Annual Report — Form 10-K — Sect. 13 / 15(d) – SEA’34 Filing Table of Contents
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Comprehensive Income
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Securities registered under Section 12(g) of the Exchange Act:
Title of each class
Common Stock, par value $0.001 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate by checkmark whether the Issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive Information or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter on June 30, 2011 was $48,166,822.
The number of shares of the registrant’s only class of common stock issued and outstanding was 30,058,128 shares as of March 31, 2012.
Portions of the registrant’s definitive Information Statement to be filed with the Securities and Exchange Commission and delivered to shareholders in connection with the registrant’s 2012 Annual Meeting of Shareholders (Part III).
EXPLANATORY NOTE
Prior to December 7, 2011, the Company’s fiscal year-end was May 31. On December 8, 2011, the Company changed its year-end to December 31. As a result this Transitional Report (“Report”) is filed under the Securities and Exchange Commission’s (“SEC”) guidelines.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
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Item 6.
Selected Financial Data
28
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
28
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
45
Item 8.
Financial Statements and Supplementary Data
45
Item 9.
Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
45
Item 9A.
Controls and Procedures
45
Item 9B.
Other Information
46
PART III
Item 10.
Directors, Executive Officers and Corporate Governance
47
Item 11.
Executive Compensation
47
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
47
Item 13.
Certain Relationships and Related Transactions, and Director Independence
47
Item 14.
Principal Accounting Fees and Services
47
PART IV
Item 15.
Exhibits, Financial Statement Schedules
48
Signatures
49
Certifications
3
PART I
ITEM 1. BUSINESS
In General
The company (“Company”, or “SunSi”, or “we”, “us”, “our”) was incorporated in Nevada on January 30, 2007. On March 24, 2009, the Company changed its name to SunSi Energies Inc. (fka Bold View Resources, Inc.) and changed its business focus to the acquisition of trichlorosilane (“TCS”) production facilities and TCS distribution rights in China. SunSi, through its subsidiaries operating in China, is a manufacturer and distributor of TCS, a critical raw material used to produce polysilicon which is used in approximately 75% of
the solar photovoltaic panel industry in the world today.
SunSi’s objective is to acquire and develop a portfolio of high quality TCS distribution rights and production facilities that are strategically located and possess a potential for future growth and expansion. Relatively unknown, but essential to the solar energy industry, TCS is the main feedstock of the solar energy industry, used in the production of polysilicon, which in turn is used in the production of solar photovoltaic (“PV”) energy producing panels, the most common device used worldwide to convert sunlight into power.
On December 8, 2010, we completed the acquisition of 90% of Zibo Baokai Commerce and Trade Co., Ltd., (“Baokai”) a company located in Zibo City, China, which owns the right to globally distribute, without restriction, all of the TCS production of Zibo Baoyun Chemical Plant (“ZBC”). ZBC is the same production facility that we had attempted to purchase in 2009 and 2010, but discontinued our efforts to do so because we believed the terms of acquisition were not beneficial to SunSi shareholders. As a result of the consummation of the Baokai acquisition, we began generating revenues in December 2010, and, also as a result we transitioned from a development stage company to planned operations. Consequently, disclosure of certain historical data which has previously been presented in our filings is no longer necessary.
In March 2011, we acquired a 60% equity interest in Wendeng Hexie Silicon Industry Co., Ltd. (“Wendeng”) a TCS production facility located in Weihai City, China. As a result of the acquisitions of Baokai and Wendeng, we currently control approximately 55,000 metric tons (“MT”) of TCS production.
We intend to grow our TCS production capacity from 55,000 MT to 140,000 MT by expanding our Wendeng facility from its current 30,000 MT of capacity to 75,000 MT, and by acquiring another TCS production facility and expanding its production. In order to achieve our target of 140,000 MT of TCS, we will be required to raise approximately $25.0 million over the next two years. This expansion would be comprised of $10.0 million to expand Wendeng and approximately $15.0 million to acquire another facility of up to 40,000 MT. The total cost to expand Wendeng is $15.0 million of which $10.0 mllion will be paid by us and $5.0 million contributed by our 40% minority owner. There can be no assurances that we will be successful in raising $25.0 million. If we are unable to expand our capacity above 55,000 metric tons, we believe we can generate earnings and positive cash flow from operations, although there can
be no assurances due to the recent oversupply of polysilicon as described throughout this Report (see Polysilicon and TCS Market, and our Future Strategy) below.
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Change of Year End Reporting Period
Prior to December 7, 2011, the Company’s fiscal year-end was May 31. On December 8, 2011, the Company changed its year-end to December 31. As a result, this Transition Report is filed under the Securities and Exchange Commission’s (“SEC”) guidelines 210.3-06. This Report includes the following information:
Audited statements of operations, changes in stockholders’ equity and cash flows for the seven months ended December 31, 2011 and years ended May 31, 2011 and 2010
●
Pro forma statements of operations and cash flows for 12 months ended December 31, 2011 and 2010
Trichlorosilane, Polysilicon and PV Production
TCS is a colorless liquid containing silica powder, hydrogen and chlorine and is the critical intermediate compound used to produce pure polysilicon. It takes approximately 6.5 MT of TCS to make 1 MT of polysilicon.
Polysilicon is then cast into a multicrystalline ingot in a DSS furnace. The ingot then moves into the wafering operation where it is sawed into bricks and the bricks are then sawed into thin wafers. Next, the wafers are processed into solar cells through a series of etching, doping, coating and electrical contact processes. The next step involves interconnecting and assembling PV solar cells into solar modules. Finally, PV solar modules, along with other system components such as batteries and inverters, are installed as solar power systems.
Depending on the cost of TCS relative to the cost of polysilicon at any given time, TCS represents approximately 20% of the cost of polysilicon. During the period from January 1, 2011 through April 1, 2012, the price of polysilicon has dropped from approximately $70.00 per kilogram to approximately $25.00 per kilogram primarily due to an overcapacity of polysilicon producing facilities worldwide. During this period of time, the price of TCS has dropped from approximately $1,300 per MT to $700 per MT. The pricing for TCS is typically determined in a short term “spot market” due to the volatility in pricing and the constantly changing levels of supply and demand in the solar industry.
PV Industry
Today, the majority of the world's electricity supply is generated by fossil fuels such as oil, coal and natural gas. Volatile global energy prices, increasing demand for electricity, particularly in developing economies, growing environmental awareness of the consequences of fossil fuel-based energy sources and the desire for energy security are, we believe, driving the demand for renewable energy sources such as solar photovoltaic (PV) systems. PV systems are used in industrial, commercial and residential applications to convert sunlight directly into electricity. Today, electricity costs generated from PV energy are higher than electricity generated by traditional energy sources, although the difference has decreased substantially in recent years. To offset the higher costs associated with solar energy and to encourage the adoption of alternative energy supplies, certain countries have implemented various tax credits and
other incentives in connection with the use of renewable energy.
Global PV cell production grew to an impressive 37.2 GW in 2011, according to a market survey by PHOTON International - The Solar Power Magazine, for a 36-percent increase over the 27.4 GW produced in 2010. But the annual survey also reveals a dramatic reduction in year-on-year growth. Compared to a record 120-percent jump in 2010, the 2011 cell output was the PV industry's lowest growth rate since a 34-percent increase in 2003.
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Manufacturers across the various segments comprising the PV manufacturing process are lowering their manufacturing costs and improving cell efficiency in an effort to make solar generated electricity more price competitive with electricity generated from traditional sources.
Polysilicon and the TCS Market
During calendar year 2011, the world polysilicon prices decreased approximately 60% as the top five producers more than doubled output, according to data compiled by Bloomberg News. For the week ended March 26, 2012, the polysilicon spot price averaged $25.93 per KG. According to the Macquarie Group Ltd. global investment banking and diversified financial services group regarding the oversupply situation, the polysilicon industry will make about 20 percent more than is needed this year, and the oversupply will increase to 28 percent in 2012. As a result of historically low prices for polysilicon in November and December of 2011, about 90 percent of China’s polysilicon plants, comprising half of the country’s production suspended output in November and December according to the China Nonferrous Metals Industrial Association, which acts as a conduit between industry and government, said. This oversupply
situation has continued throughout 2012 with an estimated 50-80% of China’s polysilicon capacity currently idle. A leading solar industry publication, Solarbuzz stated that “it is significant that polysilicon manufacturing capacity long the most constrained and profitable part of the PV chain now has the highest capacity in the PV chain”.
During November and December 2011, the low price of polysilicon coupled with the significant oversupply of polysilicon had a material adverse impact on the price we could sell TCS for, and the level of plant utilization at Wendeng and our exclusive supplier to Baokai, ZBC. This negatively impacted our revenues and results of operations. We believe that due to the current polysilicon oversupply there will be an industry consolidation where we will emerge as one of the strongest entities and lowest cost producers. The ZBC plant that supplies our Baokai distribution operations and the Wendeng facility has been closed since December 2011. We had expected these facilities to open at the end of February 2012 after the Chinese New Year, however, the ongoing low pricing of polysilicon and the resulting low price bids from our customers to supply them TCS would not enable us to operate profitably. Currently during the shutdown period, the Baokai distribution
segment is at a breakeven level because we are not incurring any marketing or business development expenses directly associated with Baokai operations.
Based upon our knowledge and experience in the TCS marketplace in China, and based upon our ongoing discussions with our existing and potential new customers, we believe that no TCS supplier in China can produce TCS profitably at current price levels. At Wendeng, our operating losses of approximately $30,000-$40,000 per month when closed are significantly less than the loss we would incur by producing TCS at the current market price. Therefore our operating losses are lower by staying closed rather than manufacturing TCS at a significantly higher loss. Our Wendeng facility has sold some of its existing inventory during 2012 at a loss; however, it has not manufactured any TCS during 2012. Based on the current level of request for price quotes we are receiving, and ongoing negotiations with a number of potential existing and new customers; we expect the Wendeng facility to re-open due to a rise in the demand and price for
TCS thus enabling us to begin manufacturing and selling TCS by the end of April 2012; although there can be no assurances.
Additionally, there can be no assurances that we will be successful in our efforts to operate Wendeng, or to sell TCS at a price that will enable Wendeng to operate profitably. Additionally, there can be no assurance that the price of polysilicon will not continue to fall or that an industry consolidation will occur.
In 2011 and reiterated in 2012, the Chinese government in widely publicized announcements has promised to commit $454 billion dollars towards to alternative energy which includes a commitment to expand and support a fivefold increase in solar production above current levels over the next five to years ten years. We believe the oversupply of polysilicon will be mitigated during 2012, and that the demand and price of TCS will increase significantly as this commitment is implemented, although there can be no assurances. Currently we remain committed to expanding our Wendeng facility from 30,000 MT to 75,000 MT. We estimate the total amount of funding required to complete this expansion to be $15.0 million. We expect to raise $10.0 million through the sale of our common stock, with the remainder expected to be contributed by our 40% minority partner of Wendeng. If we are unable to raise this amount through the sale of equity
securities, we will have to secure additional debt financing to complete the acquisition and the planned expansion project. If necessary, we intend to negotiate terms of a revolving line of credit and/or conditions for a construction/term loan with various banking institutions. However, there is no assurance that debt financing will be available or, if available, on terms that are favorable to us. In addition, if we are unable to raise sufficient equity capital to commence development of the plant expansion, we may pursue the plant expansion through alternative ownership structures, such as joint ventures with other entities. We currently have no commitment for either equity or debt financing. There can be no assurances that the Company will be successful in raising sufficient funds to complete the expansion.
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During 2011, substantially all of our sales were within China, however we did record one sale of approximately $188,000 to Nitol Solar in Russia. During 2012, we expect to sell more of our TCS outside of China and are not aware of any export restrictions in China that would prevent us from continuing to doing so. Currently, we are negotiating with companies located in the U.K. and Germany to sell them our TCS. Historically, countries such as Germany and Italy have led the demand for solar PV in recent years, while China, the United States and Japan are expected to experience a significant growth by 2014 in the renewable energy and solar markets. There can be no assurances that we will be successful in selling TCS outside of China.
Acquisition of Zibo Baokai Commerce and Trade Co. Ltd
During a significant portion of 2009 and into early 2010, we performed due diligence and negotiated with the shareholders of ZBC, a 25,000 MT TCS production factory located in Zibo, China, to acquire their facility. On December 12, 2009, prior to our determining whether or not we would buy ZBC, we secured the exclusive international distribution rights (“international rights”) for all of the TCS produced by the ZBC factory. These international rights, which were secured by our wholly-owned subsidiary SunSi Energies Hong Kong Limited ("SunSi HK"), for nominal consideration, were not contingent on our purchasing ZBC. The international rights entitled us to sell TCS produced by the ZBC factory outside of China only. It gave us no rights to sell ZBC’s production within China. ZBC granted us these international rights because they were hopeful we could generate new
customers for their TCS production outside of China. Historically, all of ZBC’s sales have been within China.
In early 2010, we determined that despite our best efforts, we could not acquire ZBC, as planned, on terms that would be beneficial to SunSi. Therefore, we discontinued our efforts to acquire the ZBC factory, and instead turned our attention to acquiring the exclusive rights to domestically distribute the TCS produced by ZBC within China in order to supplement the exclusive international distribution rights which we had already acquired on December 12, 2009 (described above).
In April 2010, SunSi HK signed a definitive agreement to acquire 90% of Baokai, a distribution company, for approximately $270,000. Prior to its acquisition by SunSi, Baokai had been the exclusive distributor for all of ZBC’s production of TCS, but did not have any equity interest in ZBC.
On December 8, 2010, we completed the acquisition of 90% of Baokai which gave us the exclusive distribution rights to 100% of ZBC’s production both internationally and domestically; however, we did not acquire any interest or ownership position in the ZBC factory.
As part of the Baokai distribution rights, ZBC agreed to sell Baokai all of its TCS production to us at a price of cost, plus a 10% to 15% mark-up depending on the nature of the sale. During the period ended February 28, 2011, we generated approximately $4.6 million in revenues with a gross margin of approximately 2.0%. By mutual agreement with ZBC, Baokai agreed to earn a smaller profit margin than originally anticipated on these sales because the sales came from existing customers of ZBC and from the efforts of the ZBC sales force. The Company continues to work on business development efforts to obtain new clients for Baokai but has been unsuccessful to date in doing so. In the event the company is
successful in obtaining new clients, the pricing anticipated for these clients would revert to the 10-15% mark-up. There can be no assurances that the Company will be successful in securing new clients for Baokai.
