market-leading innovative and eco-friendly ready-mix concrete products.
Termination of Going-Private Transaction
On October 24, 2011, the Company announced that it had entered into a definitive agreement and plan of merger with Novel Gain Holdings Limited, a British Virgin Islands company ("Novel Gain"), CACMG Acquisition, Inc., a Delaware corporation and a wholly owned, direct subsidiary of Novel Gain ("Merger Sub"), Mr. Xianfu Han and Mr. Weili He, pursuant to which Merger Sub will merge with and into the Company with the Company continuing as the surviving corporation and a wholly owned subsidiary of Novel Gain.
Under the terms of the merger agreement, each share of the Company Common Stock issued and outstanding immediately prior to the effective time of the merger will be converted into the right to receive $2.65 in cash without interest, except for (i) shares in respect of which appraisal rights have been properly exercised under Delaware law, and (ii) shares owned by Novel Gain and Merger Sub (including shares to be contributed to Novel Gain by Messrs. Han and He (the "Rollover Investors") pursuant to a rollover agreement between Novel Gain and the Rollover Investors immediately prior to the effective time of the merger), which shares will be cancelled without the Rollover Investors receiving any consideration.
On July 9, 2012, the Board of Directors of the Company, acting on the unanimous recommendation of the Special Committee of the Board of Directors, determined to terminate the merger agreement based on the determination by all parties that the conditions to consummate the Merger cannot be satisfied, and the Company and the other parties to the Merger Agreement entered into the Termination of Agreement and Merger Agreement to terminate the Merger Agreement. The termination takes effect immediately, and no fees are payable by the Company or the other parties in connection therewith.
Principal Factors Affecting Our Financial Performance
We believe that the following factors will continue to affect our financial performance:
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Large Scale Contractor Relationships. We have contracts with major construction contractors which are constructing key infrastructure, commercial and residential projects. Our sales efforts focus on large-scale projects and large customers which place large recurring orders and present less credit risk to us. For the years ended June 30, 2013, five customers accounted for approximately 22.1% of the Company’s sales and 8.2% of the Company’s account receivables as of June 30, 2013. Should we lose these customers in the future and are unable to obtain additional customers, our revenues will suffer.
- Experienced Management. Management’s technical knowledge and business relationships give us the ability to secure major infrastructure projects, which provides us with leverage to acquire less sophisticated operators, increase production volumes, and implement quality standards and environmentally sensitive policies. If there be any significant turnover in our senior management, it could deplete the institutional knowledge held by our existing senior management team.
- Innovation Efforts. We strive to produce the most technically and scientifically advanced products for our customers and maintain close relationships with Tsinghua University, Xi’an University of Architecture and Technology and Beijing DongfangJianyu Institute of Concrete Science & Technology (the “Institute”) which assist us with our research and development activities. During our five year agreement with the Institute, we have realized an advantage over many of our competitors by gaining access to a wide array of resources and knowledge. One payment of approximately $2.3 million to DongfangJianyu Institute of Concrete Science and Technology was paid under the agreement.
- Competition. Our competition includes a number of state-owned and large private PRC-based manufacturers and distributors that produce and sell products similar to ours. We compete primarily on the basis of quality, technological innovation and price. Essentially all of the contracts on which we bid are awarded through a competitive bid process, with awards often being made to the lowest bidder though other factors such as shorter schedules or prior experience with the customer are often just as important. Within our markets, we compete with many national, regional and local state-owned and private construction entities some of which have achieved greater market penetration or have greater financial and other resources than us. In addition, there are a number of larger national companies in our industry that could potentially establish a presence in our markets and compete with us for contracts. If we are unable to compete successfully in our markets, our relative market share and profits could be reduced.
PRC Taxation
China-ACMH and VIEs are governed by the income tax laws of the PRC and the income tax provision in respect to operations in the PRC is calculated at the applicable tax rates on the taxable income for the periods based on existing legislation, interpretations and practices in respect thereof. After January 1, 2008, under the new Chinese Enterprise Income Tax (“EIT”) law, the statutory corporate income tax rate applicable to most companies is 25%. As granted by the State Administration of Taxation of the PRC, Xin Ao was entitled to an income tax reduction from 25% to 15% from January 1, 2009 to June 12, 2012. The Company has received the approval of the income tax reduction from 25% to 15% for the period from June 13, 2012 to December 31, 2014.
In accordance with the EIT Law and related regulations, enterprises established under the laws of foreign countries or regions and whose “place of effective management” is located within the PRC territory are considered PRC resident enterprises and subject to the PRC income tax at the rate of 25% on worldwide income. The regulations define the term “place of effective management” as “establishments that carry out substantial and overall management and control over the manufacturing and business operations, personnel, accounting, properties, etc. of an enterprise.” The State Administration of Taxation issued a SAT Circular 82 on April 22, 2009, which provides that the “place of effective management” of a Chinese-controlled overseas incorporated enterprise is located in China if the following requirements are satisfied: (i) the senior management and core management departments in charge of its daily operations function are mainly located in the PRC; (ii) its financial and human resources decisions are subject to determination or approval by persons or bodies located in the PRC; (iii) its major assets, accounting books, company seals, and minutes and files of its board and shareholders’ meetings are located or kept in the PRC; and (iv) no less than half of the enterprise’s directors or senior management with voting rights reside in the PRC. SAT Circular 82 applies only to overseas registered enterprises controlled by PRC enterprises, not to those controlled by PRC individuals. If the Company’s non-PRC incorporated entities are deemed PRC tax residents, such entities would be subject to PRC tax under the EIT Law. The Company has analyzed the applicability of this law, and for each of the applicable periods presented, the Company has not accrued for PRC tax on such basis. The Company continues to monitor changes in the interpretation and/or guidance of this law.
The EIT Law also imposes a 10% withholding income tax, subject to reduction based on tax treaty where applicable, for dividends distributed by a foreign invested enterprise to its immediate holding company outside China. Such dividends were exempted from PRC tax under the previous income tax law and regulations. The Company considers permanently reinvested undistributed earnings of Chinese operations located in the PRC. As a result, there is no deferred tax expense related to withholding tax on the future repatriation of these earnings.
Warrants Liability
The Company follows provisions of ASC 815, which determines whether an instrument (or embedded feature) is indexed to an entity’s own stock. This accounting standard specifies that a contract which would otherwise meet the definition of a derivative but is both (a) indexed to the Company’s own stock and (b) classified as stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument. This accounting standard provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the scope exception.
As such, our warrants are not afforded equity treatment because the warrants have a downward ratchet provision on the exercise price. As a result, the warrants are not considered indexed to the Company’s own stock, and, as such, all changes in the fair value of these warrants were recognized in earnings until they expired during the year ended June 30, 2013.
Business Segments and Periods Presented
We have provided a discussion of our results of operations on a consolidated basis and have also provided certain detailed segment information for each of our business segments below for the years ended June 30, 2013 and 2012, in order to provide a meaningful discussion of our business segments. We have organized our operations into three principal segments: concrete sales, manufacturing services, and corporate. We present our segment information along the same lines that our chief executives review our operating results in assessing performance and allocating resources.
For the year ended June 30, 2013:
For the year ended June 30, 2012:
(1) All amounts shown in the Corporate column were incurred at the company headquarter level and did not relate specifically to any of the other reportable segments. Included in the segment loss was the provision for doubtful accounts which was recorded based on by customers and not by segment on the accounts receivable aging.
(2) Segment profit reflects general and administrative expenses not specifically allocated by segments.
Concrete Sales Business
Our concrete sales business segment is comprised of the formulation, production and delivery of the Company’s line of C10-C100 concrete mixtures primarily through our current fixed plant network of two ready mix concrete batching plants in Beijing. For this segment of our business, we procure all of our own raw materials, mix them according to our measured mixing formula, ship the final products in mounted transit mixers to the destination work sites, and, for more sophisticated structures, will pump the mixture and set it into structural frame molds as per structural design parameters.
Manufacturing Services Business
Our manufacturing services business segment is comprised of the formulation, production and delivery of project-specific concrete mixtures primarily through our current portable plant network of 10 rapid assembly and deployment batching plants, located in various provinces throughout China. Our clients will purchase and provide the raw materials in volume on a separate account which we will then proportion and mix according to our formulation for a given project’s specifications. At present, our manufacturing services business segment is primarily dedicated to various high-speed rail projects in China which demand very high quality standards on a time sensitive work schedule.
Consolidated Results of Operations
The following table sets forth key components of our results of operations for the years ended June 30, 2013 and 2012, in US dollars:
Revenue. Our revenue is primarily generated from sales of our advanced ready-mix concrete products and manufacturing services. For the year ended June 30, 2013, we generated total revenue of approximately $74.5 million, as compared to approximately $145.1 million during the year ended June 30, 2012, a decrease of approximately $70.7 million, or 49%. Such decrease was primarily due to our sales generated from the concrete division for the year ended June 30, 2013, which was approximately $69.3 million, a decrease of approximately $65.5 million, or 49%, as compared to $134.8 million for the year ended June 30, 2012. The decrease in revenue attributable to concrete sales was principally due to the decreased demand of concrete sales in line with continuing slowing down of the local housing markets in the areas in which we operate, and the overall slowing of economic growth in China. China’s central government continues to impose restrictions on the purchase of residential apartments in order to regulate housing prices in China, and, in addition, China’s economic growth has been decelerating since 2012, which has caused adverse impact on construction industry in China.
During the year ended June 30, 2013, we continued to supply concrete products to three railway projects in China through our portable plants, specifically our projects located in Anhui Province. We temporarily suspended the operations of some portable plants in the first quarter ended March 31, 2013 due to inspections of high speed railroad projects by the government in China. The three railway projects contributed approximately $5.2 million to our total revenue for the year ended June 30, 2013, a decrease of approximately $5.2 million, or 50%, as compared $10.4 million for the year ended June 30, 2012. The decrease in revenues attributable to our manufacturing services was principally due to the suspension of operations of a number of our portable plants during the year ended June 30, 2013.
Cost of Revenue. Total cost of revenue, which consists of direct labor, rentals, depreciation, other overhead and raw materials, including inbound freight charges, was approximately $60.8 million for the year ended June 30, 2013, as compared to approximately $116.6 million for the year ended June 30, 2012, a decrease of approximately $55.8 million, or 48%. The decrease of cost of revenue was primarily due to the overall decrease in production from our fixed concrete plants in the Beijing area and decreased production on manufacturing services compared to the year ended June 30, 2012.
The cost of revenue on concrete decreased approximately $50.8 million, or 47%, for the year ended June 30, 2013, as compared to the year ended June 30, 2012. Such decrease was due to a decrease in our concrete production leading to a smaller base of raw material purchases with lower overall volume of traditional concrete sales.
Cost of revenue with respect to our manufacturing services was primarily due to our manufacturing services, which decreased approximately $5.0 million, or 53%, during the year ended June 30, 2013, as compared to the same period last year.
Gross Profit. Our gross profit is equal to the difference between our revenue and cost of sales. Total gross profit was approximately $13.7 million for the year ended June 30, 2013, as compared to approximately $28.6 million for the year ended June 30, 2012. Our gross profit for sale of concrete was approximately $13.0 million, or 19% of revenue, for the year ended June 30, 2013, as compared to approximately $27.7 million, or 21% of revenue for the year ended, 2012, a decrease of approximately $14.7 million. The lower gross profit for concrete sales for the year ended June 30, 2013, as compared with the same period last year, reflects lower demand and lower prices for our concrete products in Beijing as compared to the prior fiscal year.
Our gross profit with respect to our manufacturing services was approximately $0.7 million, or 13%, for the year ended June 30, 2013, a decrease of $0.2 million from $0.9 million during the year ended June 30, 2012, while the gross profit margin increased from 8% for the year ended June 30, 2012 to 13% for the year ended June 30, 2013. Such decrease was principally due to the decrease cost of revenue for manufacturing services for year ended June 30, 2013, as a result of the decrease in the number of portable plants. The primary reasons for the margin increase compared to the same period last year were higher production rates at our plants and a decrease in costs of transportation and cost for lease.
Provision for Doubtful Accounts. Provision for doubtful accounts was approximately $15.2 million for the year ended June 30, 2013, a decrease of approximately $7.3 million, as compared to approximately $22.5 million for year ended June 30, 2012. In accordance with our allowance for doubtful accounts policy, at the end of each quarter, we conduct aging analysis of each customer’s arrears to determine whether allowance for doubtful accounts is adequate. In establishing allowance for doubtful accounts, we consider the historical experience, economy, the trend in the construction industry, the expected collectability of amount receivable that past due and the expected collectability of overdue receivable. An estimate of doubtful accounts is recorded when collection of the full amount is no longer probable. Known bad debts are written off against allowance for doubtful accounts when identified. The provision is 15% for accounts receivable past due more than 180 days but less than one year, 60% for accounts receivable past due from one to two years and 75% for accounts receivable past due beyond two years. The allowance for doubtful accounts increased to approximately $36.5 million at June 30, 2013, as compared to approximately $24.9 million at June 30, 2012, as a result of tightening monetary policy by the Chinese government causing shortage in cash and declining business to certain of our customers.
As of June 30, 2013, our accounts and notes receivable aging are as follows:
Selling, General and Administrative Expenses. Selling, general and administrative expenses consist of sales commissions, advertising and marketing costs, office rent and expenses, costs associated with staff and support personnel who manage our business activities, professional and legal fees paid to third parties. We incurred selling, general and administrative expenses of approximately $12.5 million for the year ended June 30, 2013, a decrease of approximately $0.5 million, or 4%, as compared to approximately $13.1 million for the year ended June 30, 2012. The decrease was principally due to a $0.3 million decrease in professional expenses and a $0.2 million decrease in board of director fee.
Research and development expenses. Research and development expenses were approximately $2.2 million and $2.9 million for the years ended June 30, 2013 and 2012, respectively. The Company’s R&D expenditure was maintained at a certain percentage of revenue. The $0.8 million decrease was mainly due to lower R&D expenditures resulting from decreased revenue.
Loss from termination of lease. On September 25, 2012, the Company entered an agreement with a third party to terminate one operating lease, which was originally effective from June 15, 2009 to June 14, 2014. Under the agreement, the fair value of net assets of the related operation were determined to be RMB 130.1 million (approximately $20.6 million) on September 25, 2012, and were settled for RMB 112 million (approximately $17.8 million). The Company recognized approximately $4.1 million loss from the termination of the lease for the year ended June 30, 2013.
Loss realized from disposal of property, plant and equipment. For the year ended June 30, 2013, we incurred $6.0 million loss realized from disposal of property, plant and equipment. During the year ended June 30, 2012, we incurred $1.0 million loss realized from disposal of property, plant and equipment. The increase of $5.0 million was due to disposal of certain portable plants and related equipment.
Impairment loss of long-lived assets. For the year ended June 30, 2013, we incurred $0.3 million impairment of long-lived assets due to the carrying values of some of our portable plants were impaired. During the year ended June 30, 2013, the operations of a number of our portable plants were temporarily suspended. The sum of the discounted future cash flows expected to result from the portable plants and their disposition is less than the carrying value. Therefore we determined the fair value of those portable plants was $0.3 million less than the carrying value at June 30, 2013.
Loss from Operations. We recognized loss from operations of approximately $26.5 million for the year ended June 30, 2013, as compared to loss from operations of approximately $14.3 million for the year ended June 30, 2012, an increase of approximately $12.3 million in loss from operations. Such increase in loss from operations was primarily due to a $14.9 million decrease in gross profits of our concrete sales and manufacturing services, a $4.1 million increase in loss from the termination of a lease and a $5.0 million increase in loss realized from disposal of property, plant and equipment, offset by a $7.3 million decrease in provision of doubtful accounts, a $0.5 million decrease in selling, general and administration expenses and a $0.8 million decrease in research and development expenses.
Income from operations of our concrete sales business for the year ended June 30, 2013, was approximately $3.5 million, a decrease of 87% from income from operations of this segment of $22.4 million for the year ended June 30, 2012. The decrease was primarily due to decrease in our concrete production with lower overall volume of traditional concrete sales and lower manufacturing services sales and a $4.1 million loss from the termination of a lease.
Income from operations of our manufacturing services business for the year ended June 30, 2013, was approximately $0.6 million, as compared to loss from operations of this segment of approximately $3.6 million for the year ended June 30, 2012. The change from loss to profit was primarily due to a decrease of approximately $3.1 million in impairment loss of long-lived assets during the year ended June 30, 2013 as compared to the same period in June 30, 2012.
Our Corporate segment recorded depreciation of approximately $0.3 and $0.4 million for the year ended June 30, 2013 and 2012, respectively. Corporate recorded segment loss of approximately $30.6 million for the year ended June 30, 2013, as compared to recorded segment loss of approximately $36.5 million for the year ended June 30, 2012. The $5.9 million decrease in corporate segment loss was primarily due to a $7.3 million decrease in provision for doubtful accounts, offset by a $1.5 million increase in general and administrative expenses during year ended June 30, 2012.
Other Income (Expense), net. Our other income (expense) consists of valued added tax exemption from the PRC government, interest income (expense), change in fair value of warrants, and other non-operating income (expense). We recorded net other expense of approximately $3.1 million for year ended June 30, 2013, as compared to net other income of approximately $7.9 million for the year ended June 30, 2012, a decrease of approximately $4.8 million, or 61%. The decrease in net other income was mainly due to a $5.0 million decrease in other subsidy income and a $0.3 million decrease in change in fair value of warrants liability, offset by a $0.2 million increase in interest income and $0.3 million increase in other income. Due to the fact that we use recycled raw materials to manufacture our products, the State Administration of Taxation granted us VAT tax exemption from August 2005 to June 2013, and thereafter a two year extension on the VAT tax exemption from June 2013 through June 2015. The VAT tax collected during the aforementioned period from our customers is retained by the Company and recorded as other subsidy income. In addition, we had interest expense of $1.8 million for the year ended June 30, 2013, as compared to $1.6 million for the year ended June, 2012, an increase of $0.2 million related to increased short-term loans and capital leases. The Company also had interest income of $0.7 million for the year ended June 30, 2013, as compared to $0.5 million in year ended June 30, 2012, an increase of $0.2 million related to increased short term investments.
Provision for Income Taxes. Provision for income taxes amounted to approximately $0.2million for the year ended June 30, 2013, as compared to income taxes benefit of $0.1 million for the year ended June 30, 2012. The Company had loss from operations since the quarter ended June 30, 2012. In expecting the loss from operations in the near term, the Company decided to provide a $1.7 million valuation allowances against the deferred tax assets related to provision for doubtful accounts as of June 30, 2013, since management estimates that certain bad debts were more likely than not to be allowed to deduct future pre-tax income by the Chinese tax authorities. We have used recycled raw materials in our concrete production since our inception, which entitled us to an income tax rate reduction from 25% to 15% through June 12, 2015, as granted by the State Administration of Taxation, PRC. Since January 1, 2009, we have been subject to a 15% income tax rate. In the past, Xin Ao has paid the corporate income tax on behalf of China-ACMH, and there could be a potential liability for additional taxes for China-ACMH, though at present the Company is unable to determine the extent of such liability, if any.
Net Loss. We recognized net loss of approximately $23.6 million for year ended June 30, 2013, as compared to net loss of approximately $6.2 million for the year ended June 30, 2012, an increase of $17.4 million in net loss. Such increase in net loss was primarily due to the decrease in gross profits of concrete sales and manufacturing service, and the increase in loss from termination of lease and loss realized from disposal of property, plant and equipment, offset by the decrease in provision of doubtful accounts and R&D expenses.
Liquidity and Capital Resources
As of June 30, 2013, we had cash and cash equivalents of approximately $3.9 million and restricted cash of approximately $6.5 million. As of June 30, 2013, subsidiaries outside the U.S. held, in the aggregate, cash and cash equivalents of approximately $3.9 million and restricted cash of approximately $6.5 million, which represented 100% of our cash. We would be required to accrue and pay U.S. taxes if we were to repatriate these funds. Any company which is registered in mainland China must apply to the State Foreign Exchange Administration for approval in order to remit foreign currency to any foreign country. We currently do not intend to repatriate to the U.S. the cash and short-term investments held by our foreign subsidiaries. However, if we were to repatriate funds to the U.S., we would assess the feasibility and plan any transfer in accordance with foreign exchange regulations, taking into account tax consequences. As we conduct all of our operations in China, the inability to convert cash and short-term investments held in RMB to other currencies should not affect our liquidity. As of June 30, 2013, we had working capital of approximately $38.0 million. We believe that our cash and cash equivalents along with our working capital will be sufficient to fund our operations for the next twelve months.
The following table provides summary information about our net cash flow for financial statement periods presented in this report:
Principal demands for liquidity are for construction or acquisition of concrete mixture stations, purchases of concrete mixers and pump trucks, working capital and general corporate purposes.