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Baokai has one client LDK Solar which accounted for substantially all of their sales for the seven month period ended December 31, 2011, and since our acquistion of Baokai in December 2010. The facility is easily accessible via rail and major highways, in addition to being well equipped for handling chemical products. We believe we can expand Baokai’s client base in the future, although there can be no assurances.
ZBC
ZBC, the sole supplier of Baokai, is strategically located in the Shandong province of China. Founded in 2000, the ZBC facility was originally a wholly-owned subsidiary of Baoxin Mining Company that focused on the research, development, production and marketing of organic silicon products. In 2003, ZBC was built on a 24-acre property located in the city of Zibo, Shandong Province, China (approximately 50 miles east of Jinan).
ZBC’s current capacity is 25,000 MT per year. ZBC is ISO9001 certified.
Acquisition of Wendeng He Xie Silicon Co. Ltd
On March 18, 2011, we completed the purchase (“Wendeng Acquisition”) of a 60% interest in Wendeng, a trichlorosilane manufacturing company, from Liu Dongqiang, a Chinese individual. Wendeng is located in the Shandong province of China close to strategic ports, including Weihai and Qingdao. The state-of-the-art Wendeng facility was built in 2008 and currently has an annual capacity of 30,000 MT of TCS. The Wendeng facility was designed and is currently managed by Zhang Fahe, who possesses over 30 years of experience in the Chinese chemical industry. Mr. Fahe has been working in the TCS field since 2001 where he developed efficient TCS production technologies. As part of the closing, Wendeng was re-formed as a joint venture business under Chinese law and issued a new business license.
Pursuant to the terms of the Wendeng Acquisition, the Company:
(i)
paid Mr. Liu USD $445,075 within three months of the issuance of the business license;
(ii)
issued 1,349,628 shares of our common stock to Mr. Liu or his assigns, such shares carry a right of redemption by Mr. Liu whereby the Company (or an affiliate of the Company) shall buy such shares back from Mr. Liu within six months at a price of USD equivalent to RMB 18,000,000 on the transfer date (currently equal to approximately USD $2,700,000). This redemption right was waived by Mr. Liu on June 13, 2011- see below, and;
(iii)
caused an affiliate of the Company to transfer 1,574,566 shares of its Company common stock to Mr. Liu, or his assigns, with such shares being restricted from resale for 2.5 years.
As of March 18, 2011, Wendeng had a production capacity of approximately 20,000 MT tons of Trichlorosilane. As a result of closing the Acquisition, SunSi began to immediately consolidate all of Wendeng’s revenues, and 60% of its profits.
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On June 13, 2011, we amended the terms of the Wendeng Acquisition, whereby Mr. Liu canceled our obligation to buy back the 1,349,628 shares of our stock and confirmed that the purchase price for the 60% equity interest in Wendeng is fully paid. Such shares had been classified as “Redeemable Common Stock” on the Company's balance sheet and excluded from Stockholders’ Equity, and will subsequently be included in the Company’s Stockholders’ Equity section of the balance sheet at a value of approximately $2.7 million.
Our plan after acquisition was to expand the manufacturing capacity of Wendeng to 75,000 MT per year. In October 2011, the construction of the expanded capacity from 20,000 to 30,000 MT was completed. The cost of this 10,000 MT ton expansion was approximately $1.5 million. We estimate the total amount of funding required by SunSi to complete the Wendeng expansion from 30,000 MT to 75,000 MT is currently approximately $15.0 million. Mr. Liu, our 40% minority partner in the facility, is expected to contribute between $3.0-5.0 million towards this expansion. Our portion of this expansion if we are successful in raising capital to fund this expansion, will be approximately $10-12 million.
If we are unable to raise this amount through the sale of equity securities, we will have to secure additional debt financing to complete the acquisition and the planned expansion project. If necessary, we intend to negotiate terms for a revolving line of credit and/or conditions for a construction/term loan with various banking institutions. However, there is no assurance that debt financing will be available or, if available, on terms that are favorable to us. In addition, if we are unable to raise sufficient equity capital to commence development of the plant expansion, we may pursue the plant expansion through alternative ownership structures, such as joint ventures with other entities. We currently have no commitment for either equity or debt financing. There can be no assurances that the Company will be successful in raising sufficient
funds to complete the expansion.
Wendeng Profile
We believe Wendeng is one of the largest TCS manufacturers in China, and is located in the Shandong province of China close to strategic ports including Weihai and Qingdao. It started producing TCS in 2009. The Wendeng facility was designed and is currently managed by Zhang Fahe, with over 30 years of experience in the Chinese chemical industry. Mr. Fahe has been working directly in the field of TCS since 2001 where he has developed efficient TCS production technology.
Wendeng has four major clients which comprised approximately 50.2%, 19.4%, 9.0% and 9.2%, respectively, or approximately 87.8% of their sales for the seven month period ended December 31, 2011. The facility is easily accessible via rail and major highways, in addition to be being well equipped for handling chemical products. We believe we can expand Wendeng’s client base in the future.
Wendeng Equipment Suppliers
The Wendeng facility is situated within a province that specializes in the chemical industry. Most standard equipment can therefore be sourced locally. Some equipment needs to be customized specifically for the production of TCS. This customization can also be achieved locally. The local management team already has experience working with the different suppliers and the suppliers are also well aware of the equipment requirements specific to TCS production.
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Wendeng Site Selection
The Wendeng facility is strategically located for exportation and also gives us access to supply and product transportation due to the heavy truck and train volume in the area.
The Wendeng facility site includes utilities infrastructure and highway access. When we assessed this acquisition, we considered the following:
●
Proximity to feedstock suppliers;
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Proximity to ports;
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Road, rail and water transportation infrastructure at the site;
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Existing storage and transfer infrastructure;
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TCS market proximity; and
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Skilled labor availability.
Goodwill Impairment
Goodwill represents the excess of cost over fair value of assets of businesses acquired. Goodwill acquired in a business combination is not amortized. The Company evaluates the carrying amount of goodwill for impairment annually on December 31 and whenever events or circumstances indicate impairment may have occurred.
When evaluating whether goodwill is impaired, the Company compares the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s carrying amount, including goodwill. The fair value of the reporting unit is estimated using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies’ data. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the implied fair value of reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess
of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value.
Due to the inability to meet anticipated sales growth, the Company assessed the acquired goodwill associated with its related business units for impairment as of December 31, 2011. Based on the discounted cash flows model utilizing estimated future earnings and cash flows, the fair value of the reporting units was less than the carrying value of the acquired goodwill. The Company’s evaluation of goodwill resulted in a total impairment charge of $2,800,000; of which $2,487,567 was attributed to Wendeng and $312,433 was attributed to Baokai.
Segment Information
Our operating segments are determined based upon several criteria including: our internal organizational structure; the manner in which our operations are managed; the criteria used by our Chief Executive Officer, who functions as our Chief Operating Decision Maker to evaluate segment performance; and the availability of separate financial information. Our business is organized as two operating segments, Baokai and Wendeng. Baokai is a distributor of TCS and purchases all of its TCS from ZBC, an unaffiliated third party. Wendeng is a manufacturer of TCS as well as a distributor of TCS. Both segments sell TCS to primarily polysilicon makers at approximately the same price. Since Baokai is a distributor only of TCS and does not earn any profit on the manufacturing process since the manufacturing is done by ZBC, Baokai gross margins are substantially less than Wendeng. Our Director of Business Development oversees both segments, which
are marketed jointly to enhance the visibility of both segments inside and outside of China.
During the seven month period ended December 31, 2011, approximately 41.3% of our revenue or $5,956,999 came from Baokai, and 58.7% or $8,463,841 came from Wendeng. Net loss from Baokai was $253,726, and the net loss at Wendeng was $2,791,439. Further information regarding our operating segments is presented in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of this Annual Report on Form 10-K and in Note 18 "Segment Information" to the consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K.
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Environmental and Other Regulatory Matters; Governmental Approvals
Before we begin any TCS manufacturing expansion project, we will be required to obtain various environmental, construction and operating permits. Permits for the expansion of an existing facility are generally easier to obtain than permits for new infrastructures. We will be responsible for obtaining all permits. If permitting delays occur, acquisition and subsequent expansion of an acquired plant may be delayed.
In addition, permitting and environmental and other regulatory requirements may change in the future. Changes in permitting and regulatory requirements could make compliance more difficult and costly. If we are unable to obtain necessary permits or to comply with the requirements of such permits or any other environmental regulations, our business may be adversely affected and we may not be able to construct or operate the plant.
Regulatory Permits
We will be subject to regulations and will need to obtain a number of permits, which may include zoning and building permits, environmental permits as well as work safety permits. To date, we have not begun the permitting process, but intend to commence that activity as soon as the necessary financing is in place. Once we begin the permitting process, we believe that obtaining the necessary permits will generally take between three and four months.
All the permits above can be obtained in parallel to the construction work and should therefore not affect the realization of the expansion. If for any reason any of these permits are not granted, renovation costs for the plant may increase or the plant may not be operated at all. In addition, the provincial and local governments could impose conditions or other restrictions in the permits that are detrimental to us or that increase permit requirements or the testing protocols and methods necessary to obtain a permit either before, during or after the permitting process. The Regional Government of Wendeng could also modify the requirements for obtaining permits. This would likely have a material adverse impact on our operations, cash flows and financial performance.
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TCS Quality Testing Procedures
Quality targets are set in function of the required purity levels of TCS. Purity levels are currently being tested prior to shipment as well as by the customer at the receiving end. Some impurities such as Calcium, Magnesium and Copper are currently not being tested as this is not required by China industry standards. To achieve our exportation objectives, new testing installations will have to be implemented to meet the requirements of western customers. There is currently an officer specifically assigned to quality control at the Wendeng facility as well as at the ZBC facility.
Customers and Sales
Wendeng
During calendar 2011, Wendeng shipped its TCS to the following customers:
1.
Jiangsu Zhong Neng Silicon Industry Technology Development Co. Ltd (GCL Silicon Technology Holdings Inc.)
2.
Zhejiang Zhong Neng Technology Development Co. Ltd.
3.
Luo Yang Zhong Silicon Hi-Tech Technology Development Co. Ltd.
4.
Wuxi Zhong Cai Technology Development Co. Ltd.
5.
Lian Yun Gang Zhong Cai Technology Development Co. Ltd.
6.
Zhejiang Xie Cheng Gui Co. Ltd.
7.
Wendeng Shi Huahai Chemical Co. Ltd.
8.
Nitol Solar
Nitol Solar is the only one of these companies located outside of China.
Baokai
Substantially all of Baokai’s revenues since acquisition in December 2010 have been to LDK Solar Co., Ltd, Hi-Tech Industrial Park. We are attempting to diversify our customer base at Baokai to include customers from outside of China; however, there can be no assurances we will be successful in doing so.
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Inputs and Procurement Plan
Wendeng has contracts with key suppliers of silica powder, chlorine liquid and methanol. Chlorine liquid, methanol and silica powder are currently sourced locally in Shandong. We foresee that our current suppliers will be able to meet the demand of the expanded capacity of our production facility being developed.
Government Incentives and Regulations
The market for electricity generation products is heavily influenced by foreign, federal, state and local government regulations and policies concerning the electric utility industry, as well as policies promulgated by electric utilities. These regulations and policies often relate to electricity pricing and technical interconnection of customer-owned electricity generation. In the United States and in a number of other countries, these regulations and policies are being modified and may continue to be modified. Customer purchases of, or further investment in the research and development of, alternative energy sources, including solar power technology, could be deterred by these regulations and policies, which could result in a significant reduction in the potential demand for our TCS. For example, without a regulatory mandated exception for solar power systems, utility customers are often charged interconnection or standby
fees for putting distributed power generation on the electric utility grid. These fees could increase the cost to consumers of solar power systems, which could decrease the market for PV installations, thereby harming our business, prospects, results of operations and financial condition.
The installation of PV systems is subject to oversight and regulation in accordance with foreign, national and local ordinances relating to building codes, safety, environmental protection, utility interconnection and metering and related matters. It is difficult to track the requirements of individual states and design equipment to comply with the varying standards. Any new government regulations or utility policies pertaining to PV systems may result in significant additional expenses to us and, as a result, could cause a significant reduction in demand for PV installations. In addition, the manufacture of TCS involves the use of materials that are hazardous to human health and the environment, the storage, handling and disposal of which will be subject to government regulation. Under various foreign, federal, state and local laws, ordinances and regulations, an owner or operator of real estate is liable for costs of removal
or remediation of certain hazardous or toxic substances on or in such property. These laws often impose such liability without regard to whether the owner or operator knew of, or was responsible for, the presence of such substances.
Solar Energy Government Incentives
Support programs for PV solar electricity generation, depending on the jurisdiction, include feed-in tariffs (FiTs), quotas (including renewable portfolio standards and tendering systems), and net metering programs. In addition to these, financial incentives for renewables include tax incentives, grants, loans, rebates, and production incentives.
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Under a basic FiT program, producers of renewable energy are paid a set rate for their electricity, usually differentiated according to the technology used and size of the installation. For PV solar, the rate has historically been set above market rates and is fixed for a period of up to 25 years. In most countries with FiTs, grid operators are obliged to provide priority and guaranteed access to the grid for renewable energy installations. The additional costs of these schemes are generally passed through to the electricity consumers by way of a premium on the kilowatt hour (kWh) end-user price.
Whereas FiT laws set the price and let the market determine capacity and generation, quota systems work in reverse. In general, governments mandate a minimum share of capacity or (grid-connected) generation of electricity to come from renewable energy sources. This share often increases over time, with a specific final target and end-date. The mandate can be placed on producers, distributors, or consumers.