Operating Activities. Net cash used in operating activities totaled approximately $16.9 million for the year ended June 30, 2013, was primarily attributable to the net loss adjusted to reconcile to net cash provided by operating activities of $4.6 million, plus the adjustments for $3.3 million of depreciation, $15.2 million of provision for doubtful accounts, $6.0 million of loss realized from disposal of property, plant and equipment, and $4.1 million loss from termination of lease. Net cash used in changes in operating assets and liabilities resulted in a net cash outflow of $21.5million, which mainly included cash outflow in other receivables of $2.0 million, cash outflow in prepayments of $16.2 million, cash outflow in accounts payable $7.8 million, cash outflow in other payables of $2.8 million and cash outflow in taxes payables of $1.0 million, offset by $4.6 million collection of accounts and notes receivable, a $0.9 million collection of inventories, $2.8 million inflow in other receivable from termination of lease and $0.9 million inflow in customer deposits.
Net cash used in operating activities totaled approximately $9.8 million for the year ended June 30, 2012, which was primarily attributable to net loss and adjustments to reconcile to net cash provided by operating activities of $20.8 million, which primarily included adjustments for $4.3 million of depreciation, $3.9 million of deferred tax benefit, and a $22.5 million of provision for doubtful accounts. Net cash used in changes in operating assets and liabilities resulted in a net cash outflow of $30.7 million, which mainly included the increase in accounts and notes receivable of $45.5 million and cash outflow in prepayments of $6.4 million, offset by $1.0 million inflow in other receivables, $1.6 million inflow in long term prepayments, $14.8 million inflow in accounts payable and $4.0 million inflow in other payables.
One factor that had an impact on our net cash provided by operating activities was slower collection of accounts receivable and other receivables on account of the tightening monetary policy by the Chinese government due to its concern over inflation, which affects the real estate and construction industries adversely. Since some of our customers appeared to have the problems of declining business and shortage in cash, our days sales outstanding lengthened to 413 days in the year ended June 30, 2013, compared to 245 days in the year ended June 30, 2012, and accordingly, our accounts receivable turnover ratio was 0.88 in the year ended June 30, 2013, compared to 1.49 in the year ended June 30, 2012.
We aim to make improvements in our cash flow from operating activities stemming from anticipated increases in construction industry activity in Beijing, combined with winning more favorable terms with our suppliers and customers which will be offset by greater working capital needs for our expanding operations.
Investing Activities. Net cash used in investing activities was approximately $5.8 million for year ended June 30, 2013, which was primarily attributable to $5.1 million acquisition for short term investments, $0.3 million purchases of property, plant and equipment and a $1.0 million principal payments of capital lease equipment, offset by $0.7 million proceeds from disposal of property, plant and equipment. Net cash provided by investing activities was approximately $13.0 million for the year ended June 30, 2012, was primarily attributable to $12.4 million net proceeds from investment and $1.0 million proceeds from disposal of property, plant, offset by $0.4 million purchases of property, plant and equipment.
Financing Activities. Net cash provided by financing activities totaled approximately $24.2 million for the year ended June 30, 2013, which was primarily attributable to $54.7 million cash proceeds from bank loans and letters of credit and a $0.2 million decrease in restricted cash, offset by $30.7 million repayments of bank loans. Net cash used in financing activities totaled approximately $2.4 million for the year ended June 30, 2012, was primarily attributable to $28.1 million of loan repayments and $5.6 million increase in restricted cash, offset by $31.2 million in proceeds from a short term loan.
Cash. As of June 30, 2013, we had cash of approximately $3.9 million as compared to approximately $2.4 million as of June 30, 2012. We believe that our cash and revenues from ongoing operations, in addition to closely managing our accounts payable and accounts receivable, is sufficient to meet our liquidity and capital requirements for all of our ongoing operations. However, we may need to raise additional capital in order to undertake our plans for expansion.
Loan Facilities
We had a total of $43.8 million and $19.0 million outstanding on loans and credit facilities as of June 30, 2013 and 2012, respectively.
Short term loans, banks:
*On August 23, 2013, $1.2 million was repaid.
Each of the guarantors identified above are suppliers of the Company. Mr. Xianfu Han and Mr. Weili He are the Company’s Chief Executive Officer and Chief Financial Officer, respectively. Also see Note 11- Related Party Transactions.
Obligations Under Material Contracts
Below is a table setting forth our contractual obligations as of June 30, 2013:
Seasonality
Our manufacturing operations are primarily located in northeastern China, which is extremely cold during the winter months. During such time, we are able to manufacture our advanced ready-mix concrete materials, however many construction projects operate on an abbreviated work schedule, if at all.
Critical Accounting Policies and Estimates
The accompanying consolidated financial statements include the financial statements of China ACM and its wholly owned subsidiaries, BVIACM, China-ACMH, its variable interest entity Xin Ao and its subsidiaries (collectively, the “Company”). All significant inter-company transactions and balances have been eliminated in consolidation. In accordance with FASB ASC 810, Consolidation of Variable Interest Entities, variable interest entities, or VIEs, are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability. All VIEs with which the Company is involved must be evaluated to determine the primary beneficiary of the risks and rewards of the VIE. The primary beneficiary is required to consolidate the VIE for financial reporting purposes. The Company concludes that Xin Ao is a VIE and China ACM is the primary beneficiary. The financial statements of Xin Ao are then consolidated with China ACM’s financial statements.
Our management’s discussion and analysis of our financial condition and results of operations are based on the 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 assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported net sales and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and assumptions. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included, we believe that the following accounting policies are the most critical to aid you in fully understanding and evaluating this management discussion and analysis:
Revenue recognition
Revenue is realized or realizable and earned when four criteria are met:
• Persuasive evidence of an arrangement exists (the Company considers its sales contracts and technical service agreements to be pervasive evidence of an arrangement);
• Delivery has occurred or services have been rendered;
• The seller’s price to the buyer is fixed or determinable; and
•
Collectability of payment is reasonably assured.
The Company sells its concrete products and provides concrete technical services primarily to major local construction companies. Sales agreements are signed with each customer. The agreements list all terms and conditions with the exception of delivery date and quantity, which are evidenced separately in purchase orders. The purchase price of products is fixed in the agreement and customers are not permitted to renegotiate after the contracts have been signed. The agreements include a cancellation clause if the Company or customers breach the contract terms specified in the agreement.
The Company does not sell products to customers on a consignment basis. There is no right of return after the product has been delivered into the location specified by the contract and accepted by the customer. The Company recognizes revenue when title and ownership of the goods are transferred upon shipment to the customer or services are provided by the Company.
Sales revenue represents the invoiced value of goods, net of a value added tax (“VAT”). All of the Company’s concrete products that are sold in the PRC are subject to a Chinese VAT at the rate of 6% of the gross sales price.
The Company includes shipping and handling fee in both revenue and cost of revenue.
Due to the fact that we use recycled raw materials to manufacture our products, the State Administration of Taxation granted us VAT tax exemption from August 2005 to June 2013, and thereafter a two year extension on the VAT tax exemption from June 2013 through June 2015. The VAT tax collected during the aforementioned period from the Company’s customers is retained by the Company and recorded as other subsidy income.
Accounts receivable
During the normal course of business, the Company extends unsecured credit to its customers. Accounts are considered past due after 30 days. In establishing the required allowance for doubtful accounts, management considers the historical experience, economy, trend in the construction industry, the expected collectability of amount receivable that past due and the expected collectability of overdue receivable. Management reviews its accounts receivable each reporting period to determine if the allowance for doubtful accounts is adequate. An estimate for doubtful accounts is recorded when collection of the full amount is no longer probable. Accounts balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovering is considered remote.
Expecting longer collection periods on accounts receivable and higher probability of uncollectable accounts receivable, during the year ended June 30, 2013 the Company changed its estimate of its allowance for doubtful accounts as follows: 15% for accounts receivable past due more than 180 days but less than one year, 60% for accounts receivable past due from one to two years and 75% for accounts receivable past due beyond two years. For the year ended June 30, 2012, the Company’s estimate of its allowance for doubtful accounts was as follows: 5% for accounts receivable past due less than one year, 50% for accounts receivable past due from one to two years and 100% for accounts receivable past due beyond two years.
Impairment review for long-lived assets.
We classify our long-lived assets into: (i) plant and machinery; (ii) transportation equipment, (iii) office and equipment; and (iv) buildings and improvements. The classification is based on the Company’s accounting policy which is set by management. For example, Machinery and equipment is broken down into categories such as plant and machinery, transportation equipment, and office and equipment.
We conduct our review of the long-lived assets held and used by us in accordance with ASC 36-10-35. Whenever events or changes in circumstances (such as technological or other industry changes) indicate that the carrying value of the assets groups may not be recoverable, we will perform a two-step approach to estimate the fair value of our assets groups by first preparing the undiscounted cash flows analysis to obtain such value. If the undiscounted cash value is greater than the carrying value of the assets groups, no impairment is recognized. If the undiscounted cash flows value is less than our carrying costs of our assets groups, then we will perform step 2 by obtaining the fair value by using the discounted cash flows method. Impairment is recognized to the extent that the carrying value of the assets groups exceeds its fair value which was determined through the discounted cash flows method.
We must make various assumptions and estimates regarding estimated future cash flows and other factors in determining the fair values of the respective assets. We use set criteria that are reviewed and approved by various levels of management, and estimate the fair value of our asset groups. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for the underlying assets at such time. Any such resulting impairment charges could be material to our results of operations.
As of June 30, 2013, the fair value of our property, plant and equipment other than the portable plants used in the manufacturing segment exceeded our carrying value of these assets by approximately 990.0% . We used the cash flows model to determine the fair value of these assets. The key assumptions that were included in the model are the revenue generated by the estimated revenue and other subsidy income forecasted by our historical revenues data with no projected growth. We believed these assumptions provided us the best estimates of projecting our future cash flows on these assets, net of any related cash outflow of our cost, expenses and taxes in related to these revenues.
As of March 31, 2013, we recorded an impairment loss of approximately $252,000. The portable plants related to this impairment loss were disposed during the quarter ended June 30, 2013.
As of June 30, 2013, the fair value of our portable plants used in the manufacturing segment exceeded our carrying value of these assets by approximately 21.2% . We used the cash flows model to determine the fair value of these assets. The key assumptions that were included in the model are the revenue generated by the existing services contracts and the current reselling value of the assets. We believed these assumptions provided us the best estimates of projecting our future cash flows on these assets, net of any related cash outflow of our cost, expenses and taxes in related to these revenues.
The estimated fair value of these assets might be lower than their current fair value, thus could result in future impairment charge if potential events will occur to further reduce the current selling price of our production unit sold or increase our cost that are associated with our revenues. In addition, competitive pricing pressure and changes in interest rates could materially and adversely affect our estimates of future net cash flows to be generated by our long-lived assets, and thus could result in future impairment losses.
Income taxes
The Company uses the assets and liability method of accounting for income taxes. Under the assets and liability method, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between financial statement carrying amounts and the tax bases of existing assets and liabilities and operating loss and tax credit carry forward. Under this accounting standard, the effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if it is more likely than not that some portion, or all of, a deferred tax asset will not be realized.