There are two main types of quota systems used: obligation/certificate and tendering systems. A renewable portfolio standard (RPS) is in the former category. Under an RPS, regulated utilities are required to procure a specified percentage of their total electricity sales to end-user customers from eligible renewable resources, such as solar generating facilities, by a specified date. Some programs further require that a specified portion of the total percentage of renewable energy must come from solar generating facilities. The majority of states in the U.S. have enacted legislation adopting RPS mechanisms. RPS legislation and implementing regulations vary significantly from state to state, particularly with respect to the percentage of renewable energy required to achieve the state’s RPS mandate, the definition of eligible renewable energy resources, and the extent to which renewable energy credits
(paper certificates representing the generation of renewable energy) qualify for RPS compliance. Currently, there is no federal RPS mandate or clean energy standard, although the Obama Administration has called upon the United States Congress to create one. Measured in terms of the volume of renewable electricity required to meet its RPS mandate, California’s RPS program is the most significant in the U.S., and the California market for renewable energy dominates the western U.S. region. First enacted in 2002, California’s RPS statute has been amended several times to increase the overall percentage requirement as well as to accelerate the target date for program compliance. Pursuant to amendments enacted by the California Legislature in April 2011, the California RPS program now requires obligated load serving entities to procure 33% of their retail electricity demand from eligible renewable resources by 2020.
In contrast to an RPS system, tendering systems of procurement (such as those used in South Africa and India) are focused on specific targets for new capacity. In South Africa, for example, the government is procuring bids under a competitive tender with solicitation dates spread over about two years. The request for proposal (RFP) is the first major solicitation in support of a target of over 8 GW of renewable energy in South Africa’s Integrated Resource Plan. Project proponents bid competitively at each solicitation date until all the capacity has been allocated. The tender solicitation approach allows governments or utilities to proscribe project construction time frames to achieve specific generation targets for the electricity system.
Net energy metering programs enable end-users to install renewable systems and to offset their retail energy consumption with production from on-site facilities and, in some cases, to sell excess solar electricity to their retail electricity provider. Because the bundled cost of retail electricity usually exceeds the cost of unbundled electricity, net metering programs provide an incentive to the end-user, based on the savings for the electricity system. The policies governing net energy metering vary by state and utility. Some utilities pay the end-user in advance, while others credit the end-user’s bill.
Tax incentive programs exist in the United States at both the federal and state level and can take the form of investment and production tax credits, accelerated depreciation and sales and property tax exemptions. At the federal level, investment tax credits for business and residential solar systems have gone through several cycles of enactment and expiration since the 1980’s. In October 2008, the United States Congress extended the 30% federal investment tax credit (ITC) for both residential and commercial solar installations for eight years, through December 31, 2016. The ITC is a primary economic driver of solar installations in the United States. Two federal programs related to renewable energy ended in 2011: (i) the Department of Energy Section 1705 loan guarantee program for renewable energy projects, renewable energy manufacturing facilities and electric power transmission
projects and (ii) the Department of the Treasury Section 1603 cash grant program, which provided cash grants equal to 30% of the cost of the system for solar installations that were placed into service during 2009, 2010 and 2011 and for certain solar installations for which construction began prior to December 31, 2011. This cash grant was available in lieu of receiving the 30% federal investment tax credit.
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In Europe, renewable energy targets, in conjunction with FiTs, have contributed to the growth in PV solar markets. Renewable energy targets prescribe how much energy consumption must come from renewable sources, while FiT policies are intended to support new supply development by providing investor certainty. A 2001 European Union (EU) directive for promoting renewable energy use in electricity generation (Directive 2001/77/EC) set varying national indicative targets for renewable energy production from individual member states. A 2009 EU directive on renewable energy (Directive 2009/28/EC), which replaced the 2001 directive, sets varying targets for all EU member states in support of the directive's goal of a 20% share of energy from renewable sources in the EU by 2020, and requires national action plans that establish clear pathways for the development of renewable energy sources.
In China, governmental authorities recently adopted a national FiT policy for large scale projects. China also expanded the Golden Sun Program, an upfront cost subsidy program, aimed primarily at distributed generation. In addition, according to the current draft of the 12th 5-year plan for solar energy, the government intends to raise the 2015 goal for total cumulative solar energy capacity to 15 GW and 50 GW by 2020.
Competition
We compete directly with independent producers of TCS on the basis of reputation, technology, delivery, service and price. Many of these producers have significantly greater resources than we do. We also expect the number of our competitors to increase significantly in the future. We also compete indirectly with polysilicon and solar PV panel manufacturers that produce their own proprietary TCS, as opposed to purchasing it from independent TCS manufacturers such as us. The development of other TCS plants, particularly those in close proximity to our plant, will increase the supply of TCS and may result in lower local TCS and glycerin prices and higher costs for feedstock.
Currently, we believe there are approximately 25 TCS producers, most of which have relatively small production capacity, and less than 10 have a production capacity of over 2,000 MT per year. We believe many of the smaller production facilities are no longer operating due to the reduction in the price of polysilicon described throughout this report. We believe total independent Chinese TCS production capacity is approximately 300,000 MT per year.
China’s independent TCS producers are mainly located in Jiangxi, Tangshan of Hebei, Zibo of Shandong, Chongqing of Sichuan, Wuhan of Hubei, and Shanghai. We believe our main direct competitors are Leshan Yongxiang Resins Co., Ltd., Tangshan Sunfar Silicon Industries Co., Ltd., Huaxiang Chemical Industry Co., Ltd., and Kaihua Synthetic Material Co., Ltd.
Employees
We have 84 full-time employees, 80 of these employees are located in China.
Research and Development Expenditures
We have not incurred any research or development expenditures since our incorporation.
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ITEM 1A. RISK FACTORS.
RISK FACTORS
Our business, operating results and cash flows can be impacted by a number of factors, any one of which could cause our actual results to vary materially from recent results or from our anticipated future results. You should carefully consider the risks described below and the other information in this Annual Report on Form 10-K before deciding to invest in shares of our common stock. These are the risks and uncertainties we believe are most important for you to consider. Additional risks and uncertainties not presently known to us, which we currently deem immaterial or which are similar to those faced by other companies in our industry or business in general, may also impair our business operations. If any of the following risks or uncertainties actually occurs, our business, financial condition and operating results would likely suffer. In that event, the market price of our common stock could decline and an investor in
our common stock could lose all or part of their investment.
Risks Related to Our Business
General economic conditions may have an adverse impact on demand for our TCS. Demand for TCS product is affected by general economic conditions. A downturn in the global solar PV panel market reduces demand for TCS. Uncertainties about economic conditions, negative financial news, tighter credit markets and declines in asset values have recently caused our customers to postpone or cancel making purchases of TCS. Increasing budgetary pressures could reduce or eliminate government subsidies and economic incentives for on-grid solar electricity applications. A prolonged downturn in the global economy, and a continuing worldwide oversupply of polysilicon, which requires TCS to be manufactured, could have a material adverse effect on our business in a number of ways, including decreased demand and lower pricing for our products, which would result in lower sales and/or net revenues. Uncertainty about future economic
conditions and the overall status of solar energy compared to other sources of energy makes it challenging for us to forecast demand for our products and our operating results, make business decisions and identify the risks that may affect our business. If we are not able to timely and appropriately adapt to changes resulting from the difficult macroeconomic environment, our business, results of operations and financial condition may be materially and adversely affected.
Because we are recently formed and have little operating history and little experience operating a TCS production plant, we may have difficulties successfully completing and operating the plant. We have little operating history and limited resources. We are dependent on our officers and directors to manage our business and development. However, our officers and directors have little to no experience managing or operating a TCS production plant and make us dependent on our Chinese plant managers. Our lack of an operating history and our inexperience may make it difficult for us to successfully complete and operate the plant. If we do not successfully operate our Wendeng plant efficiently, our results may be adversely affected.
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We will operate in an intensely competitive industry, and there can be no assurance that we will be able to compete effectively. The TCS business is highly competitive, and other companies presently in the market, or that could enter the market, could adversely affect prices for the TCS we intend to sell. There are numerous other entities operating TCS plants, some of which are near or in our potential trade territory and supply region. Additionally, the Wendeng plant and Baokai operation will be in direct competition with other TCS producers, many of which have greater resources than we do. In light of such competition, and the current oversupply of polysilicon in the world and Chinese there is no assurance that we will be able to complete or successfully sell our products at a profitable price.
To produce TCS we must purchase significant amounts of feedstock, which may not be available to us at reasonable costs or at all. TCS production requires significant amounts of feedstock including silica powder, chlorine liquid and methanol. We have entered into agreements with third party suppliers of feedstock, including silica powder, liquid chlorine and methanol, which are needed to produce TCS. It is currently believed that these third party suppliers will likely be able to supply increased demand for either feedstock. However, even if the producers of such materials are willing to supply such feedstock for use in the operation of our plant(s), there can be no assurance at this point that we will be able to enter into long-term contracts for such supplies at all or at favorable rates. A significant reduction in the
quantity of feedstock or an increase in the prices of feedstock could result in increased costs with adverse financial consequences to us.
Our operating costs could be higher than we expect, and this could reduce any dividends we may potentially pay. In addition to general market fluctuations and economic conditions, we could experience significant operating cost increases from numerous factors, many of which are beyond our control. These increases could arise from, among others:
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Higher feedstock prices because of an inadequate supply of or greater demand for feedstock;
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Higher labor costs, particularly if there is a labor shortage;
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Higher costs for electricity due to market conditions and demands; and
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Higher transportation costs because of greater demands on truck transportation services.
In addition, operating the plant subjects us to ongoing compliance with applicable governmental regulations, such as those governing pollution control, occupational safety and other matters. We may have difficulty complying with these regulations and our compliance costs could increase significantly.
The price of TCS is affected primarily by the price of polysilicon. Recently due to a significant worldwide oversupply of polysilicon, the price of TCS, and the amount of new TCS orders required has materially decreased which has decreased the amount of revenue we generate. The length of time that this oversupply will continue is unknown. Our competitors may have large inventories of TCS that they are willing to sell at a loss. The demand for TCS is dependent on numerous factors, including the price of polysilicon, governmental regulations, governmental incentives, and the development of other technologies or products that may compete with TCS. We cannot assure you that the demand for TCS will increase if the oversupply situation is mitigated. If the demand for TCS does not sufficiently increase and competitive TCS suppliers are willing to sell their existing TCS inventories at a loss, then TCS prices may remain
at historically low levels. Decreases in the price of TCS will result in the Company generating lower projected revenue and profitability.
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Technological advances could significantly decrease the cost of producing TCS or result in the production of higher quality TCS, and if we are unable to adopt or incorporate technological advances into our operations, the plant could become uncompetitive or obsolete. We expect that technological advances in the processes and procedures for processing TCS will continue to occur. It is possible that those advances could make the processes and procedures that we intend to use at the plant less efficient or obsolete, or cause the TCS we produce to be of a lesser quality. These advances could also allow our competitors to produce TCS at a lower cost than us. If we are unable to adopt or incorporate technological advances, our TCS production methods and processes could be less efficient than our competitors, which could cause the plant to become uncompetitive.
Our business will not be diversified because we will be primarily dependent on one product: TCS. As a consequence, we may not be able to adapt to changing market conditions or endure any decline in the TCS industry. Our success depends on our ability to timely construct the plant and efficiently produce TCS. With the exception of the selling of Phosphorous Oxychloride, Phosphorous Trichloride and Divinylbenzene that are produced as co-products of our TCS production, we do not have any other lines of business or other sources of revenue to rely on if we are unable to produce and sell TCS and glycerin, or if the market for those products declines. We will not have the ability to produce any other products. Our lack of diversification means that we may not be able to adapt to changing market conditions or to weather any significant decline in the TCS industry.
Competition for qualified personnel in the TCS industry is intense, and we may not be able to hire and retain qualified managers, engineers and operators to operate the plant efficiently. Our success depends in part on our ability to attract and retain competent personnel. We must hire or otherwise engage qualified managers, engineers and accounting, human resources, operations and other personnel. Competition for employees in the TCS industry is intense. If we are unable to hire, train and retain qualified and productive personnel, we may not be able to operate the plant efficiently and the amount of TCS we produce and market may decrease.
Our plant requires substantial amounts of electricity, which we will depend on independent utilities to provide. Any interruption in our electricity supply may force us to halt operations. The market price of electricity fluctuates significantly. Any significant increase in the market price of electricity or our generating costs will result in increased operating costs and lower profit margins and could have a material adverse effect on our business.
If we are unable to hire and retain a sales staff to market our products, we will not be able to sell the TCS that we produce. We presently do not have a sales staff to market the sale of our products. If we are unable to attract and retain competent personnel or our sales staff is unable to perform its duties, we may not have any readily available means to sell our products. Consequently, we may not obtain the best possible prices for our products. We will depend upon the performance of the sales staff we hire and our failure to sell all of our products may result in less income from sales.
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Risks Relating to the Solar Photovoltaic Industry
Government subsidies and economic incentives for on-grid solar electricity applications could be reduced or eliminated. Demand for PV equipment, including on-grid applications, has historically been dependent in part on the availability and size of government subsidies and economic incentives. Currently, the cost of solar electricity exceeds the retail price of electricity in most major markets in the world. As a result, federal, state and local governmental bodies in many countries, most notably Germany, Italy, Spain, South Korea, Japan, China and the United States, have provided subsidies in the form of feed-in tariffs, rebates, tax write-offs and other incentives to end-users, distributors, systems integrators and/or manufacturers of PV products to promote the use of solar energy in on-grid applications and to reduce dependency on other forms of energy. Many of these government incentives have expired or are
due to expire in time, phase out over time, cease upon exhaustion of the allocated funding and/or are subject to cancellation or non-renewal by the applicable authority. For example, Germany and Italy have recently announced reductions in government subsidies of solar energy. The reduction, expiration or elimination of relevant government subsidies or other economic incentives may result in the diminished competitiveness of solar energy relative to conventional and other renewable sources of energy, and adversely affect demand for PV equipment or result in increased price competition, all of which could cause our sales and revenue to decline and have a material adverse effect on our financial condition, results of operations, business and/or prospects.
Further, any government subsidies and economic incentives could be reduced or eliminated altogether at any time and for any reason. Relevant statutes or regulations may be found to be anti-competitive, unconstitutional or may be amended or discontinued for other reasons. Some government subsidies and incentives have been subject to challenge in courts in certain foreign jurisdictions. New proceedings challenging minimum price regulations or other government incentives in other countries in which we conduct our business may be initiated, and if successful, could cause a decrease in demand for our products.
The reduction, expiration or elimination of relevant government subsidies or other economic incentives may result in the diminished competitiveness of solar energy relative to conventional and other renewable sources of energy, and adversely affect demand for PV equipment or result in increased price competition, all of which could cause our sales and revenue to decline and have a material adverse effect on our financial condition, results of operations, business and/or prospects.