The determination whether uncertainty in income taxes exists and the evaluation of a tax position is a two-step process. The first step is to determine whether it is more likely than not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position. The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50 percent likelihood of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met.
Penalties and interest incurred related to underpayment of income tax are classified as income tax expense in the period incurred.
United States federal, state and local income tax returns prior to 2010 are not subject to examination by any applicable tax authorities.
Value Added Tax
Enterprises or individuals, who sell commodities, engage in repair and maintenance, or import and export goods in the PRC are subject to a value added tax. The standard VAT rate is 6% of gross sales for the Company’s industry. A credit is available whereby VAT paid on the purchases of raw materials used in the production of the Company’s finished products can be used to offset the VAT due on sales of finished products. Since the Company uses recycled raw materials to manufacture its products, the State Administration of Taxation has granted the Company VAT exemption through June 2015.
Financial instruments
The US GAAP accounting standards regarding fair value of financial instruments and related fair value measurements define fair value, establish a three-level valuation hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The three levels of inputs are defined as follows:
Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 inputs to the valuation methodology are unobservable.
Cash, restricted cash, investment, accounts receivable, other assets, short term loans, accounts payable, and accrued expenses and current capital lease obligations qualify as financial instruments, and their carrying amounts are reported in the consolidated balance sheets at face value or cost, which approximate fair value because of the short period of time between the origination of such instruments and their expected realization and their current market rates of interest.
The fair value of the warrants liability was determined using the Cox-Ross-Rubinstein (CRR) Binomial Model, as Level 2 inputs, and recorded the gains or loss in the earnings at each reporting period. Long-lived assets were recorded at fair value on a nonrecurring basis as a result of impairment charges determined using Level 3 inputs. The Level 3 inputs used were management’s projected cash flows.
Stock-based compensation
The Company records stock-based compensation expense at fair value on the grant date and recognize the expense over the employee's requisite service period. The Company’s expected volatility assumption is based on the historical volatility of Company’s stock or the expected volatility of similar entities. The expected life assumption is primarily based on historical exercise patterns and employee post-vesting termination behavior. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The expected dividend yield is based on the Company’s current & expected dividend policy.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to our stockholders.
Recently Issued Accounting Pronouncements
Refer to Note 2 of Notes to Consolidated Financial Statements for a discussion of recent accounting standards and pronouncements.
Interest Rate Risk
At times when we have short-term loans outstanding, we are exposed to interest rate risk due primarily to our short-term bank loans. Although the interest rates for our short-term loans are typically fixed for the terms of the loans, the terms are typically twelve months and interest rates are subject to change upon renewal. The new interest rates are approximately 6.0% for Renminbi bank loans with a term of 12 months or less. The change in interest rates has minimum impact on our bank loans. Our total borrowings that were subject to interests were approximately $19.5 million as of June 30, 2013.
Credit Risk
The Company is exposed to credit risk from its cash in bank and fixed deposits, and accounts receivable. The credit risk on cash in bank and fixed deposits is limited because the counterparties are recognized financial institutions. However, the Company’s cash in bank deposited in the financial institutions in PRC is not insured. Accounts receivable are subjected to credit evaluations. An allowance has been made for estimated irrecoverable amounts which have been determined by reference to past default experience and the current economic environment.
Foreign Exchange Risk
The value of the Renminbi against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. The Renminbi does not fluctuate with the U.S. Dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the Renminbi may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future, PRC authorities may lift restrictions on fluctuations in the Renminbi exchange rate and lessen intervention in the foreign exchange market.
Because substantially all of our earnings and cash assets are denominated in Renminbi, but our reporting currency is the U.S. dollar, fluctuations in the exchange rate between the U.S. dollar and the Renminbi will affect our balance sheet and our earnings per share in U.S. dollars. In addition, appreciation or depreciation in the value of the Renminbi relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue in the future that will be exchanged into U.S. dollars and earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi into foreign currencies.
Most of the transactions of the Company are settled in Renminbi and U.S. dollars. In the opinion of the directors, the Company is not exposed to significant foreign currency risk.
Inflation
Inflationary factors, such as increases in the cost of raw materials and overhead costs, could impair our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of sales revenue if the selling prices of our products do not increase with these increased costs.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable.
Item 8.
Item 8. Financial Statements and Supplementary Data
The full text of our audited consolidated financial statements as of June 30, 2013 and 2012 begins on page of this Report.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) that are designed to ensure that information that would be required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including to our Chief Executive Officer, Chief Operating Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As required by Rule 13a-15 under the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2013. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of June 30, 2013, our disclosure controls and procedures were not effective to satisfy the objectives for which they are intended due to the material weakness in our internal control over financial reporting discussed below.
(b) Management’s annual report on internal control over financial reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Exchange Act defines internal control over financial reporting as a process designed by, or under the supervision of, our principal executive and principal financial officers and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and includes those policies and procedures that:
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and;
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of June 30, 2013. In making this assessment, management used the 1992 COSO framework set forth in the report entitled Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. The COSO framework summarizes each of the components of a company’s internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and communication, and (v) monitoring. Our management has implemented and tested our internal control over financial reporting based on these criteria and did not identify any significant deficiencies and material weaknesses as of June 30, 2013. However, based on the fact that we do not have any full-time accounting personnel who have U.S. GAAP experience, our management has considered this as a material weakness and determined that as of June 30, 2013, the internal control over financial reporting was not effective.
In an effort to remedy this material weakness in the future, we intend to do the following:
Develop a comprehensive training and development plan, for our finance, accounting and internal audit personnel, including our Chief Financial Officer, Financial Manager, and others, in the principles and rules of U.S. GAAP, SEC reporting requirements and the application thereof.
Design and implement a program to provide ongoing company-wide training regarding the Company’s internal controls, with particular emphasis on our finance and accounting staff.
Implement an internal review process over financial reporting to review all recent accounting pronouncements and to verify that the accounting treatment identified in such report have been fully implemented and confirmed by our internal control department. In the future, we will continue to improve our ongoing review and supervision of our internal control over financial reporting.
Hire an individual that possesses the requisite U.S. GAAP experience and education.
Despite the material weakness reported above, our management believes that our consolidated financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented.
(c) Changes in internal control over financial reporting
During the quarter ended June 30, 2013, there were no changes in our internal control over financial reporting identified in connection with the evaluation performed during the fiscal year covered by this report that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this Item is incorporated herein by reference to the section entitled “Directors and Executive Officers and Corporate Governance” of our Proxy Statement related to the 2013 Annual Meeting of Stockholders (the “2013 Proxy Statement”).
Item 11.
Item 11. Executive Compensation
The information required by this Item is incorporated herein by reference to the section entitled “Executive Compensation” of our 2013 Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item is incorporated herein by reference to the section entitled “Security Ownership of Certain Beneficial Owners and Management and Related Matters” of our 2013 Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is incorporated herein by reference to the section entitled “Certain Relationships of Certain Beneficial Owners and Management and Related Matters” of our 2013 Proxy Statement.
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this Item is incorporated herein by reference to the section entitled "Principal Accounting Fees and Services" of our 2013 Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a) Financial Statements
(1)
Financial statements for our company are listed in the index under Item 8 of this document
(2)
Parent company financial information under Rule 5-04 of Regulation S-X
(b) Exhibits
The interactive data files in Exhibit No. 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, and not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
AUDITED FINANCIAL STATEMENTS
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC.
JUNE 30, 2013 AND 2012
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
China Advanced Construction Materials Group, Inc.
We have audited the accompanying consolidated balance sheets of China Advanced Construction Materials Group, Inc. and Subsidiaries as of June 30, 2013 and 2012, and the related consolidated statements of operations and comprehensive loss, shareholders’ equity and cash flows for the years then ended. China Advanced Construction Materials Group, Inc.’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of China Advanced Construction Materials Group, Inc. and Subsidiaries as of June 30, 2013 and 2012, and the results of their operations and cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
/s/ Friedman LLP
New York, New York
September 25, 2013
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2013 AND
(*) Retrospectively restated shares for a 1-for-12 reverse split.
The accompanying notes are an integral part of these consolidated financial statements.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED JUNE 30, 2013 AND 2012
(*) Retrospectively restated shares for a 1-for-12 reverse split.
The accompanying notes are an integral part of these consolidated financial statements.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(*) Retrospectively restated shares for a 1-for-12 reverse split.
The accompanying notes are an integral part of these consolidated financial statements.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 2013 AND 2012
The accompanying notes are an integral part of these consolidated financial statements.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Organization and description of business
China Advanced Construction Materials Group, Inc. (“CADC Delaware”) was incorporated in the State of Delaware on February 15, 2007. CADC Delaware through its 100% owned subsidiaries and its variable interest entities (“VIEs”) (collectively, the “Company”), is engaged in producing general ready-mix concrete, customized mechanical refining concrete, and other concrete-related products that are mainly sold in the People’s Republic of China (“PRC”). CADC Delaware has a wholly-owned subsidiary in the British Virgin Islands, Xin Ao Construction Materials, Inc. (“BVI-ACM”), which is a holding company with no operations. BVI-ACM has a wholly-owned foreign enterprise, Beijing Ao Hang Construction Material Technology Co., Ltd. (“China-ACMH”), and China-ACMH has contractual agreements with an entity which is considered a VIE.
In March and April 2010, Beijing XinAo Concrete Group, our VIE, established five 100% owned subsidiaries in the PRC for consulting, concrete mixing and equipment rental services: (1) Beijing Heng Yuan Zheng Ke Technical Consulting Co., Ltd (“Heng Yuan Zheng Ke”), (2) Beijing Hong Sheng An Construction Materials Co., Ltd (“Hong Sheng An”), (3) Beijing Heng Tai Hong Sheng Construction Materials Co., Ltd (“Heng Tai”), (4) Da Tong Ao Hang Wei Ye Machinery, Equipment Rental Co., Ltd (“Da Tong”) and (5) Luan Xian Heng Xin Technology Co., Ltd (Heng Xin). The purpose of these subsidiaries is to support the Company’s future growth.
On September 20, 2010, CADC Delaware established a 100% owned subsidiary, Advance Investment Holdings Co., Inc. (“AIH”) in the State of Nevada. AIH never commenced operations following its incorporation and was thereafter dissolved on August 30, 2011.
On August 1, 2013, after the completion of the Reverse Split (See note 19), CADC Delaware consummated a reincorporation merger with its newly formed wholly-owned subsidiary, China Advanced Construction Materials Group, Inc. (“China ACM”), a Nevada corporation, for the purpose of changing CADC Delaware’s state of incorporation from Delaware to Nevada.
Note 2 - Summary of significant accounting policies
Basis of presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and have been consistently applied.