Existing regulations and policies and changes to these regulations and policies may present technical, regulatory and economic barriers to the purchase and use of photovoltaic products. The market for electricity generation products is heavily influenced by government regulations and policies concerning the electric utility industry, as well as policies promulgated by electric utilities. These regulations and policies often relate to electricity pricing and technical interconnection of user-owned electricity generation. In the United States and in a number of other countries, these regulations and policies are currently being modified and may be modified again in the future. These regulations and policies could deter end-user purchases of PV products and investment in the research and development of PV technology. For example, without a mandated regulatory exception for PV systems, utility customers are often charged
interconnection or standby fees for putting distributed power generation on the electric utility grid. These fees could increase the cost to end-users of PV systems and make such systems less attractive to potential customers, which may have a material adverse effect on demand for our products and our financial condition, results of operations, business and/or prospects.
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The photovoltaic industry may not be able to compete successfully with conventional power generation or other sources of renewable energy. Although the PV industry has experienced growth in recent years, it still comprises a relatively small component of the total power generation market and competes with other sources of renewable energy, as well as conventional power generation. Many factors may affect the viability of widespread adoption of PV technology and thus demand for solar wafer manufacturing equipment, including the following:
● cost-effectiveness of solar energy compared to conventional power generation and other renewable energy sources;
● performance and reliability of solar modules compared to conventional power generation and other renewable energy sources and products;
● availability and size of government subsidies and incentives to support the development of the solar energy industry;
● success of other renewable energy generation technologies such as hydroelectric, wind, geothermal and biomass; and
● fluctuations in economic and market conditions that affect the viability of conventional power generation and other renewable energy sources, such as increases or decreases in the prices of oil and other fossil fuels.
As a result of any of the foregoing factors, our financial condition, results of operations, business and/or prospects could be materially adversely affected.
Risks Related to the Wendeng Plant Expansion
We may change our business plan and decide not to expand the Wendeng facility. Our board of directors reserves the right not to expand the Wendeng plant. If the board of directors decides not to expand the Wendeng plant to 75,000 MT, we may not produce as many MT of TCS as planned and may also be subject to increased costs to pay for additional resources. This could cause us to be less profitable.
We may not be able to raise sufficient capital to expand the Wendeng facility. Due to the difficulty of raising capital for solar industry projects, we may be unable to obtain the necessary capital on reasonable terms to expand the Wendeng facility.
We may need to revise cost estimates for the expansion of the Wendeng plant, and such expansion could result in dilution to shareholders if the expansion requires additional capital. We based our anticipated capital needs on a contractual commitment and of a total project cost of approximately $10,000,000. There is also no assurance that there will not be design changes in the planned expansion, or cost overruns associated with the expansion of the plant. Any significant increase in the estimated expansion cost of the plant could delay our ability to generate revenues because our projected revenue stream may not be able to adequately support the increased cost and expense attributable to increased set-up costs, and may result in the issuance of additional equity causing dilution to shareholders.
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Compliance with new and existing environmental laws and rules could significantly increase our set-up and start-up costs, and force us to delay or halt set-up or operation. To expand the Wendeng plant, we will need to obtain and comply with a number of permitting requirements. As a condition of granting necessary permits, regulators could make demands that increase our costs of setting-up and operations, in which case we could be forced to obtain additional debt or equity capital. Environmental issues, such as contamination and compliance with applicable environmental standards, could arise at any time during the set-up and operation of the plant. If this occurs, it would require us to spend significant resources to remedy the issues and may delay or prevent set-up or operation of the plant. This would significantly increase the cost of the project. We cannot assure you that we will be able to obtain and comply
with all necessary permits to expand and operate the Wendeng plant.
Significant increases in the cost of the Wendeng expansion project may require us to obtain additional debt or equity capital that may be difficult and expensive to obtain, or may not be available at all, and which could delay and diminish our profitability. The estimated expansion cost of the Wendeng plant is based on certain estimates, and there is no assurance that the final cost will not be higher. Certain other events and conditions, including economic factors, site conditions, design modifications and set-up delays or overruns, could also lead to significant increases in the project costs. Delays and changes are not uncommon in similar projects such as the one in which we intend to engage, and such delays and changes may increase the cost of the project, and delay operation and expansion. Increases in the cost of the project would likely require us to procure additional debt financing, which may be difficult
and expensive to obtain, or may not be available at all. If costs increase, the total cost of the expansion and capital required could increase, perhaps significantly, and our revenues may not be able to adequately support the increased expense and debt attributable to increased set-up costs. In that event, our projected profitability could be delayed and decreased.
Delays due to, among others things, weather, labor or material shortages, permitting or zoning delays, or opposition from local groups, may hinder our ability to timely commence operations. Our schedule depends upon several assumptions, including the effectiveness of agreements that remain to be negotiated and signed. We could also incur delays in the expansion of the plant due to permitting or zoning delays, opposition from local groups, shortages of labor or material, defects in materials or workmanship or other causes. In addition, the availability of financing, changes in interest rates or the credit environment or changes in political administrations at the Chinese federal, provincial or local level that result in policy changes toward the plant could result in delays in our timetable for setting-up and commencement of operations. Delays will hinder our ability to commence operations and generate revenue.
Defects in the performance of the Wendeng plant could result in a reduction in our revenues and profitability. Although we intend to engage third party companies to expand the plant, we do not believe we will receive any warranties with respect to materials and workmanship or assurances that the project will operate at design capacity. Defects in the setting-up or performance of the plant could occur, and there is no assurance that we, our sub-contractors or anyone else that we contract with could correct these problems. If defects delay the set-up or hinder the operations of the plant, our revenues and profitability could be materially adversely affected.
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Risks Related to Doing Business in China
Our business operations take place primarily in China. Because Chinese laws, regulations and policies are continually changing, our Chinese operations will face several risks summarized below.
Limitations on Chinese economic market reforms may discourage foreign investment in Chinese businesses. The value of investments in Chinese businesses could be adversely affected by political, economic and social uncertainties in China. The economic reforms in China in recent years are regarded by China’s central government as a way to introduce economic market forces into China. Given the overriding desire of the central government leadership to maintain stability in China amid rapid social and economic changes in the country, the economic market reforms of recent years could be slowed, or even reversed.
Certain political and economic considerations relating to China could adversely affect our company. China is transitioning from a planned economy to a market economy. While the PRC government has pursued economic reforms since its adoption of the open-door policy in 1978, a large portion of the Chinese economy still operates under five-year and annual state plans. Through these plans and other economic measures, such as control on foreign exchange, taxation and restrictions on foreign participation in the domestic market of various industries, the PRC government exerts considerable direct and indirect influence on the economy. Many of the economic reforms carried out by the PRC government are unprecedented or experimental, and are expected to be refined and improved. Other political, economic and social factors can
also lead to further readjustment of such reforms. This refining and readjustment process may not necessarily have a positive effect on our operations or future business development. Our operating results may be adversely affected by changes in China’s economic and social conditions as well as by changes in the policies of the PRC government, such as changes in laws and regulations, or the official interpretation thereof, which may be introduced to control inflation, changes in the interest rate or method of taxation, and the imposition of additional restrictions on currency conversion.
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.
Due to various restrictions under PRC laws on the distribution of dividends by our PRC operating companies, we may not be able to pay dividends to our stockholders. The PRC government imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of the PRC. If we ever determine to pay a dividend, we may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency.
Currency conversion and exchange rate volatility could adversely affect our financial condition and the value of our common stock. The PRC government imposes control over the conversion of Renminbi, or RMB, into foreign currencies. Under the current unified floating exchange rate system, the People’s Bank of China, or PBOC, publishes an exchange rate, which we refer to as the PBOC exchange rate, based on the previous day’s dealings in the inter-bank foreign exchange market. Financial institutions authorized to deal in foreign currency may enter into foreign exchange transactions at exchange rates within an authorized range above or below the PBOC exchange rate according to market conditions.
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Pursuant to the Foreign Exchange Control Regulations of the PRC issued by the State Council which came into effect on April 1, 1996 (which has been amended in 1997 and 2008), and the Regulations on the Administration of Foreign Exchange Settlement, Sale and Payment of the PRC which came into effect on July 1, 1996, regarding foreign exchange control, conversion of RMB into foreign exchange by Foreign Investment Enterprises, or FIEs, for use on current account items, including the distribution of dividends and profits to foreign investors, is permissible. FIEs are permitted to convert their after-tax dividends and profits to foreign exchange and remit such foreign exchange to their foreign exchange bank accounts in China. Conversion of RMB into foreign currencies for capital account items, including direct investment, loans,
and security investment, is still under certain restrictions. On January 14, 1997, the State Council amended the Foreign Exchange Control Regulations and added, among other things, an important provision, which provides that the PRC government shall not impose restrictions on recurring international payments and transfers under current account items.
Enterprises in China, including FIEs, which require foreign exchange for transactions relating to current account items, if within a certain limited amount may, without approval of the State Administration of Foreign Exchange, or SAFE, effect payment from their foreign exchange account or convert and pay at the designated foreign exchange banks by providing valid receipts and proofs.
Convertibility of foreign exchange for capital account items, such as direct investment and capital contribution, is still subject to certain restrictions, and prior approval from the SAFE or its relevant branches must be sought.
Between 1994 and 2004, the exchange rate for RMB against the US dollar remained relatively stable, most of the time in the region of RMB8.28 to US$1.00. However, in 2005, the Chinese government announced it would begin pegging the exchange rate of the RMB against a number of currencies, rather than just the US dollar. Currently, the exchange rate for RMB against the U.S Dollar is 6.32 to 1. As our operations are primarily in China, any significant revaluation of the RMB may materially and adversely affect our cash flows, revenues, financial condition and the value of our common stock. For example, to the extent that we need to convert US dollars into RMB for our operations, appreciation of this currency against the US dollar could have a material adverse effect on our business, financial condition, results of operations and the value of our common stock. Conversely, if we decide to convert our Renminbi into US dollars for
the purpose of declaring dividends on our common stock or for other business purposes and the US dollar appreciates against the RMB, the US dollar equivalent of our earnings from our subsidiaries in China would be reduced.
The legal system in China has inherent uncertainties that may limit the legal protections available in the event of any claims or disputes with third parties. The legal system in China is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since 1979, the central government has promulgated laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. As China’s foreign investment laws and regulations are relatively new and the legal system is still evolving, the interpretation of many laws, regulations and rules is not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit the remedies available in the event of any claims or disputes with third parties. In addition, any litigation in China may be protracted
and result in substantial costs and diversion of resources and management attention.
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Risks Related to Regulation and Governmental Action
Compliance with new and existing environmental laws and regulations could significantly increase our expansion costs, and force us to delay or halt expansion operation. To operate our plant, we need to comply with a number of permitting requirements. We may have difficulties obtaining these permits. As a condition of granting necessary permits, regulators could make additional demands that increase our costs of expansion and operations, in which case we could be forced to obtain additional debt or equity capital. Environmental issues, such as contamination and compliance with applicable environmental standards, could arise at any time during the expansion and operation of the plant. If this occurs, it would require us to spend significant resources to remedy the issues and may delay or prevent expansion or operation of the plant. This would significantly increase the cost of the plant. We cannot
assure you that we will be able to obtain and comply with all necessary permits to expand and operate the plant.
Our business is subject to extensive and potentially costly environmental regulations that could change and significantly increase our operating costs. We are subject to environmental regulations of China regulatory agencies. These regulations could result in significant compliance costs and may change in the future. Also, such agencies may seek to implement additional regulations or implement stricter interpretations of existing regulations. Changes in environmental laws or regulations or stricter interpretation of existing regulations may require significant additional capital expenditures or increase our operating costs, thereby causing the loss of some or all of your investment.
In addition, the plant could be subject to environmental nuisance or related claims by employees, property owners, environmental groups or residents near the plant arising from air, water or other discharges.
These individuals and entities may object to these discharges and emissions into the environment from the plant. Environmental and public nuisance claims, tort claims based on emissions, or increased environmental compliance costs could significantly increase our operating costs and affect our profitability.
Risks Related to our Common Stock
There is no assurance that we will be able to pay dividends to our shareholders, which means that you could receive little or no return on your investment. Payment of dividends from our earnings and profits may be made at the sole discretion of our board of directors, subject to the provisions of the Nevada Revised Statutes, our articles and restrictions imposed by our creditors. There is no assurance that we will generate any distributable cash from operations. Our board may elect to retain cash for operating purposes, debt retirement, plant improvements or expansion. Consequently, you may receive little or no return on your investment.
We may authorize and issue shares of new classes that could be superior to or adversely affect you as a holder of our common stock. Our board of directors and shareholders have the power to authorize and issue shares of classes that have voting powers, designations, preferences, limitations and special rights, including preferred distribution rights, conversion rights, redemption rights and liquidation rights. These shares may be issued at a price and on terms determined by our board of directors. The terms of the shares and the terms of issuance of the shares could have an adverse impact on your rights and could dilute your financial interest in us.
24
Our shares will be subordinate to all of our debts and liabilities, which increases the risk that you could lose your entire investment. Our shares are equity interests that will be subordinate to all of our current and future indebtedness with respect to claims on our assets. In any liquidation, all of our debts and liabilities must be paid before any payment is made to our shareholders. The amount of any debt financing we incur to finance the construction and commencement of operations at the plant, plus possible additional borrowings and operating liabilities, creates a substantial risk that in the event of our bankruptcy, liquidation or reorganization, we may have no assets remaining for distribution to our shareholders after payment of our debts.
There is a limited public market for our common stock. We have applied for a NASDAQ Capital Markets listing; however, we may not be approved. There is currently a limited public market for the common stock. Holders of our common stock may, therefore, have difficulty selling their common stock, should they decide to do so. In addition, there can be no assurances that such markets will continue or that any shares of common stock will be able to be sold without incurring a loss. Any such market price of the common stock may not necessarily bear any relationship to our book value, assets, past operating results, financial condition or any other established criteria of value, and may not be indicative of the market price for the common stock in the future. Further, the market price for the common stock may be volatile depending on a number of factors, including business performance,
industry dynamics, news announcements or changes in general economic conditions.
In September 2011, we applied for listing on the NASDAQ Capital Markets. Although the Company believes it currently meets the NASDAQ listing criteria, in terms of minimum net worth and the number of required shareholders, due to the current share price of our common stock and other factors determined by the NASDAQ we may not receive approval for listing.
Our common stock may be deemed penny stock with a limited trading market. Our common stock is currently listed for trading in the OTCQB, which is generally considered to be a less efficient market than markets such as NASDAQ or other national exchanges, and which may cause difficulty in conducting trades and difficulty in obtaining future financing. Further, our securities are subject to the “penny stock rules” adopted pursuant to Section 15 (g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The penny stock rules apply to non-NASDAQ companies whose common stock trades at less than $5.00 per share or which have tangible net worth of less than $5,000,000 ($2,000,000 if the company has been operating for three or more years). Such rules require, among other
things, that brokers who trade “penny stock” to persons other than “established customers” complete certain documentation, make suitability inquiries of investors and provide investors with certain information concerning trading in the security, including a risk disclosure document and quote information under certain circumstances. Many brokers have decided not to trade “penny stock” because of the requirements of the penny stock rules and, as a result, the number of broker-dealers willing to act as market makers in such securities is limited. In the event that we remain subject to the “penny stock rules” for any significant period, there may develop an adverse impact on the market, if any, for our securities. Because our securities are subject to the “penny stock rules,” investors will find it more difficult to dispose of our securities. Further, for companies whose securities are traded in the OTCQB, it is more difficult: (i) to obtain
accurate quotations, (ii) to obtain coverage for significant news events because major wire services, such as the Dow Jones News Service, generally do not publish press releases about such companies, and (iii) to obtain needed capital.
25
ITEM 1B. UNRESOLVED STAFF COMMENTS
A smaller reporting company is not required to provide the information required by this Item.
ITEM 2. PROPERTIES
Wendeng
Our Wendeng TCS manufacturing facilities and related offices are located on approximately 11 acres of property in Beizhenge Village, Mishan Town, Wendeng City, China. The annual property tax is approximately $20,000.
Corporate Offices
We lease our principal offices at 245 Park Avenue, 24th Floor, New York, New York, 10167 at a cost of $2,400 per year. Our phone number is (212) 672-1786.
Trading Symbol
Our common stock trades on the OTCQB under the ticker symbol “SSIE”.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. MINE SAFETY DISCLOSURES
None.
26
PART II
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is currently quoted on the OTCQB of OTC Markets. The OTCQB is a network of security dealers who buy and sell stock. The dealers are connected by a computer network that provides information on current "bids" and "asks", as well as volume information. Our shares are quoted on the OTCQB under the symbol “SSIE”.
The following table sets forth the range of high and low bid quotations for our common stock for each of the periods indicated as reported by the OTCQB. These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
As of March 23, 2102, we had 30,058,128 shares of our common stock issued and outstanding, held by 505 shareholders of record.
Dividends
The Company has not declared, or paid, any cash dividends since inception and does not anticipate declaring or paying a cash dividend for the foreseeable future.
Nevada law prohibits our board from declaring or paying a dividend where, after giving effect to such a dividend, (i) we would not be able to pay our debts as they came due in the ordinary course of our business, or (ii) our total assets would be less than the sum of our total liabilities plus the amount that would be needed, if the corporation were to be dissolved at the time of distribution, to satisfy the rights of any creditors or preferred stockholders.
27
Securities Authorized for Issuance under Equity Compensation Plans
We do not have any equity compensation plans.
Recent Sales of Unregistered Securities
In the month of December 2011, we issued an aggregate of 6,000 shares of our restricted common stock to our three independent directors as compensation valued at $24,000 for director services for the quarter ended November 30, 2011 (prior to the change in our fiscal year end). The securities were issued exempt from registration under the Securities Act of 1933 pursuant to an exemption provided by Section 4(2) of the Securities Act of 1933.
ITEM 6. SELECTED FINANCIAL DATA
A smaller reporting company is not required to provide the information required by this Item.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements-
Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives, and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words “believes,”“project,”“expects,”“anticipates,”“estimates,”“intends,”“strategy,”“plan,”“may,”“will,”“would,”“will be,”“will continue,”“will likely result,” and similar expressions. We intend such forward-looking statements to be covered by the safe-harbor provisions for forward-looking
statements contained in the Private Securities Litigation Reform Act of 1995, and are included in this statement for purposes of complying with those safe-harbor provisions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Some of the factors that could cause results or events to differ materially from current expectations include, but are not limited to: general economic, market or business conditions; general stock market performance; the performance of the solar energy industry in general; the consolidation of the TCS industry in China; an increasingly competitive environment for TCS; changing regulatory conditions or requirements; changing government incentive programs for solar energy projects; changing
alternative energy technologies; raising sufficient capital to fund the expansion of Wendeng to 75,000 MT and acquisition of other TCS manufacturing facilities; our ability to find suitable TCS acquisition targets; our ability to complete the Wendeng expansion on budget and on time; the price of TCS sold within China and outside of China; the price of, and demand for, polysilicon; the price of, and demand for, solar PV panels; the level of production by the Wendeng factory; the opening of our Wendeng facility by the end of April 2012; Baokai's success in attaining new clients under its TCS distribution agreement; the decision by potential investors who have signed subscription agreements not to pay for such SunSi common shares; a decision by NASDAQ to reject the Company's application for listing; our ability to successfully manage a business in China; and success in implementing productivity
initiatives. These risks and uncertainties should also be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Further information concerning our business, including additional factors that could materially affect our financial results, is included herein and in our other filings with the SEC.
28
Overview
SunSi’s goal is to acquire and develop a portfolio of high quality TCS producing facilities (and in some cases distribution rights) that are strategically located and possess a potential for future growth and expansion. TCS is the main feedstock of the solar energy industry, used in the production of silicon, which in turn is used in the production of solar PV energy producing panels.
Acquisition of Zibo Baokai Trade and Commerce Co. Ltd.
During a significant portion of 2009 and into early 2010, we performed due diligence and negotiated with the shareholders of ZBC, a 25,000 MT TCS production factory located in Zibo China, to acquire their facility. On December 12, 2009, prior to our determining whether or not we would buy ZBC, we secured the exclusive international distribution rights (“international rights”) for all of the TCS produced by the ZBC factory. These international rights which were secured by SunSi HK, for nominal consideration, were not contingent on our purchasing ZBC. The international rights entitled us to sell TCS produced by the ZBC factory outside of China only. It gave us no rights to sell ZBC’s production within China. ZBC granted us these international rights because they were hopeful we could generate new customers for their TCS production outside of China. Historically, all of
ZBC’s sales have been within China.
In early 2010, we determined that despite our best efforts, we could not acquire ZBC, as planned, on terms that would be beneficial to SunSi. Therefore, we discontinued our efforts to acquire the ZBC factory, and instead negotiated with ZBC to obtain the exclusive domestic distribution rights, for the TCS produced by ZBC within China to supplement the exclusive international distribution rights which we acquired on December 12, 2009 (described above).
On December 8, 2010, SunSi HK acquired 90% of Baokai for $270,000, an acquisition which gave us the exclusive distribution rights to 100% of ZBC’s production both internationally and domestically; however, we did not acquire any interest or ownership position in the ZBC factory.
As part of the Baokai distribution rights, ZBC agreed to sell Baokai all of its TCS production at a price of cost, plus a 10% to 15% mark-up depending on the nature of the sale. Since December 2010 we have generated a gross margin of approximately 2.0% on Baokai revenues. By mutual agreement with ZBC, Baokai agreed to earn a smaller profit margin than originally anticipated on these sales because the sales came from existing customers of ZBC and from the efforts of the ZBC sales force. We are in discussions with a number of international clients who are interested in purchasing TCS from Baokai. These new purchases would generate significantly higher gross margins for Baokai than the 2.0%; however, there can be no assurances that we will be successful in obtaining sales from these new customers.
Baokai has one client which accounted for substantially all of their sales for the seven month period ended December 31, 2011 and since December 2010. The facility is easily accessible via rail and major highways, in addition to being well equipped for handling chemical products. We believe we can expand Baokai’s client base in the future, although there can be no assurances.
Acquisition of Wendeng He Xie Silicon Co. Ltd
On March 18, 2011, we acquired (“Wendeng Acquisition”) a 60% interest in Wendeng, a trichlorosilane manufacturing company, from Liu Dongqiang, a Chinese individual. Wendeng is located in the Shandong province of China close to strategic ports, including Weihai and Qingdao. The state-of-the-art Wendeng facility was built in 2008 and currently has an annual capacity of 30,000 MT of TCS. The Wendeng facility was designed and is currently managed by Zhang Fahe, who possesses over 30 years of experience in the Chinese chemical industry. Mr. Fahe has been working in the TCS field since 2001 where he developed efficient TCS production technologies. As part of the closing, Wendeng was re-formed as a joint venture business under Chinese law and issued a new business license.
29
As of March 18, 2011, Wendeng had a production capacity of approximately 20,000 MT tons of Trichlorosilane. As a result of closing the Wendeng Acquisition, SunSi began to immediately consolidate all of Wendeng’s revenues, and 60% of its profits.
On June 13, 2011, we amended the terms of the Wendeng Acquisition, whereby Mr. Liu canceled our obligation to buy back the 1,349,628 shares of our stock and confirmed that the purchase price for the 60% equity interest in Wendeng is fully paid. Such shares had been classified as “Redeemable Common Stock” on the Registrant balance sheet and excluded from Stockholders’ Equity and were subsequently included in the Company’s Stockholders’ Equity section of the balance sheet at a value of approximately $2.7 million.
Our plan after acquisition is to expand the manufacturing capacity of Wendeng to 75,000 MT per year. In October 2011, the construction of the expanded capacity from 20,000 to 30,000 MT was substantially completed. The cost of this 10,000 MT ton expansion was approximately $1.5 million. The expanded capacity is now fully operational at that time. We estimate the total amount of funding required by SunSi to complete the Wendeng expansion from 30,000 MT to 75,000 MT is currently approximately $15.0 million. Mr. Liu, our 40% minority partner in the facility, is expected to contribute $5.0 million towards this expansion. Our portion of this expansion will be approximately $10 million.
If we are unable to raise this amount through the sale of equity securities, we will have to secure additional debt financing to complete the acquisition and the planned expansion project. If necessary, we intend to negotiate terms of a revolving line of credit and/or conditions for a construction/term loan with various banking institutions. However, there is no assurance that debt financing will be available or, if available, on terms that are favorable to us. In addition, if we are unable to raise sufficient equity capital to commence development of the plant expansion, we may pursue the plant expansion through alternative ownership structures, such as joint ventures with other entities. We currently have no commitment for either equity or debt financing. There can be no assurances that the Company will be successful in raising sufficient
funds to complete the expansion.
As described throughout this Report in December 2010 we consummated the acquisitions of Baokai, and in March 2011 we consummated the acquisition of Wendeng. As a result of these acquisitions, we emerged from a Development Stage company into planned operations. On December 8, 2011, we changed our fiscal year end from May 31st to December 31st. The results of operations reflected below include seven months of operations for Baokai and Wendeng during the seven months ended December 31, 2011, respectively, compared to one month and nil in the previous seven month period ended December 31, 2010. Therefore, comparisons between 2011 and 2010 may not be indicative of current trends because of partial year operating results.
30
Segment Results
The following table sets forth operations by segment for the seven month periods ended December 31, 2011 and 2010:
2011
2010
Sales:
(unaudited)
Baokai
$
5,956,999
$
1,165,239
Wendeng
8,463,841
—
Corporate
—
—
Total
$
14,420,840
$
1,165,239
Cost of goods sold:
Baokai
$
5,837,859
$
1,141,605
Wendeng
6,374,278
—
Corporate
—
—
Total
$
12,212,137
$
1,141,605
Gross margin:
Baokai (1)
$
119,140
$
23,634
Wendeng (2)
2,089,563
—
Corporate
—
—
Total
$
2,208,703
$
23,634
Operating expenses:
Baokai
$
352,697
$
—
Wendeng
4,982,293
—
Corporate
545,370
445,647
Total
$
5,880,360
$
445,647
Provision for income taxes (benefit):
Baokai
$
19,719
$
5,909
Wendeng
(101,291
)
—
Corporate
—
—
Total
$
(81,572
)
$
5,909
Net income (loss):
Baokai
$
(253,276
)
$
17,725
Wendeng
(2,791,439
)
—
Corporate
(545,370
)
(445,647)
Total
$
(3,590,085
)
$
(427,922)
(1) Includes goodwill impairment charge of $312,433.
(2) Includes goodwill impariment charge of $2,487,567
Our operating segments do not sell any products to each other, and accordingly, there are no inter-segment revenues to be reported.
31
Net Revenue
Revenue for the seven months ended December 31, 2011 from the sales of TCS was $14,420,840, compared to $1,165,239 for the same period ended December 31, 2010. The revenues generated in fiscal 2011 were as a result of two acquisitions (Baokai and Wendeng) described throughout this Report. Baokai recorded $5,956,999 and $1,165,239 in revenue for the seven month periods ended December 31, 2011 and 2010 respectively, and Wendeng recorded $8,463,841 and $-0- in revenue, respectively, for same seven month periods ended December 31, 2011 and 2010. With the exception of approximately $200,000 in revenue from one shipment made by Wendeng
during 2011 to Nitol Solar in Russia, all of these revenues were recorded within China. The price of TCS in China is typically based on short term contracts and the spot market enabling both the buyer and the seller to adapt to market conditions. The price of TCS varied very significantly in the seven month period ended December 31, 2011 ranging from a high price of approximately $1,600 per metric ton, to a low price of approximately $700 per metric ton. The price of polysilicon, of which TCS is an essential raw material required to make polysilicon, has come down approximately 50 - 60% since January 2011 which has had a material negative impact on the pricing of TCS and the amount of orders we received at the end of 2011 and through the beginning of 2012. As of April 2012 the spot price for TCS was $700 per metric ton. Based
on our knowledge of the TCS industry in China, we do not believe there are any suppliers that can produce TCS profitably at $700 per metric ton. We believe other TCS manufacturers are selling their supplies of existing TCS inventory at a loss. The breakeven sales price for Wendeng, and for ZBC to supply TCS to Baokai, is approximately $770 -$800 per MT in China. Since neither Baokai or Wendeng can operate profitably at current price levels, they have remained closed throughout 2012; although Wendeng has sold some of its hand inventory of TCS in 2012 that it manufactured in 2011.