Principles of consolidation
The consolidated financial statements reflect the activities of the following subsidiaries and VIEs. All material intercompany transactions have been eliminated.
VIEs are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability. All VIEs with which the Company is involved must be evaluated to determine the primary beneficiary of the risks and rewards of the VIE. The primary beneficiary is required to consolidate the VIE for financial reporting purposes.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Management makes ongoing assessment of whether China ACM is the primary beneficiary of Xin Ao and its subsidiaries. Based upon a series of contractual arrangements, The Company determined that Xin Ao and its subsidiaries are VIEs subject to consolidation and that the Company is the primary beneficiary. Accordingly, the accounts of Xin Ao and its subsidiaries are consolidated with those of the Company.
The carrying amount of the VIEs’ assets and liabilities are as follows:
* Payables to China - ACMH and BVI-ACMH are eliminated upon consolidation.
Use of estimates and assumptions
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. The significant estimates and assumptions made in the preparation of the Company’s consolidated financial statements include the valuation of warrants and share-based payments, deferred income taxes, income tax payable, allowance for doubtful accounts, capital lease obligations, the fair value and useful lives of property, plant and equipment. Actual results could be materially different from those estimates, upon which the carrying values were based.
Foreign currency translation
The reporting currency of the Company is the U.S. dollar. The functional currency of China ACM and BVI-ACM is the U.S. dollar. China-ACMH and its VIEs use their local currency Chinese Renminbi (“RMB”) as their functional currency. In accordance with the US GAAP guidance on Foreign Currency Translation, the Company’s results of operations and cash flows are translated at the average exchange rates during the period, assets and liabilities are translated at the exchange rates at the balance sheet dates, and equity is translated at historical exchange rates. As a result, amounts related to assets and liabilities reported on the consolidated statements of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheets.
Asset and liability accounts at June 30, 2013 and 2012, were translated at RMB 6.19 to $1.00 and RMB 6.31 to $1.00. The average translation rates applied to the consolidated statements of income and cash flows for the years ended June 30, 2013 and 2012, were RMB 6.28 and RMB 6.35 to $1.00, respectively.
Translation 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. The effects of foreign currency translation adjustments are included in stockholders’ equity as a component of accumulated other comprehensive income.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Revenue recognition
Revenue is realized or realizable and earned when four criteria are met:
• Persuasive evidence of an arrangement exists (the Company considers its sales contracts and technical service agreements to be pervasive evidence of an arrangement);
• Delivery has occurred or services have been rendered;
• The seller’s price to the buyer is fixed or determinable; and
• Collectability of payment is reasonably assured.
The Company sells its concrete products and provides concrete technical services primarily to major local construction companies. Sales agreements are signed with each customer. The agreements list all terms and conditions with the exception of delivery date and quantity, which are evidenced separately in purchase orders. The purchase price of products is fixed in the agreement and customers are not permitted to renegotiate after the contracts have been signed. The agreements include a cancellation clause if the Company or customers breach the contract terms specified in the agreement.
The Company does not sell products to customers on a consignment basis. There is no right of return after the product has been delivered into the location specified by the contract and accepted by the customer. The Company recognizes revenue when title and ownership of the goods are transferred upon shipment to the customer or services are provided by the Company.
Sales revenue represents the invoiced value of goods, net of a value added tax (“VAT”). All of the Company’s concrete products that are sold in the PRC are subject to a Chinese VAT at the rate of 6% of the gross sales price.
The Company includes shipping and handling fee in both revenue and cost of revenue.
Financial instruments
The US GAAP accounting standards regarding fair value of financial instruments and related fair value measurements define fair value, establish a three-level valuation hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The three levels of inputs are defined as follows:
Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 inputs to the valuation methodology are unobservable.
Cash, restricted cash, investment, accounts receivable, other assets, short term loans, accounts payable, and accrued expenses qualify and current capital lease obligations as financial instruments, and their carrying amounts are reported in the consolidated balance sheets at face value or cost, which approximate fair value because of the short period of time between the origination of such instruments and their expected realization and their current market rates of interest.
The fair value of the warrants liability was determined using the Cox-Ross-Rubinstein (CRR) Binomial Model, as Level 2 inputs (See Note 9). The fair value of non-current other receivable and long-term capital lease obligations approximate their fair value as interest rates approximate the market rate. The Company’s Long-lived assets were recorded at fair value on a nonrecurring basis as a result of impairment charges determined using Level 3 inputs. The Level 3 inputs used were management’s projected cash flows.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The Company recognized impairment charges of approximately $0.3 million and $3.4 million for the years ended June 30, 2013 and 2012, respectively, related to the impairment in the portable plants used in the manufacturing segment, as further discussed below under Accounting for long-lived assets.
Stock-based compensation
The Company records stock-based compensation expense at fair value on the grant date and recognize the expense over the employee's requisite service period. The Company’s expected volatility assumption is based on the historical volatility of Company’s stock or the expected volatility of similar entities. The expected life assumption is primarily based on historical exercise patterns and employee post-vesting termination behavior. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The expected dividend yield is based on the Company’s current & expected dividend policy.
Cash and cash equivalents
The Company considers all highly liquid investments with the original maturity of three months or less at the date of purchase to be cash equivalents. The Company currently maintains substantially all of its day-to-day operating cash balances with major financial institutions within PRC and US. As of June 30, 2013 and 2012, the Company had deposits in excess of federally insured limits totaling approximately $3.8 million and $1.8 million, respectively. Restricted cash
Restricted cash consists of collateral totaling $6.5 million representing cash deposits for short term loans.
Accounts receivable
During the normal course of business, the Company extends unsecured credit to its customers. Accounts are considered past due after 30 days. In establishing the required allowance for doubtful accounts, management considers the historical experience, economy, trend in the construction industry, the expected collectability of amount receivable that past due and the expected collectability of overdue receivable. Management reviews its accounts receivable each reporting period to determine if the allowance for doubtful accounts is adequate. An estimate for doubtful accounts is recorded when collection of the full amount is no longer probable. Accounts balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovering is considered remote. Write offs for the years ended June 30, 2013 and 2012 approximated $1.7 million and $2.7 million, respectively. The allowance for doubtful accounts was approximately $36.5 million and $24.9 million at June 30, 2013 and 2012, respectively.
Other receivables
Other receivables primarily include other receivables from termination of lease, advances to employees, an unrelated entity, and receivables from an insurance company, VAT tax refund and other deposits. Management regularly reviews aging of receivables and changes in payment trends and records allowance when management believes collection of amounts due are at risk. Accounts considered uncollectible are written off after exhaustive efforts at collection. The allowance for other receivable was approximately $2.2 million and $0.8 million at June 30, 2013 and 2012, respectively
Inventories
Inventories consist of raw materials and are stated at the lower of cost or market, as determined using the weighted average cost method. Management compare the cost of inventories with the market value and an allowance is made for writing down the inventory to its market value, if lower than cost. As of June 30, 2013 and 2012, the Company determined no reserves for obsolescence were necessary.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Short term investments
During May 2013, the Company entered into an investment agreement for a maximum period of two years with a financial investment company, whereby the Company could invest up to approximately RMB 100 million ($16.2 million). The Company can redeem the investment any time within the agreed period with a 30-day notice. The financial investment company invests the Company’s funds in certain financial instruments including bonds, mortgage trust or mutual funds. The rate of return on this investment was guaranteed no less than 7% per annum. The Company’s investment is not subject to market fluctuation; therefore, the Company did not experience gain or loss on its investment. However, the Company’s funds deposited with the financial investment company are not insured. The Company made an investment of approximately $5.1 million in the financial investment company during the year ended June 30, 2013. The Company also had a similar investment agreement with the same financial investment company, which was terminated in October 2011. The Company received approximately $12.4 million cash proceeds from the financial investment company during the year ended June 30, 2012.
During November and December 2011, the Company entered into two two-month agreements with another financial investment company for aggregate amount of RMB 41 million (approximately $6.4 million). Under the agreements, RMB 26 million (approximately $4.1 million) investment expired on January 23, 2012 and RMB 15 million (approximately $2.3 million) investment expired on February 1, 2012. The interest rate was 9% per annum. The Company received $4.1 million cash proceeds plus interest from the above financial investment company on January 21, 2012 and another $2.3 million on February 3, 2012.
Prepayments and advances, and advances on equipment purchases, net
The Company advances monies to certain suppliers for raw materials, plant and equipment, and factory rent. These advances are interest free and unsecured. During the year ended June 30, 2013, the Company recorded a bad debt allowance for advances on equipment purchases for approximately $1.2 million.
Property, plant and equipment
Property, plant and equipment are stated at cost. Expenditures for maintenance and repairs are charged to operations as incurred while additions, renewals and betterments are capitalized. Depreciation is provided over the estimated useful life of each class of depreciable assets and is computed using the straight-line method with 5% residual value. Leasehold improvements are amortized over the lesser of estimated useful lives or lease terms, as appropriate.
The estimated useful lives of assets are as follows:
Accounting for long-lived assets
The Company classifies its long-lived assets into: (i) machinery and equipment; (ii) transportation equipment, (iii) office and equipment; and (iv) buildings and improvements.
Long-lived assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be fully recoverable. It is possible that these assets could become impaired as a result of technology or other industry changes. If circumstances require a long-lived asset or asset group be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques, including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The Company makes various assumptions and estimates regarding estimated future cash flows and other factors in determining the fair values of the respective assets. The Company uses set criteria that are reviewed and approved by various levels of management, and estimates the fair value of the asset or asset group by using discounted cash flow analyses. If these estimates or their related assumptions change in the future, it is required to record impairment charges for the underlying assets at such time. Any such resulting impairment charges could be material to our results of operations.
If the value of an asset is determined to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are reported at the lower of the carrying amount or the fair value, less disposition costs. The Company recognized approximately $0.3 million and $3.4 impairment charges relating to the portable plants for the years ended June 30, 2013 and 2012, respectively.
Competitive pricing pressure and changes in interest rates could materially and adversely affect our estimates of future net cash flows to be generated by the long-lived assets, and thus could result in future impairment losses.
Income taxes
The Company accounts for income taxes in accordance with ASC 740, Income Taxes, which requires the Company to use the assets and liability method of accounting for income taxes. Under the assets and liability method, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between financial statement carrying amounts and the tax bases of existing assets and liabilities and operating loss and tax credit carry forward. Under this accounting standard, the effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if it is more likely than not that some portion, or all of, a deferred tax asset will not be realized.
ASC 740-10, Accounting for Uncertainty in Income Taxes defines uncertainty in income taxes and the evaluation of a tax position is a two-step process. The first step is to determine whether it is more likely than not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position. The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50 percent likelihood of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met.
Penalties and interest incurred related to underpayment of income tax are classified as income tax expense in the period incurred.
United States federal, state and local income tax returns prior to 2010 are not subject to examination by any applicable tax authorities.
Value Added Tax
Enterprises or individuals, who sell commodities, engage in repair and maintenance, or import and export goods in the PRC are subject to a value added tax. The standard VAT rate is 6% of gross sales for the Company’s industry. A credit is available whereby VAT paid on the purchases of raw materials used in the production of the Company’s finished products can be used to offset the VAT due on sales of finished products. Since the Company uses recycled raw materials to manufacture its products, the State Administration of Taxation has granted the Company VAT exemption through June 2015.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Research and development, advertising and repair and maintenance
Research and development, advertising and repair and maintenance costs are expensed as incurred. The cost of materials and equipment that are acquired or constructed for research and development activities, and have alternative future uses, either in research and development, marketing, or sales, are classified as property and equipment, and depreciated over their estimated useful lives. Research and development costs for the years ended June 30, 2013 and 2012, were approximately $2.2 million and $2.9 million, respectively. Advertising costs for the years ended June 30, 2013 and 2012, were approximately $0.6 million and $0.2 million, respectively. Repair and maintenance costs for the years ended June 30, 2013 and 2012, were $0.9 million and $1.2 million, respectively.
Earnings (loss) per share
The Company reports earnings (loss) per share in accordance with the US GAAP, which requires presentation of basic and diluted earnings (loss) per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings (loss) per share excludes dilution and is computed by dividing income (loss) available to common shareholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts, such as warrants, options, restricted stock based grants and convertible preferred stock, to issue common stock were exercised and converted into common stock. Common stock equivalents having an anti-dilutive effect on earnings per share are excluded from the calculation of diluted earnings per share. Diluted loss per share is the same as basic loss per share since the addition of any contingently issuable share would be anti-dilutive.
ASC 260-10-55 requires that stock dividends or stock splits be accounted for retroactively if the stock dividends or stock splits during the period, or retroactively if the stock dividends or stock splits occur after the end of the period but before the release of the financial statements, by considering it outstanding of the entirety of each period presented. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.
All share and per share amounts used in the Company’s consolidated financial statements and notes thereto have been retroactively restated to reflect the 1-for-12 reverse stock split effective on August 1, 2013 (See Note 19).
Comprehensive income
Comprehensive income consists of net income and foreign currency translation adjustments.
Reclassifications
Certain amounts from prior periods have been reclassified to conform to the current period’s presentation. The reclassification did not have any impact to the consolidated statements of operations and comprehensive loss.
Recently issued accounting pronouncements
In February 2013 the FASB issued an accounting standards update ("ASU") No. 2013-02 "Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income," requiring new disclosures for items reclassified out of accumulated other comprehensive income ("AOCI"), including (1) changes in AOCI balances by component and (2) significant items reclassified out of AOCI. The guidance does not amend any existing requirements for reporting net income or OCI in the financial statements. The standards update was effective for reporting periods beginning after December 15, 2012, to be applied prospectively. The Company is currently evaluating the impact of adopting this standard on its consolidated financial statements. As this guidance only requires expanded disclosures, the adoption of this guidance is not expected to have a significant impact on the Company's consolidated financial statements.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
In March 2013, the FASB issued an accounting standards update (“ASU”) No. 2013-05 “Foreign Currency Matters (Topic 830): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity,’ requiring the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. The standards update is effective prospectively for fiscal years and interim reporting periods within those years beginning after December 15, 2013. Early adoption is permitted. The Company does not expect the adoption of this guidance will have a significant impact on the Company's consolidated financial statements.
In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of Unrecognized Tax Benefit When a Net Operating Loss Carryforward, A Similar Tax Loss, or a Tax Credit Carryforward Exists (A Consensus the FASB Emerging Issues Task Force). ASU 2013-11 provides guidance on financial statement presentation of unrecognized tax benefit when a net operating loss carrforward, a similar tax loss, or a tax credit carryforward exists. The FASB’s objective in issuing this ASU is to eliminate diversity in practice resulting from a lack of guidance on this topic in current U.S. GAAP. This ASU applies to all entities with unrecognized tax benefits that also have tax loss or tax credit carryforwards in the same tax jurisdiction as of the reporting date. This amendment is effective for public entities for fiscal years beginning after December 15, 2013 and interim periods within those years. The company does not expect the adoption of this standard to have a material impact on the Company’s consolidated financial statements.
Note 3 - Supplemental disclosure of cash flow information
For the years ended June 30, 2013 and 2012, the Company paid interest in the amount of approximately $1.8 million and $1.2 million, respectively.
Cash payments for income tax for the years ended June 30, 2013 and 2012 were $1.3 million and $3.4 million, respectively.
Non-cash investing and financing activities
For the year ended June 30, 2013, the Company transferred accounts receivable of $34.8 million, inventory of $0.1 million, long term deferred expenses of $1.3 million, property, plant and equipment of $0.3 million, accounts payable of $16.6 million and other payables of $0.4 million to the lessor to settle the termination of one of the Company’s leases (See Note 5).
For the year ended June 30, 2013, the Company acquired property, plant and equipment under capital lease agreements for approximately $7.4 million (See note 6).
For the year ended June 30, 2013, the Company had other payables of approximately $0.9 million as a result of purchase of property, plant and equipment that has not been paid. The Company had other receivables of approximately $3.9 million as a result of disposal of property, plant and equipment that has not been collected. The Company offset other payables with disposal of property, plant and equipment for approximately $0.1 million.
Note 4 - Accounts and notes receivable
Accounts and notes receivable are generated from concrete products sold and technological consulting services provided to the Company’s customers and other concrete companies with which the Company conducts business. The payment terms are defined in the respective contracts.
Expecting longer collection periods on accounts receivable and higher probability of uncollectable accounts receivable, during the year ended June 30, 2013 the Company changed its estimate of its allowance for doubtful accounts as follows: 15% for accounts receivable past due more than 180 days but less than one year, 60% for accounts receivable past due from one to two years and 75% for accounts receivable past due beyond two years. The allowance for doubtful accounts was approximately $36.5 million and $24.9 million at June 30, 2013 and 2012, respectively.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Accounts and notes receivable and allowance for doubtful accounts consisted of the following:
Note 5 - Other receivables and other receivable from termination of lease
Other receivables from termination of lease
On September 25, 2012, the Company entered an agreement with a third party to terminate one operating lease, which was originally effective from June 15, 2009 to June 14, 2014. Under the agreement, the fair value of net assets of the related operation were determined to be RMB 130.1 million (approximately $20.6 million) on September 25, 2012 (the closing date), and were settled for RMB 112 million (approximately $17.8 million). The Company recognized approximately $4.1 million loss from the termination of lease for year ended June 30, 2013. As of June 30, 2013, the Company has received approximately $4.0 million of the total $17.8 million, and the remaining $13.8 million proceeds will be paid in installments with no interest bearing by December 31, 2014. In connection with this transaction, we have returned $1.2 million to the lessor as it was considered as part of the $20.6 million net assets. Since the note is interest-free, the Company has imputed the interest rate based on bank borrowing rate of 7%, imputed interest was approximately $1.2 million at December 31, 2012. At June 30, 2013, the receivables from termination of lease had a net balance of approximately $12.6 million, net of allowance of $0.7 million and discount on note of $0.7 million.
Other receivables and allowance for doubtful accounts consisted of the following:
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
As of the disposal date, the book value of the net assets underlying the lease and the determination of the $4.1 million loss is as follows:
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 6 - Property, plant and equipment
Property, plant and equipment consist of the following:
Depreciation expense for the years ended June 30, 2013 and 2012 amounted to approximately $3.3 million and $4.4 million, respectively. Accumulated depreciation and depreciation expense for the leased equipment were both $0.2 million for the year ended June 30, 2013.
(A) Capital lease
In January 2013, the Company entered into two lease agreements with a third party to lease eight concrete pump trucks for total lease payments of approximately of $6.6 million. The lease term is for three years, starting from January 2013 to January 2016 with monthly lease payment of approximately $0.2 million and interest rate per annum of 7.68% . The ownership of the equipment will be transferred to the Company if there is no default of the lease payment within the three-year lease term (see Note 10). The Company recognized approximately $0.2 million of interest expense and $0.2 million of depreciation expense and accumulated depreciation related to the lease equipment for the year ended June 30, 2013.
In June 2013, the Company entered into another lease agreement with a third party to lease twenty-eight concrete mixer trucks for total lease payments of approximately of $1.0 million. The lease terms range from 5 to 27 months, from June 2013 to September 2015 , interest rate per annum of 7.98% per annum. The ownership of the equipment will be transferred to the Company if there is no default of the lease payment within the lease term (see Note 10). Both lease payments and depreciation of the assets will commence when put in use in July 2013.
Note 7 - Prepayments and advances
Prepayments consisted of the following:
Note 8- Short term loans, banks and Bank guarantees
Short term loans, banks:
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Short term loans represent amounts due to banks that are due within one year or on demand. As of June 30, 2013 and 2012, the outstanding balances on these loans consisted of the following:
*On August 23, 2013, $1.2 million was repaid.
The above guarantors are various suppliers of the Company. Mr. Han Xianfu and Mr. He Weili are the Company’s Chief Executive Officer and Chief Financial Officer, respectively. Also see Note 11 - Related party transactions.
Interest expense on short-term loans for the years ended June 30, 2013 and 2012 amounted to approximately $1.5 million and $1.3 million, respectively.
Bank guarantees:
Bank guarantees represent amounts due to issuing banks after beneficiary vendors completed shipments and presented the letters of credit to advising banks. Bank guarantees are noninterest-bearing and due within six months. As of June 30, 2013 and 2012, the outstanding balances on these bank guarantees consisted of the following:
* On July 1, 2013, $4.8 million was repaid.
Note 9 -Warrants liability
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
A contract that would otherwise meet the definition of a derivative but is both (a) indexed to the Company’s own stock and (b) classified in stockholders’ equity in the statement of financial position is not considered a derivative financial instrument. This accounting standard provides a two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the scope exception.
The Company’s warrants had down-round ratchet provision on the exercise price. As a result, the warrants were not considered indexed to the Company’s own stock, and were classified as liabilities with all future changes in the fair value of these warrants recognized in earnings until the warrants expired on June 11, 2013.
These common stock purchase warrants did not trade in an active securities market, and as such, their fair value was estimated by using the Cox-Ross-Rubinstein (CRR) Binomial Model using the following assumptions:
Expected volatility was based on the historical volatility of the Company’s common stock. The Company had no reason to believe future volatility over the expected remaining life of these warrants was likely to differ materially from historical volatility. The expected life was based on the remaining term of the warrants. The risk-free interest rate was based on U.S. Treasury securities according to the remaining term of the warrants. The expected dividend yield was based on the Company’s current and expected dividend policy.