Based on the current level of request for price quotes we are receiving, and ongoing negotiations with a number of potential existing and new customers; we expect the Wendeng facility to re-open due to a rise in the demand and price for TCS thus enabling us to begin manufacturing and selling TCS by the end of April 2012; although there can be no assurances. Nor can there be any assurances that the price of TCS will rise to sufficient levels to enable either Baokai or Wendeng to operate profitably.
Gross Margin
Gross margin is calculated by subtracting cost of sales from net revenue. The gross margin for the seven months ended December 31, 2011 was $2,208,703 compared to the $23,634 for the same period in 2010. The increase in gross margin is attributable to the inclusion of Wendeng revenues in 2011 compared to -0- in the prior year. The gross margin percentage is calculated by dividing the gross margin by net revenues. The gross margin percentage of approximately 15.2% for the seven month period ended December 31, 2011 is attributable to a 24.7% margin on sales at Wendeng, offset by a 2% margin earned on net revenues at Baokai. Wendeng gross margin reached approximately 31% in mid-2011 and has been declining since that time due to the oversupply of polysilicon described throughout this
report. Wendeng operated at a margin of -4.2% during the period from October through December 2011 and has remained closed during 2012 because it cannot operate profitably at the current spot price of TCS.
Margins are fixed at 2% at Baokai because we are a distributor of TCS produced by the ZBC factory and our purchase price is fixed to the percentage of selling price. The gross margin for the seven month period ended December 31, 2011 was 2% since all of the revenue was recorded from the Baokai segment. The gross margin at Baokai is fixed at 2% for all existing customers, but will increase if we can bring new customers to Baokai that will purchase TCS from the ZBC TCS factory which Baokai buys all of its TCS from. There can be no assurances that we will be successful in doing so. If the price of TCS fluctuates at Baokai, we will still earn a 2% margin; however, if there are price fluctuations either up or down for TCS, our gross margin percentage will be impacted.
Professional Fees
We incurred professional fees of $473,794 and $319,918, respectively, for the seven months ended December 31, 2011 and 2010, respectively. Professional fees consist of legal, accounting and other due diligence fees. The increase in 2011 professional fees, which were primarily incurred in the United States associated with public company activity compared to the same period in 2010, is attributable to an increase in due diligence activities due to the consummation of the Baokai and Wendeng acquisitions.
32
General and Administrative Expenses
General and administrative expenses (G&A) were $2,606,566 for the seven month period ended December 31, 2011 compared to $125,729 for the period ended December 31, 2010. The increase in G&A expense in 2011 is primarily attributable to the inclusion of G&A expenses at Wendeng in 2011 due to the acquisition of Wendeng on March 18, 2011. The primary components of G&A expenses include, office expense, salaries and benefits not directly associated with manufacturing process, and building expenses and maintenance.
Goodwill Impairment
Goodwill represents the excess of cost over fair value of assets of businesses acquired. Goodwill acquired in a business combination is not amortized. The Company evaluates the carrying amount of goodwill for impairment annually on December 31 and whenever events or circumstances indicate impairment may have occurred.
When evaluating whether goodwill is impaired, the Company compares the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s carrying amount, including goodwill. The fair value of the reporting unit is estimated using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies’ data. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the implied fair value of reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess
of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value.
Due to the inability to meet anticipated sales growth, the Company assessed the acquired goodwill associated with its related business units for impairment as of December 31, 2011. Based on the discounted cash flows model utilizing estimated future earnings and cash flows, the fair value of the reporting units was less than the carrying value of the acquired goodwill. The Company’s evaluation of goodwill resulted in a total impairment charge of $2,800,000; of which $2,487,567 was attributed to Wendeng and $312,433 was attributed to Baokai.
Provision for Income Taxes
The provision for income taxes was $(81,572) or (.57%) for the seven month period ended December 31, 2011 compared to $5,909 or .50 % for the same period ended December 31, 2010.
As a result of profits recorded at the Baokai subsidiary and Wendeng subsidiaries located in China for the period ended December 31, 2010, we have recorded a tax provision of $5,909 or 25% tax rate which is the statutory rate in China for all earnings. The profits generated in China are not available to be offset against net operating losses in the United States.
Potential benefits of income tax losses are not recognized in the accounts until realization is more likely than not. The Company has incurred a U.S net operating loss of approximately $2,239,370 which expires in 2031. Pursuant to ASC 740, the Company is required to compute tax asset benefits for net operating losses carried forward. Potential benefit of net operating losses have not been recognized in these financial statements because the Company cannot be assured it is more likely than not it will utilize the net operating losses in the United States carried forward in future years.
Net loss attributable to SunSi's common shareholders
For the seven month period ended December 31, 2011, we had a loss of $2,448,182, or ($0.08) per share, compared to a loss of $429,695, or ($0.02) per share, for the comparable period ended December 31, 2010. During 2010, we were a development stage company with no revenues and only expenses. For the seven months period ended December 31, 2011, approximately $3,495,541 of our loss was non-cash in nature due to depreciation and amortization of $695,541 and an impairment recorded against goodwill of $2,800,000. No similar expenses were realized in the comparable period 2010. We expect to be unprofitable from operations for the period from January 1, through June 30, 2012, although our
cash losses will be minimal due to our low expense operating structure both in China and the United States.
The weighted average number of basic and fully diluted shares outstanding for the seven month periods ended December 31, 2011 and 2010 were 29,843,712 and 27,462,961, respectively. There are no dilutive equivalents included in our calculation of fully diluted shares in either period, nor are there any fully diluted equivalents that would have been included if we had been profitable in either period.
33
Liquidity and Capital Resources
As of December 31, 2011, we had cash on hand of $674,291. Of this amount, $186,423 was in the U.S. and $474,891 was in China and $12,977 was in Hong Kong. For the foreseeable future, we do not intend to repatriate any funds from China to support operations in the United States. U.S. operations are comprised of a holding company with expenses and no business operating activities that are revenue generating. Historically, the sole source of funding for U.S. corporate activities has been in the form of private placements of our common stock. Subsequent to December 31, 2011, we have sold 25,000 shares of our stock and raised approximately $50,000 in cash, net of fees. Additionally, we have received a stock subscription agreement for $100,000 that we expect to receive in April 2012. We believe our current cash on hand and our
ability to continue raising funds from the sale of equity will be sufficient to fund our U.S. activities for the next year.
We have been seeking funding in the form of equity or debt to expand our Wendeng facility from 30,000 MT to 75,000 MT. We estimate that this expansion will cost approximately $10.0 million. There can be no assurances that we will be successful in raising these funds.
As of December 31, 2011, we had a working capital deficit of $4,386,301. The deficit is primarily attributable to the related party payable of $5,665,245 due to the 40% minority shareholder of Wendeng. These funds were used to build and expand the Wendeng facility. The minority shareholder is currently not requesting repayment of this amount; however, since this is an interest free demand loan to the Company, it has been categorized as a current liability.
Net cash used in operating activities was $245,246 for the seven months ended December 31, 2011 compared to $630,311 for the same period in 2010. The decrease in the net cash used in the seven months ended December 31, 2011 compared to 2010 is primarily attributable to an increase in operating losses in 2011 net of goodwill impairment, offset by an increase in depreciation and amortization in 2011 and an improvement in the net change in operating assets and liabilities in 2011.
Net cash used in investing activities was $827,035 for the seven months ended December 31, 2011 compared to $263,647 in the same period in 2010. The net cash used in 2011 is attributable to the purchase of $470,310 in plant and equipment subsequent to acquisition of Wendeng, and the purchase of intangible assets of $356,725 related to the acquisition of Wendeng in 2011. The net used in investing activities in 2010 relates to the purchase of Baokai.
Net cash provided by financing activities was $1,090,500 for the seven months ended December 31, 2011 compared to $871,776 for the same period in 2010. The proceeds received in both periods are primarily attributable to the sale of equity through private placements.
During our fiscal year ended May 31, 2011, we consummated the acquisitions of Baokai in December, 2010 and Wendeng in March 2011 as described throughout this Report. As a result of these acquisitions, we emerged from a Development Stage company into planned operations. The results of operations include approximately five and one-half months of operations for Baokai and two and one-half months of operations for Wendeng, respectively for 2011, compared to nil in the previous fiscal year ended May 2010. Therefore, comparisons between 2011 and 2010 may not be indicative of current trends because of partial year operating results.
34
Segment Results
The following table sets forth operations by segment for the years ended May 31, 2011 and 2010:
2011
2010
Sales:
Baokai
$
9,755,030
$
—
Wendeng
5,327,758
—
Corporate
—
—
Total
$
15,082,788
$
—
Cost of goods sold:
Baokai
$
9,538,061
$
—
Wendeng
3,506,938
—
Corporate
—
—
Total
$
13,044,999
$
—
Gross margin:
Baokai
$
216,969
$
—
Wendeng
1,820,820
—
Corporate
—
—
Total
$
2,037,789
$
—
Operating expenses:
Baokai
$
37,000
$
—
Wendeng
975,882
—
Corporate
921,247
621,835
Total
$
1,934,129
$
621,835
Provision for income taxes:
Baokai
$
44,992
$
—
Wendeng
211,235
—
Corporate
—
—
Total
$
256,227
$
—
Net income (loss):
Baokai
$
134,977
$
—
Wendeng
633,703
—
Corporate
(921,247
)
(621,835
)
Total
$
(152,567
)
$
(621,835
)
Operating segments do not sell products to each other, and accordingly, there is no inter-segment revenue to be reported.
35
Net Revenue
Revenue from the sale of TCS for the year ended May 31, 2011 was $15,082,788, compared to $-0- for the year ended May 31, 2010. The revenues generated in fiscal 2011 were as a result of two acquisitions; Baokai and Wendeng. Baokai recorded $9,755,030 in revenue for the five and one-half month period following its December 9, 2010 acquisition. Wendeng recorded $5,327,758 in revenue for the two and one-half month period following its March 18, 2011 acquisition. All of these revenues were recorded within The People’s Republic of China. The price of TCS in China is typically based on short-term contracts and the spot market enabling both the
buyer and the seller to adapt to market conditions. During these periods, the price of TCS ranged approximately between $1,400-$1,600 USD per metric ton. These prices included value added taxes (“VAT”) of 17%. For GAAP accounting purposes, VAT included within the selling price to customers is excluded in the determination of net revenues. From January 2011, the price of polysilicon, to which TCS is an essential raw material, declined approximately 30%. The price of TCS declined approximately 10% during the same period.
Gross Margin
Gross margin is calculated by subtracting cost of sales from net revenue. Gross margin percentage is calculated by dividing the gross margin by net revenues. The gross margin percentage of approximately 13.5% for the year ended May 31, 2011 is attributable to a 34.2% percent gross margin on sales at Wendeng, offset by a 2% gross margin on sales at Baokai. Our Baokai segment is a distributor of the TCS produced by the Zibo Baoyun Chemical Plant and our purchase price is fixed to a percentage of selling price. As such, Baokai realizes a gross margin fixed at 2% on sales to existing customers; however, this will potentially increase if we introduce new customers that purchase the TCS manufactured by ZBC.
Professional Fees
We incurred professional fees of $618,992 and $580,981, respectively, for the fiscal years ended May 31, 2011 and 2010, respectively. Professional fees consist of legal, accounting and other due diligence fees. The increase in 2011 professional fees, which were primarily incurred in the United States associated with public company activity compared to the same period in 2010, is attributable to an increase in due diligence activities due to the consummation of the Baokai and Wendeng acquisitions.
General and Administrative Expenses
General and administrative expenses (G&A) were $1,315,137 for the fiscal year ended May 31, 2011 compared to $40,854 for the period ended May 31, 2010. The increase in G&A expenses in 2011 is primarily attributable to the inclusion of G&A expenses at Wendeng in 2011 due to the acquisition of Wendeng on March 18, 2011. The primary components of G&A expenses include, office expense, salaries and benefits not directly associated with manufacturing process, and building expenses and maintenance.
36
Provision for Income Taxes
The provision for income taxes was $256,227 or 247.2% for the period ended May 31, 2011 compared to $0 (0%) for the same period ended May 31, 2011.
As a result of profits recorded at the Baokai subsidiary and Wendeng subsidiaries located in China for the period ended May 31, 2011, we have recorded a tax provision of $256,227, or 25% tax rate which is the statutory rate in China for all earnings. The profits generated in China are not available to be offset against net operating losses in the United States.
Potential benefits of income tax losses are not recognized in the accounts until realization is more likely than not. The Company has incurred a U.S net operating loss of approximately $1,684,000 which expires in 2031. Pursuant to ASC 740, the Company is required to compute tax asset benefits for net operating losses carried forward. Potential benefit of net operating losses have not been recognized in these financial statements because the Company cannot be assured it is more likely than not it will utilize the net operating losses in the United States carried forward in future years.
Net loss attributable to SunSi's common shareholders
For the fiscal year ended May 31, 2011, we had a loss of $419,546, or ($.02) per share, compared to a loss of $621,835, or ($.02) per share, for the comparable period ended May 31, 2010. During 2010, we were a development stage company with no revenues and only expenses. During the third and fourth quarters of 2011, we consummated two acquisitions. Approximately $233,000 of our loss was non-cash in nature due to depreciation and amortization for the period ended May 31, 2011. We were profitable in the fourth quarter of fiscal 2011 ended August 31, 2011 and expect to be profitable on an annual basis going forward.
The weighted average number of basic and fully diluted shares outstanding for the periods ended May 31, 2011 and 2010 were 27,675,252 and 26,972,486, respectively. There are no dilutive equivalents included in our calculation of fully diluted shares in either period, nor are there any fully diluted equivalents that would have been included if we had been profitable in either period.
Liquidity and Capital Resources
As of May 31, 2011, we had cash on hand of $640,880. Of this amount, $51,580 was in the U.S. and $581,882 was in China and $7,418 was in Hong Kong. For the foreseeable future, we do not intend to repatriate any funds from China to support operations in the United States. U.S. operations are comprised of a holding company with expenses and no business operating activities that are revenue generating. Historically, the sole source of funding for U.S. corporate activities has been in the form of private placements of our common stock. Subsequent to May 31, 2011, we sold 510,200 shares of our stock and raised approximately $918,000 in cash, net of fees. We believe our current cash on hand and our ability to continue raising funds from the sale of equity will be sufficient to fund our U.S. activities for the next year.