The following table sets forth by level within the fair value hierarchy the warrants liability that was accounted at fair value on a recurring basis.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following is a reconciliation of the beginning and ending balances:
Note 10 - Capital lease obligations
Capital lease obligations consist of the following:
Future annual capital lease payments approximately consist of the following:
Note 11- Related party transactions
Other payables - shareholders
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Mr. He Weili, a major shareholder, leased office space to the Company which was terminated on December 31, 2011. For the years ended June 30, 2013 and 2012, the Company recorded rent expense to the shareholder of $0 and $93,000, respectively. As of June 30, 2013 and 2012, approximately $0 and $53,000 remained unpaid, and were included in other payables - shareholders.
Two shareholders advanced funds to BVI-ACM, for working capital purposes. The loans are non-interest bearing, unsecured, and are payable in cash on demand. These two shareholders and officers of the Company also guarantee some of the Company’s short-term loans payable to banks (see Note 8).
Total other payables - shareholders consisted of the following:
Note 12- Income taxes
(a) Corporate income tax
China ACM was organized in the United States. China ACM had no taxable income or loss for income tax purposes for the year ended June 30, 2013, which excludes $62,706 stock based compensation expenses and gain in fair value of warrant liabilities of $132,427. As of June 30, 2013, net operating loss carry forward for United States income taxes was approximately $1.7 million. The net operating loss carry forwards are available to reduce future years’ taxable income through year 2031. Management believes that the realization of the benefits from these losses appears uncertain due to the Company’s limited operating history and continued losses in United States companies. Accordingly, the Company has provided a 100% valuation allowance on the deferred tax asset to reduce the asset to zero. The net changes in the valuation allowance for the years ended June 30, 2013 and 2012 were a decrease of approximately $49,000 and $19,000, respectively. Management reviews this valuation allowance periodically and makes adjustments accordingly.
BVI-ACM was incorporated in the British Virgin Islands (“BVI”) and is not subject to income taxes under the current laws of the British Virgin Islands.
China-ACMH and VIEs-Chinese operations
All of the Company’s income is generated in the PRC, through VIEs. The Company’s VIE entities have cumulative undistributed earnings of approximately $17.8 million and $40.9 million as of June 30, 2013 and 2012, respectively, included in consolidated retained earnings and will continue to be indefinitely reinvested in the PRC. Accordingly, no provision has been made for U.S. deferred taxes related to future repatriation of these earnings.
China-ACMH and VIEs are governed by the income tax laws of the PRC and the income tax provision in respect to operations in the PRC is calculated at the applicable tax rates on the taxable income for the periods based on existing legislation, interpretations and practices in respect thereof. Under the Chinese Enterprise Income Tax (“EIT”) law, the statutory corporate income tax rate applicable to most companies is 25%. In 2009, Xin Ao has applied and received the Enterprise High-Tech Certificate. The certificate was awarded based on Xin Ao’s involvement in producing high-tech products, its research and development, as well as its technical services. As granted by the State Administration of Taxation of the PRC, Xin Ao was entitled to an income tax reduction from 25% to 15% until June 12, 2015.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
In accordance with the EIT Law, enterprises established under the laws of foreign countries or regions and whose “place of effective management” is located within the PRC territory are considered PRC resident enterprises and subject to the PRC income tax at the rate of 25% on worldwide income. The definition of “place of effective management” refers to an establishment that exercises, in substance, and among other items, overall management and control over the production and business, personnel, accounting, and properties of an enterprise. No detailed interpretation of guidance has been issued to define “place of effective management”. Furthermore, the administrative practice associated with interpreting and applying the concept of “place of effective management” is unclear. If the Company’s non-PRC incorporated entities are deemed PRC tax residents, such entities would be subject to PRC tax under the New EIT Law. The Company has analyzed the applicability of this law, and for each of the applicable periods presented, the Company has not accrued for PRC tax on such basis. The Company continues to monitor changes in the interpretation and/or guidance of this law.
The EIT Law also imposes a 10% withholding income tax, subject to reduction based on tax treaty where applicable, for dividends distributed by a foreign invested enterprise to its immediate holding company outside China. Such dividends were exempted from PRC tax under the previous income tax law and regulations. The Company considers permanently reinvested undistributed earnings of Chinese operations located in the PRC. As a result, there is no deferred tax expense related to withholding tax on the future repatriation of these earnings.
Loss before provision for income taxes consisted of:
Provision (Benefit) for income taxes consisted of:
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Significant components of deferred tax assets were as follows:
As of June 30, 2013, the Company believes it is more likely than not that future pre-tax income from its China operations will be generated to realize its deferred tax. The Company also provided approximately $1.7 million valuation allowance against deferred tax assets related to its allowance for doubtful accounts as management estimates that certain bad debts were more than likely not to be allowed to deduct future pre-tax income by the Chinese tax authorities.
The Company has incurred losses from operations during all periods presented. Accordingly, management provided approximately $0.6 million valuation allowances against the deferred tax assets related to the Company’s U.S. operations as of June 30, 2013, since the deferred tax benefits of the net operating loss carry forwards in the U.S. might not be utilized.
Taxes payable consisted of the following:
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the years ended June 30, 2013, and 2012.
*This represents the expenses (income) incurred by the Company that are not subject to PRC income taxes during the years..
(b) Uncertain tax positions
There were no unrecognized tax benefits as of June 30, 2013 and 2012. Management does not anticipate any potential future adjustments in the next twelve months which would result in a material change to its tax positions. For the years ended June 30, 2013 and 2012, the Company did not incur any interest and penalties.
Note 13 - Shareholders’ equity
Warrants
The warrants issued to a placement agent from a private placement which occurred in June 2008 expired in June 2013.
Following is a summary of the investor warrants activity:
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Stock Option Plan
Under the employee stock option plan, the Company’s stock options expire ten years from the date of grant. On October 3, 2008, the Company entered into a one-year agreement with one of the Company’s board of directors. In connection with his services, the Company issued an aggregate of 4,167 options of the Company’s common stock at an exercise price of $34.80 per share. The options vested in equal quarterly installments over the first year of the agreement. As of June 30, 2012, all of the 4,167 options have been fully vested.
In January, 2010, the Company appointed a CFO who was also the President of the Company. On November 14, 2011, the Company entered into an employee termination agreement with the President and CFO. Upon termination of his service, all of his vested 8,125 option were forfeited.
The following is a summary of the stock option activity:
For the years ended June 30, 2013 and 2012, the Company recognized $0 as compensation expense under its stock option plan.
Restricted Stock Grants
Restricted stock grants are measured based on the market price on the grant date. The Company has granted restricted shares of common stock to the board of directors, senior management and consultants.
For the year ended June 30, 2013, the Company granted 833 shares of restricted stock to a former director vesting immediately. For the year ended June 30, 2012, the Company granted 4,167 restricted shares to five former and current directors for one year of service vesting quarterly from the respective grant date.
During May, 2010, the Company entered into an agreement with a communication consultant and agreed to grant 833 restricted shares of common stock on an annual basis with 208 restricted shares of common stock vesting quarterly. The service agreement was terminated on December 31, 2011 and the Company agreed to issue 347 restricted shares to the consultant for the service provided from June to September 2011. Accordingly, 208 shares were issued on October 14, 2011 at a value of $4,125 and 139 shares were issued on October 31, 2011 at a value of $3,767.
For the years ended June 30, 2013 and 2012, the Company recognized $62,706 and $132,641 of compensation expenses related to restricted stock grants, respectively. The total unrecognized share-based compensation expense as of June 30, 2013 was $0.
Following is a summary of the restricted stock grants:
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 14- Reserves and dividends
The laws and regulations of the PRC require that before a foreign invested enterprise can legally distribute profits, it must first satisfy all tax liabilities, provide for losses in previous years, and make allocations, in proportions determined at the discretion of the board of directors, after the statutory reserves. The statutory reserves include the surplus reserve fund and the common welfare fund.
The Company is required to transfer 10% of its net income, as determined in accordance with the PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital. The remaining reserve to fulfill the 50% registered capital requirement amounted to approximately $2.0 million as of June 30, 2013 and 2012.
The transfer to this reserve must be made before distribution of any dividends to the Company’s shareholders. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital.
The Chinese government restricts distributions of registered capital and the additional investment amounts required by foreign invested enterprises. Approval by the Chinese government must be obtained before distributions of these amounts can be returned to the shareholders.
Note 15 - Loss per share
The basic and diluted loss per share for the years ended June 30, 2013 and 2012 are as follows:
For the years ended June 30, 2013 and 2012, 0 and 48,760 warrants outstanding were excluded in the diluted EPS calculation because their effect was anti-dilutive, respectively.
Note 16 - Employee pension
The Company offers a discretionary pension fund, a defined contribution plan, to eligible employees. The pension includes two parts: the first to be paid by the Company is 20% of the employee’s actual salary from the prior year. The other part, paid by the employee, is 8% of the actual salary. The Company’s contributions of employment benefits, including pension were approximately $0.7 million and $0.6 million for the years ended June 30, 2013 and 2012, respectively.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 17 - Commitments and contingencies
Lease Commitments
The Company entered into a lease agreement for a manufacturing plant with an unrelated party which expires on October 31, 2013, with annual payments of approximately $215,000. On August 31, 2010, the Company entered a lease agreement to lease office space from a third party, starting from November 1, 2010 to October 31, 2013, with annual payments of approximately $382,000.. On April 30, 2012, the Company entered a lease agreement to lease new office space from a third party, from May 1, 2012 to March 28, 2021, with annual payments of approximately $420,000, with three different lease terms, each having three-year expiration periods which will be automatically renewed for ensuring three-year terms and so on if the office building is not acquired or demolished by the city government.
The Company entered into three five-year and one four-year operating lease agreements for four manufacturing plants with various unrelated parties for a total monthly payment of $232,000. Certain lease payments have been prepaid and included in the prepayments, which are being amortized over the life of these leases. Three of the lease agreements were terminated early on November 30, 2010, September 25, 2012 and March 31, 2013.
Total operating lease expenses for the years ended June 30, 2013 and 2012, were approximately $2.2 million and $2.8 million, respectively. Operating lease expense is included in cost of revenue, selling, general, and administrative expenses. Future annual lease payments, net of rent prepayment non-cancelable operating leases with a term of one year or more consist of the following:
Legal Contingencies
From time to time, the Company is a party to various legal actions arising in the ordinary course of business. The Company accrues costs associated with these matters when they become probable and the amount can be reasonably estimated. Legal costs incurred in connection with loss contingencies are expensed as incurred. The Company’s management does not expect any liability from the disposition of such claims and litigation individually or in the aggregate would have a material adverse impact on the Company’s consolidated financial position ,results of operations and cash flows.