We expect to generate positive cash flow from Chinese operations during the next year. We are in the process of seeking funding in the form of equity or debt to expand our Wendeng facility from 30,000 MT to 75,000 MT. We estimate that this expansion will cost approximately $10.0 million. We believe we will be successful in raising these funds; however, there can be no assurances.
37
As of May 31, 2011, we had a working capital deficit of $5,458,737. The deficit is primarily attributable to the related party payable of $5,321,502 due to the 40% minority shareholder of Wendeng. These funds were used to build and expand the Wendeng facility. The minority shareholder is currently not requesting repayment of this amount; however, since this is an interest free demand loan to the Company, it has been categorized as a current liability.
Net cash used in operating activities was $1,205,132 for the year ended May 31, 2011 compared to $631,203 for the same period in 2010. The increase in 2011 compared to 2010 is attributable to a net change in operating assets and liabilities offset by a decrease in net loss.
Net cash provided by investing activities was $287,826 for the year ended May 31, 2011 compared to no activity for the same period in 2010. The net cash provided in 2011 is primarily due to the amount of cash acquired at Wendeng exceeding the cash consideration paid for Wendeng by approximately $472,000 and due to purchase of approximately $185,000 in equipment subsequent to acquisition.
Net cash provided by financing activities was $948,599 for the period ended May 31, 2011 compared to $1,225,481 for the same period in 2010. The proceeds received in both periods are primarily attributable to the sale of equity through private placements.
Supplemental Disclosures
Due to the change in our fiscal year from May 31st to December31st we are providing on a voluntary basis supplemental MD&A disclosures for the years ended December 31, 2011 and December 31, 2010(unaudited). The financial statement for these periods are attached as Exhibit 99 to this document.
We consummated the acquisitions of Baokai in December 2010, and in March 2011 we consummated the acquisition of Wendeng. As a result of these acquisitions, we emerged from a Development Stage company into planned operations. On December 8, 2011, we changed our fiscal year end from May 31st to December 31st. The results of operations reflected below include one month of operations for Baokai and no activity for Wendeng, respectively, during the unaudited twelve month period ended December 31, 2010. Therefore, comparisons between 2011 and 2010 may not be indicative of current trends because of partial year operating results.
Segment Results
The following table sets forth operations by segment for the years ended December 31, 2011 and 2010:
2011
2010
Sales:
Baokai
$
14,546,790
$
1,165,239
Wendeng
13,791,599
—
Corporate
—
—
Total
$
28,338,389
$
1,165,239
Cost of goods sold:
Baokai
$
14,234,315
$
1,141,605
Wendeng
9,881,216
—
Corporate
—
—
Total
$
24,115,531
$
1,141,605
Gross margin:
Baokai
$
312,475
$
23,634
Wendeng
3,910,383
—
Corporate
—
—
Total
$
4,222,858
$
23,634
Operating expenses:
Baokai
$
389,6979
(1)
$
—
Wendeng
5,958,1759
(2)
—
Corporate
1,020,970
664,806
Total
$
7,368,842
$
664,806
Provision for income taxes (benefit):
Baokai
$
58,802
$
5,909
Wendeng
109,944
—
Corporate
—
—
Total
$
168,746
$
5,909
Net income (loss):
Baokai
$
(136,024)
$
17,725
Wendeng
(2,157,736
)
—
Corporate
(1,020,970
)
(664,806)
Total
$
(3,314,730
)
$
(647,081)
(1) Includes a goodwill impairment charge of $312,433
(2) Includes a goodwill impairment charge of $2,487,567
38
Our operating segments do not sell any products to each other, and accordingly, there are no inter-segment revenues to be reported.
Net Revenue
Revenue for the year ended December 31, 2011 from the sales of TCS was $28,338,389, compared to $1,165,239 for the same period ended December 31, 2010. The revenues generated in fiscal 2011 were as a result of two acquisitions Baokai and Wendeng described above. Baokai recorded $14,546,790 and $1,165,239 in revenue for the years ended December 31, 2011 and 2010 respectively, and Wendeng recorded $13,791,599 and $-0- in revenue, respectively, for the same periods ended December 31, 2011 and 2010. With the exception of approximately $200,000 in revenue from one shipment made by Wendeng during 2011 to Nitol Solar in Russia, all of
these revenues were recorded within China. The price of TCS in China is typically based on short term contracts and the spot market enabling both the buyer and the seller to adapt to market conditions. The price of TCS varied very significantly in the year ended December 31, 2011 ranging from a high price of approximately $1,600 per metric ton, to a low price of approximately $700 per metric ton.
The price of polysilicon, of which TCS is an essential raw material required to make polysilicon, has come down approximately 50 - 60% since January 2011 which has had a material negative impact on the pricing of TCS and the amount of orders we received at the end of 2011 and through the beginning of 2012. As of April 2012, the spot price for TCS was $700 per metric ton. Based on our knowledge of the TCS industry in China, we do not believe there are any suppliers that can produce TCS profitably at $700 per metric ton. We believe other TCS manufacturers are selling their supplies of existing TCS inventory at a loss. The breakeven sales price for Wendeng, and for ZBC to supply TCS to Baokai, is approximately $770 -$800 per MT in China. Since neither Baokai nor Wendeng can operate profitably at current price levels, they have remained closed throughout 2012; although Wendeng has sold some of its on-hand inventory of TCS in 2012
that it manufactured in 2011. Based on the current level of request for price quotes we are receiving, and ongoing negotiations with a number of potential existing and new customers, we expect the Wendeng facility to re-open due to a rise in the demand and price for TCS thus enabling us to begin manufacturing and selling TCS by the end of April 2012; although there can be no assurances. Nor can there be any assurances that the price of TCS will rise to sufficient levels to enable either Baokai or Wendeng to operate profitably.
Gross Margin
Gross margin is calculated by subtracting cost of sales from net revenue. The gross margin for the year ended December 31, 2011 was $4,222,858 compared to $23,634 for the same period in 2010. The increase in gross margin is attributable to the inclusion of Wendeng revenues in 2011 compared to $-0- in the prior year. The gross margin percentage is calculated by dividing the gross margin by net revenues. The gross margin percentage of approximately 14.9% for the year ended December 31, 2011 is attributable to a 28.4% margin on sales at Wendeng, offset by a 2% margin earned on net revenues at Baokai.
Wendeng gross margin reached as high as approximately 31% in mid-2011 and has been declining since that time due to the worldwide oversupply of polysilicon. Wendeng operated at a margin of -4.2% during the period from October through December 2011 and has remained closed during 2012 because it cannot operate profitably at the current spot price of TCS. Margins are fixed at 2% at Baokai because we are a distributor of TCS produced by the ZBC factory and our purchase price is fixed to the percentage of selling price. The gross margin for the year ended December 31, 2011 was 2% since all of the revenue was recorded from the Baokai segment. The gross margin at Baokai is fixed at 2% for all existing customers, but will increase if we can bring new customers to Baokai that will purchase TCS from the ZBC TCS factory which Baokai buys all of its TCS from. There can be no assurances
that we will be successful in doing so. If the price of TCS fluctuates at Baokai, we will still earn a 2% margin; however, if there are price fluctuations either up or down for TCS, our gross margin percentage will be impacted.
Professional Fees
We incurred professional fees of $772,868 and $478,518, respectively, for the years ended December 31, 2011 and 2010, respectively. Professional fees consist of legal, accounting and other due diligence fees. The increase in 2011 professional fees, which were primarily incurred in the United States associated with public company activity compared to the same period in 2010, is attributable to an increase in due diligence activities due to the consummation of the Baokai and Wendeng acquisitions.
General and Administrative Expenses
General and administrative expenses (G&A) were $3,795,974 for the year ended December 31, 2011 compared to $186,288 for the period ended December 31, 2010. The increase in G&A expense in 2011 is primarily attributable to the inclusion of G&A expenses at Wendeng in 2011 due to the acquisition of Wendeng on March 18, 2011. The primary components of G&A expenses include office expense, salaries and benefits not directly associated with manufacturing process, and building expenses and maintenance.
Provision for Income Taxes
The provision for income taxes was $168,746 or .60% for the year ended December 31, 2011 compared to $5,909 or .50% for the same period ended December 31, 2010. As a result of profits recorded at the Baokai and Wendeng subsidiaries located in China for the period ended December 31, 2010, we have recorded a tax provision of $5,909 or 25% tax rate which is the statutory rate in China for all earnings. The profits generated in China are not available to be offset against net operating losses in the United States. Potential benefits of income tax losses are not recognized in the accounts until realization is more likely than not. The
Company has incurred a U.S net operating loss of approximately $2,239,370 which expires in 2031. Pursuant to ASC 740, the Company is required to compute tax asset benefits for net operating losses carried forward. Potential benefit of net operating losses have not been recognized in these financial statements because the Company cannot be assured it is more likely than not it will utilize the net operating losses in the United States carried forward in future years.
39
Goodwill Impairment
Goodwill represents the excess of cost over fair value of assets of businesses acquired. Goodwill acquired in a business combination is not amortized. The Company evaluates the carrying amount of goodwill for impairment annually on December 31 and whenever events or circumstances indicate impairment may have occurred.
When evaluating whether goodwill is impaired, the Company compares the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s carrying amount, including goodwill. The fair value of the reporting unit is estimated using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies’ data. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the implied fair value of reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess
of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value.
Due to the inability to meet anticipated sales growth, the Company assessed the acquired goodwill associated with its related business units for impairment as of December 31, 2011. Based on the discounted cash flows model utilizing estimated future earnings and cash flows, the fair value of the reporting units was less than the carrying value of the acquired goodwill. The Company’s evaluation of goodwill resulted in a total impairment charge of $2,800,000; of which $2,487,567 was attributed to Wendeng and $312,433 was attributed to Baokai.
Net loss attributable to SunSi's common shareholders
For the year ended December 31, 2011, we had a loss of $2,438,033, or ($0.08) per share, compared to a loss of $648,854, or ($0.02) per share, for the comparable period ended December 31, 2010. During 2010, we were a development stage company with no revenues and only expenses. For the year ended December 31, 2011 $695,541 in depreciation and amortization, and $2,800,000 for the impairment of goodwill, were non cash in nature compared to $-0- for both categories for the same period ended December 31, 2010. We expect to be unprofitable from operations for the period from January 1, through June 30, 2012, although our cash losses will be minimal due to our low expense operating structure
both in China and the United States. The weighted average number of basic and fully diluted shares outstanding for the years ended December 31, 2011 and 2010 were 29,271,281 and 27,321,154 respectively. There are no dilutive equivalents included in our calculation of fully diluted shares in either period, nor are there any fully diluted equivalents that would have been included if we had been profitable in either period.
Liquidity and Capital Resources
As of December 31, 2011, we had cash on hand of $674,291. Of this amount, $186,423 was in the U.S. and $474,891 was in China and $12,977 was in Hong Kong. For the foreseeable future, we do not intend to repatriate any funds from China to support operations in the United States. U.S. operations are comprised of a holding company with expenses and no business operating activities that are revenue generating. Historically, the sole source of funding for U.S. corporate activities has been in the form of private placements of our common stock. Subsequent to December 31, 2011, we have sold 25,000 shares of our stock and raised approximately $50,000 in cash, net of fees. Additionally, we have received a stock subscription agreement for $100,000 that we expect to receive in April 2012.
We believe our current cash on hand and our ability to continue raising funds from the sale of equity will be sufficient to fund our U.S. activities for the next year.
We have been seeking funding in the form of equity or debt to expand our Wendeng facility from 30,000 MT to 75,000 MT. We estimate that this expansion will cost approximately $10.0 million. There can be no assurances that we will be successful in raising these funds. As of December 31, 2011, we had a working capital deficit of $4,386,301. The deficit is primarily attributable to the related party payable of $5,501,598 due to the 40% minority shareholder of Wendeng. These funds were used to build and expand the Wendeng facility. The minority shareholder is currently not requesting repayment of this amount; however, since this is an interest free demand loan to the Company, it has been categorized as a current liability.
Net cash used in operating activities was $820,067 for the year ended December 31, 2011 compared to $949,882 used for the same period in 2010. The decrease in the net cash used in the year ended December 31, 2011 compared to 2010 is primarily attributable to an increase in operating losses in 2011, offset by an increase in depreciation and amortization in 2011 and an improvement in the net change in operating assets and liabilities in 2011.
Net cash used by investing activities was $275,562 for the year ended December 31, 2011 compared to $263,647 in the same period in 2010. The net cash used in 2011 is attributable to the purchase of $470,310 in plant and equipment subsequent to acquisition of Wendeng, and the purchase of intangible assets of $356,725 related to the acquisition of Wendeng in 2011. The net cash used in investing activities in 2010 relates to the purchase of Baokai.
Net cash provided by financing activities was $1,167,323 for the year ended December 31, 2011 compared to $1,288,611 for the same period in 2010. The proceeds received in both periods are primarily attributable to the sale of equity through private placements.
40
Critical Accounting Policies
We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the use of 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 and the reported amount of revenues and expenses during the reporting period. Our management periodically evaluates the estimates and judgments made. Management bases its estimates and judgments on historical experience and on various factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates as a result of different assumptions or conditions.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
In preparing financial statements in conformity with US GAAP, management is required 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 and revenues and expenses during the reported periods. These accounts and estimates include, but are not limited to, the valuation of accounts receivable, inventories, goodwill and intangible assets, deferred income taxes and the estimation on useful lives of property, plant and equipment. Actual results could differ from those estimates.
Financial Instruments
The Company considers all highly liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents are stated at cost and consist solely of bank deposits held in the United States, Hong Kong and the PRC. The carrying amount of cash and cash equivalents approximates fair value.
As of December 31, 2011, $487,868 of the cash and cash equivalents were in banks in China; the Wendeng branch of Industrial & Commercial Bank of China and a Central District, Hong Kong branch of HSBC Bank. The remittance of these funds out of China is subject to exchange control restrictions imposed by the Chinese government. Deposits in banks in the PRC are not insured by any government entity or agency, and are consequently exposed to risk of loss. Management believes the probability of a bank failure, causing loss to the Company, is remote.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. As of December 31, 2011, May 31, 2011 and May 31, 2010, substantially all of the Company’s cash and cash equivalents and restricted cash were held by major financial institutions located in the United States, Hong Kong and the PRC, which management believes are of high credit quality.