Following is the summary of the current litigation:
On July 26 2011, the Company issued a press release announcing that its board of directors received a preliminary, non-binding offer from its Chairman and Chief Executive Officer, Mr. Xianfu Han, and its Vice Chairman and Chief Operating Officer, Mr. Weili He, to acquire all of the outstanding shares of the Company’s common stock not currently owned by them in a going private transaction at a proposed price of $2.65 per share in cash (“Proposed Transaction”).
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Since July 29, 2011, multiple class action complaints (the “Stockholder Actions”) have been filed against the Company and its Board of Directors in the Court of Chancery of the State of Delaware, generally alleging that the Company and all of our directors breached their fiduciary duties in connection with the receipt by the Company of a preliminary, non-binding offer from Xianfu Han, the Company’s Chairman and Chief Executive Officer, and Weili He, the Company’s Vice Chairman and Chief Operating Officer, to acquire all of the outstanding shares of our common stock not currently owned by them in a going private transaction at a proposed price of $2.65 per share in cash (the “Proposed Transaction”). The Stockholder Actions have been consolidated under the caption In re China Advanced Construction Materials Group Litigation, Consolidated C.A. No. 6729-CS. The Stockholder Actions seek, among other things, to declare that the Proposed Transaction is unfair, unjust and inequitable, to enjoin the Company from taking any steps necessary to accomplish or implement the Proposed Transaction, and damages in the event the Proposed Transaction is consummated.
On August 14, 2012, the plaintiffs in the Stockholder Actions requested that the case be dismissed and the court approved the dismissal. The Company considers the matter to be concluded.
Merger Agreement and Termination Agreement
On October 24, 2011, the Company announced that it has entered into a definitive agreement and plan of merger with Novel Gain Holdings Limited, a British Virgin Islands company ("Novel Gain"), CACMG Acquisition, Inc., a Delaware corporation and a wholly owned, direct subsidiary of Novel Gain ("Merger Sub"), Mr. Xianfu Han and Mr. Weili He, pursuant to which Merger Sub will merge with and into the Company with the Company continuing as the surviving corporation and a wholly owned subsidiary of Novel Gain.
Under the terms of the merger agreement, each share of the Company Common Stock issued and outstanding immediately prior to the effective time of the merger will be converted into the right to receive $2.65 in cash without interest, except for (i) shares in respect of which appraisal rights have been properly exercised under Delaware law, and (ii) shares owned by Novel Gain and Merger Sub (including shares to be contributed to Novel Gain by Messrs. Han and He (the "Rollover Investors") pursuant to a rollover agreement between Novel Gain and the Rollover Investors immediately prior to the effective time of the merger), which shares will be cancelled without the Rollover Investors receiving any consideration.
On July 9, 2012, the Board of Directors of the Company, acting on the unanimous recommendation of the Special Committee of the Board of Directors, determined to terminate the merger agreement based on the determination by all parties that the conditions to consummate the Merger cannot be satisfied, and the Company and the other parties to the Merger Agreement entered into the Termination of Agreement and Merger Agreement to terminate the Merger Agreement. The termination takes effect immediately, and no fees are payable by the Company or the other parties in connection therewith.
Termination of employment
On November 14, 2011, the Company entered into an employee termination agreement (the “Termination Agreement”) with the Company’s President and Chief Financial Officer, pursuant to which his employment with the Company terminated on the date of filing of its quarterly report on Form 10-Q for the fiscal quarter ended September 30, 2011. The Termination Agreement provides that the termination of Mr. Goodwin’s employment is by mutual agreement and not for “cause” or “good reason.” Pursuant to the Termination Agreement, the Company is required to pay (i) within five business days following the termination of his employment, a fee equal to $45,000, and (ii) within five business days after the date that the Form 15 deregistering the common stock of the Company with the SEC becomes effective under the Securities Exchange Act of 1934, as amended (the “Act”), an additional fee equal to $45,000. In addition, the Company agreed to use reasonable efforts to remove the former officer as a defendant in the class action lawsuits identified in Part II, Item 1 “Legal Proceedings”, on the basis that he was not party either to the management buyout proposal or to the Board of Director’s review of such proposal and so long as is a named defendant in such suits, and prior to the deregistration of the Company’s common stock under the Act, use commercially reasonable efforts to obtain and maintain D&O liability insurance which provides the same rights and benefits as are accorded to the most favorably insured of the Company’s directors (provided that such insurance is not prohibited by the Merger Agreement).
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 18 - Business Segments
The Company’s operations are classified into three reportable segments that provide different products or services. The Company is engaged in the business of selling concrete and manufacturing concrete. Separate segments are required because each business unit is subject to different production and technology strategies.
For the year ended June 30, 2013:
For the year ended June 30, 2012:
(1) All amounts shown in the Corporate column were incurred at the company headquarter level and did not relate specifically to any of the other reportable segments. Included in the segment loss was the provision for doubtful accounts which was recorded based on by customers and not by segment on the accounts receivable aging.
(2) Segment loss of corporate reflected general and administrative expenses not specifically allocated by segments.
Note 19 - Subsequent events
On August 1, 2013, the Company effectuated a 1-for-12 reverse stock split of its issued and outstanding shares of common stock. The reverse stock split did not change the authorized numbers of shares of the Company’s common stock or its par value.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC.
SCHEDULE 1 - CONDENSED PARENT COMPANY BALANCE SHEETS
AS OF JUNE 30, 2013 AND
(*) Retrospectively restated shares for a 1-for-12 reverse split.
The accompanying condensed notes are an integral part of Schedule 1.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC.
SCHEDULE 1 - CONDENSED PARENT COMPANY STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED JUNE 30, 2013 AND 2012
The accompanying condensed notes are an integral part of Schedule 1.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC.
SCHEDULE 1 - CONDENSED PARENT COMPANY STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 2013 AND 2012
The accompanying condensed notes are an integral part of Schedule 1.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC.
CONDENSED NOTES TO SCHEDULE 1
1. Basis of presentation
Certain information and footnote disclosures normally included in financial statements prepared in conformity with generally accepted accounting principles have been condensed or omitted. The Company’s investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiaries.
2. Restricted net assets
Schedule I of Article 5-04 of Regulation S-X requires the condensed financial information of registrant shall be filed when the restricted net assets of consolidated subsidiaries exceed 25 percent of consolidated net assets as of the end of the most recently completed fiscal year. For purposes of the above test, restricted net assets of consolidated subsidiaries shall mean that amount of the registrant’s proportionate share of net assets of consolidated subsidiaries (after intercompany eliminations) which as of the end of the most recent fiscal year may not be transferred to the parent company by subsidiaries in the form of loans, advances or cash dividends without the consent of a third party (i.e., lender, regulatory agency, foreign government, etc.).
The condensed parent company financial statements have been prepared in accordance with Rule 12-04, Schedule I of Regulation S-X as the restricted net assets of the subsidiaries of China Advanced Construction Materials Group, Inc. exceed 25% of the consolidated net assets of China Advanced Construction Materials Group, Inc. The ability of our Chinese operating affiliates to pay dividends may be restricted due to the foreign exchange control policies and availability of cash balances of the Chinese operating subsidiaries. Because a significant portion of our operations and revenues are conducted and generated in China, a significant portion of our revenues being earned and currency received are denominated in Renminbi (RMB). RMB is subject to the exchange control regulation in China, and, as a result, we may be unable to distribute any dividends outside of China due to PRC exchange control regulations that restrict our ability to convert RMB into US Dollars.
3. Shareholders’ equity
Warrants
The warrants issued to a placement agent from a private placement which occurred in June 2008 expired in June 2013.
Following is a summary of the investor warrants activity:
Stock Option Plan
Under the employee stock option plan, the Company’s stock options expire ten years from the date of grant. On October 3, 2008, the Company entered into a one-year agreement with one of the Company’s board of directors. In connection with his services, the Company issued an aggregate of 4,167 options of the Company’s common stock at an exercise price of $34.80 per share. The options vested in equal quarterly installments over the first year of the agreement. As of June 30, 2012, all of the 4,167 options have been fully vested.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC.
CONDENSED NOTES TO SCHEDULE 1
In January, 2010, the Company appointed a CFO who was also the President of the Company. On November 14, 2011, the Company entered into an employee termination agreement with the President and CFO. Upon termination of his service, all of his vested 8,125 option were forfeited.
The following is a summary of the stock option activity:
For the years ended June 30, 2013 and 2012, the Company recognized $0 as compensation expense under its stock option plan.
Restricted Stock Grants
Restricted stock grants are measured based on the market price on the grant date. The Company has granted restricted shares of common stock to the board of directors, senior management and consultants.
For the year ended June 30, 2013, the Company granted 833 shares of restricted stock to a former director vesting immediately. For the year ended June 30, 2012, the Company granted 4,167 restricted shares to five former and current directors for one year of service vesting quarterly from the respective grant date.
During May, 2010, the Company entered into an agreement with a communication consultant and agreed to grant 833 restricted shares of common stock on an annual basis with 208 restricted shares of common stock vesting quarterly. The service agreement was terminated on December 31, 2011 and the Company agreed to issue 347 restricted shares to the consultant for the service provided from June to September 2011. Accordingly, 208 shares were issued on October 14, 2011 at a value of $4,125 and 139 shares were issued on October 31, 2011 at a value of $3,767.
For the years ended June 30, 2013 and 2012, the Company recognized $62,706 and $132,641 of compensation expenses related to restricted stock grants, respectively. The total unrecognized share-based compensation expense as of June 30, 2013 was $0.
Following is a summary of the restricted stock grants:
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC.
CONDENSED NOTES TO SCHEDULE 1
4. Subsequent event
On August 1, 2013, the Company effectuated a 1-for-12 reverse stock split of its issued and outstanding shares of common stock. The reverse stock split did not change the authorized numbers of shares of the Company’s common stock or its par value.
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CHINA ADVANCED CONSTRUCTION MATERIALS GROUP, INC.
By: /s/ Xianfu Han
Xianfu Han
Chief Executive Officer
(principal executive officer)
Date:
September 25, 2013
Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Title
Date
Signature
/s/ Xianfu Han
Chief Executive Officer and Chairman of the Board
(principal executive officer)
September 25, 2013
Xianfu Han
/s/Weili He
Vice Chairman, Chief Operating Officer and Interim Chief
Financial Officer (interim principal financial officer and principal
accounting officer)
September 25, 2013
Weili He
/s/Tao Jin
Director
September 25, 2013
Tao Jin
/s/Xinyong Gao
Director
September 25, 2013
Xinyong Gao
/s/Ken Ren
Director
September 25, 2013
Ken Ren