With respect to accounts receivable, the Company extends credit based on an evaluation of the customer’s financial condition. The Company generally does not require collateral for trade receivables and maintains an allowance for doubtful accounts of accounts receivable.
As of December 31, 2011, three customers accounted for approximately 11.0%, 22.1% and 65.3%, respectively, or approximately 98.4% of total accounts receivable. These same customers also accounted for approximately 11.4%, 29.5% and 50.2%, respectively, of the Company’s revenues, or approximately 91.1% of revenues for the seven month period ended December 31, 2011.
As of May 31, 2011, four customers accounted for approximately 14%, 19%, 29% and 37%, respectively, or approximately 99% of total accounts receivable. These same customers also accounted for approximately 5%, 10%, 15% and 62%, respectively, of the Company’s revenues, or approximately 92% of revenues for the period ended May 31, 2011.
41
The Company did not have any accounts receivable, nor had it recorded any sales, as of May 31, 2010.
Allowance for doubtful accounts
The Company establishes an allowance for doubtful accounts based on management’s assessment of the collectability of trade receivables. A considerable amount of judgment is required in assessing the amount of the allowance. The Company makes judgments about the creditworthiness of each customer based on ongoing credit evaluations, and monitors current economic trends that might impact the level of credit losses in the future. If the financial condition of the customers were to deteriorate, resulting in their inability to make payments, a specific allowance will be required.
Bad debts are written off when identified. The Company extends unsecured credit to customers ranging from one month in the normal course of business. The Company does not accrue interest on trade accounts receivable. Historically, losses from uncollectible accounts have not significantly deviated from the specific allowance estimated by the management. This specific provisioning policy has not changed in the past since establishment and the management considers that the aforementioned specific provisioning policy is adequate and does not expect to change this established policy in the near future.
Inventory
Inventories are stated at the lower of cost or market value. Cost is determined on weighted average basis and includes all expenditures incurred in bringing the goods in a saleable condition to the point of sale. The Company’s inventory reserve requirements generally fluctuate based on projected demands and market conditions. In determining the adequate level of inventories to have on hand, management makes judgments as to the projected inventory demands as compared to the current or committed inventory levels. Inventory quantities and condition are reviewed regularly and provisions for excess or obsolete inventory are recorded based on the condition of inventory and the Company’s forecast of future demand and market conditions.
As of December 31, 2011, the Company recorded provisions for excess or obsolete inventory of $82,706 related to its Wendeng segment. No provisions for excess or obsolete inventory were made as of December 31, 2010. The Company did not have any inventory, nor had it recorded any reserves, as of May 31, 2010.
Intangible assets
Customer relationships are stated at cost less accumulated amortization. Amortization is provided using the straight-line method over the assets estimated unseful life; determined to be three years.
Land use rights are stated at cost less accumulated amortization. Amortization is provided using the straight-line method over the terms of 50 years. The lease term is obtained from the relevant PRC land authority.
Property, plant and equipment
Property, plant and equipment is stated at cost less accumulated depreciation. Cost represents the purchase price of the asset and other costs incurred to bring the asset into its existing use.
42
The property, plant and equipment of the Company will be depreciated with straight-line method according to the following estimated residual value and service life.
Service life (year)
Estimated
residual rate
%
Annual
depreciation rate
%
Building
20
5
2.05
Furniture and equipment
5
5
3.17
Machines and equipment
10
5
7.34
Automotive equipment
5
5
10.93
Office equipment
5
5
8.64
The residual value and service life of property, plant and equipment will be reviewed on each balance sheet date, and adjusted if necessary.
The Company capitalizes the interest expenses incurred before property, plant and equipment are built and installed to the usable state, and capitalizes other loan interest expenses.
Construction in progress
The value of construction in progress comprises buildings and plants under construction, as well as machines and equipment being installed and commissioned, specifically comprises the costs of property, plant and equipment and other direct costs, relevant interests accrued during the construction period and profits and losses from foreign exchange transactions.
Depreciation will not start until the construction in progress is completed and put into operation.
Impairment of Assets
The Company reviews long-lived assets and certain identifiable intangibles held and used for possible impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In evaluating the fair value and future benefits of its long-lived assets, management performs an analysis of the anticipated undiscounted future net cash flows of the individual assets over the remaining depreciation or amortization period. The Company recognizes an impairment loss if the carrying value of the asset exceeds the expected future cash flows.
Each year, the Company performs a transitional test for impairment of goodwill and other indefinite-lived intangible assets. This test is performed by comparing, at the reporting unit level, the carrying value of goodwill to its fair value. The Company assesses fair value based upon its best estimate of the present value of future cash flows that it expects to generate by the reporting unit. The Company’s annual fair value assessment is performed each December 31 on subsidiaries with material goodwill on their respective balance sheets. However,
changes in expectations as to the present value of the reporting unit’s future cash flows might impact subsequent years’ assessments of impairment.
43
Goodwill and Intangible Assets
Under ASC 350, the Company is required to perform an annual impairment test of the Company’s goodwill and indefinite-lived intangibles. On an annual basis, management assesses the composition of the Company’s assets and liabilities, as well as the events that have occurred and the circumstances that have changed since the most recent fair value determination. If events occur or circumstances change that would more likely than not reduce the fair value of goodwill and indefinite-lived intangibles below their carrying amounts, they will be tested for impairment. The Company will recognize
an impairment charge if the carrying value of the asset exceeds the fair value determination. The impairment test that the Company has selected historically consisted of a ten year discounted cash flow analysis including the determination of a terminal value, and requires management to make various assumptions and estimates including revenue growth, future profitability, peer group comparisons, and a discount rate which management believes are reasonable.
The impairment test involves a two-step approach. Under the first step, the Company determines the fair value of each reporting subsidiary to which goodwill has been assigned. The Company then compares the fair value of each reporting subsidiary to its carrying value, including goodwill. The Company estimates the fair value of each reporting subsidiary by estimating the present value of the reporting subsidiaries' future cash flows. If the fair value exceeds the carrying value, no impairment loss is recognized. If the carrying value exceeds the fair value, the goodwill of the
reporting unit is considered potentially impaired and the second step is completed in order to measure the impairment loss.
Under the second step, the Company calculates the implied fair value of goodwill by deducting the fair value of all tangible and intangible net assets, including any unrecognized intangible assets, of the reporting unit from the fair value of the reporting unit, as determined in the first step. The Company then compares the implied fair value of goodwill to the carrying value of goodwill. If the implied fair value of goodwill is less than the carrying value of goodwill, the Company recognizes an impairment loss equal to the difference.
Income Taxes
The Company accounts for income taxes under FASB ASC 740 Accounting for Income Taxes. Under FASB ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under FASB ASC 740, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. FASB ASC 740-10-05 Accounting for Uncertainty in Income Taxes prescribes a recognition threshold and a measurement attribute for the financial statement
recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities.
The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. We assess the validity of our conclusions regarding uncertain tax positions on a quarterly basis to determine if facts or circumstances have arisen that might cause us to change our judgment regarding the likelihood of a tax position’s sustainability under audit. We have determined that there were no uncertain tax positions for the periods ended December 31, 2011, May 31, 2011 and May 31, 2010.
44
Basic and Diluted Net Income (Loss) Per Share
The Company computes net income (loss) per share in accordance with ASC 260 “Earnings per Share”. ASC 260 requires presentation of both basic and diluted earnings per share (EPS) on the face of the income statement. Basic EPS is computed by dividing net income (loss) available to common stockholders (numerator) by the weighted average number of shares outstanding (denominator) during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options or warrants. Diluted EPS excludes all dilutive potential shares if their effect is anti-dilutive.
Fair value of financial instruments
The Company adopted FASB ASC 820 on June 1, 2010. The adoption of FASB ASC 820 did not materially impact the Company's financial position, results of operations or cash flows. FASB ASC 820 requires the disclosure of the estimated fair value of financial instruments including those financial instruments for which the fair value option was not elected. The carrying amounts of both the financial assets and liabilities approximate to their fair values due to short maturities or the applicable interest rates approximate the current market rates.
Revenue Recognition
Revenue from the sales of the Company’s products is recognized upon customer acceptance. This occurs at the time of delivery to the customer, provided persuasive evidence of an arrangement exists, such as a signed sales contract. The significant risks and rewards of ownership are transferred to the customers at the time when the products are delivered and there is no significant post-delivery obligation to the Company. In addition, the sales price is fixed or determinable and collection is reasonably assured. The Company does not provide customers with contractual rights of return
for products. When there are significant post-delivery performance obligations, revenue is recognized only after such obligations are fulfilled. The Company evaluates the terms of the sales agreement with its customer in order to determine whether any significant post-delivery performance obligations exist. Currently, the sales do not include any terms which may impose any significant post-delivery performance obligations on the Company.
Revenue from the sales of the Company’s products represents the invoiced value of goods, net of the value-added tax (VAT). All of the Company’s products that are sold in the PRC are subject to a Chinese value-added tax at a rate of 17 percent of the gross sales price. This VAT may be offset by the VAT paid by the Company on raw and other materials that are included in the cost of producing the Company’s finished products.
Advertising expenses
Advertising costs are expensed as incurred.
45
Shipping and handling costs
All shipping and handling costs are included in cost of sales expenses.
Foreign Currency Translation
The Company’s functional and reporting currency is the United States dollar. Transactions may occur in Renminbi (“RMB”) dollars and management has adopted ASC 830 “Foreign Currency Matters”. The RMB is not freely convertible into foreign currencies. Monetary assets denominated in foreign currencies are translated using the exchange rate prevailing at the balance sheet date. Average monthly rates are used to translate revenues and expenses. The Company has not, to the date of these financial statements, entered into derivative instruments to offset the impact of foreign currency fluctuations.
Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchanges rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods.
Assets and liabilities of the Company’s operations are translated into the reporting currency, United States dollars, at the exchange rate in effect at the balance sheet dates. Revenue and expenses are translated at average rates in effect during the reporting periods. Equity transactions are recorded at the historical rate when the transaction occurred. The resulting translation adjustment is reflected as accumulated other comprehensive income, a separate component of stockholders' equity in the statement of stockholders' equity.
Comprehensive Gain or Loss
ASC 220 “Comprehensive Income,” establishes standards for the reporting and display of comprehensive income and its components in the financial statements. As of December 31, 2011 and May 31, 2011, the Company determined that it had items that represented components of comprehensive income and, therefore, has included a schedule of comprehensive income in the financial statements. As of May 31, 2010, the Company did not have any such items.
Off Balance Sheet Arrangements
As of December 31, 2011, there were no off balance sheet arrangements.
46
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A smaller reporting company is not required to provide the information required by this Item.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the financial statements annexed to this annual report.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in company reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include without limitation, controls and procedures designed to ensure that information required to be disclosed in company reports filed or submitted under the Exchange Act is accumulated and communicated to management, including our chief executive officer and treasurer, as appropriate to allow timely decisions regarding required disclosure.
As required by Rules 13a-15 and 15d-15 under the Exchange Act, our Chief Executive and Financial Officers carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2011. Based on their evaluation, they concluded that our disclosure controls and procedures were effective.
Management's Annual Report on Internal Control over Financial Reporting.
Our internal control over financial reporting is a process designed by, or under the supervision of, our Chief Executive and Financial Officers and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; provide reasonable assurance that transactions are recorded as necessary to permit preparation of our financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with the authorization of
our board of directors and management; 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.
47
Under the supervision and with the participation of our management, including our Chief Executive and Financial Officers, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this evaluation under the criteria established in Internal Control – Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2011.
This Annual Report on Form 10-K does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only management’s report in this Annual Report on Form 10-K.
Changes in Internal Control Over Financial Reporting.
During the most recently completed fiscal quarter, there has been no change in our internal control over financial reporting that has materially affected or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
48
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Set forth below is information with respect to our executive officers;
For other information required by this item, see the sections entitled “Election of Directors,”“Corporate Governance,”“Board of Directors and Committees” and “Security Ownership of Certain Beneficial Owners and Management—Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive Information Statement to be filed with the Securities and Exchange Commission and delivered to shareholders in connection with our 2012 Annual Meeting of Shareholders, which are incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
For information with respect to executive compensation, see the section entitled “Executive Compensation” in our definitive Information Statement to be filed with the Securities and Exchange Commission and delivered to shareholders in connection with our 2012 Annual Meeting of Shareholders, which is incorporated herein by reference.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
For information with respect to the security ownership of the Directors and Executive Officers, see the section entitled “Security Ownership of Certain Beneficial Owners and Management” in our definitive Information Statement to be filed with the Securities and Exchange Commission and delivered to shareholders in connection with our 2012 Annual Meeting of Shareholders, which is incorporated herein by reference.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
For information with respect to certain relationships and related transactions and director independence, see the sections entitled “Corporate Governance” and “Board of Directors and Committees” in our definitive Information Statement to be filed with the Securities and Exchange Commission and delivered to shareholders in connection with our 2012 Annual Meeting of Shareholders, which are incorporated herein by reference.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
For information with respect to principal accounting fees and services, see the section entitled “Principal Accounting Fees and Services” in our definitive Information Statement to be filed with the Securities and Exchange Commission and delivered to shareholders in connection with our 2012 Annual Meeting of Shareholders, which is incorporated herein by reference.
Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
In accordance with Section 13 or 15(d) 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:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To The Board of Directors and Stockholders of
Sunsi Energies Inc.
Brooklyn, New York
We have audited the accompanying consolidated balance sheets of Sunsi Energies Inc. (the Company) as of December 31, 2011, and May 31, 2011 and 2010, and the related consolidated statements of operations and comprehensive income (loss), statement of equity (deficit), and cash flows for the seven months ended December 31, 2011 and the years ended May 31, 2011 and 2010. These consolidated financial statements are the responsibility of the Company's management.
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 of America). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated 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 Sunsi Energies Inc. as of December 31, 2011, and May 31, 2011 and 2010, and the results of its operations and its cash flows for the seven months ended December 31, 2011 and the years ended May 31, 2011 and 2010, in conformity with accounting principles generally accepted in the United States of America. [Missing Graphic Reference]
Redeemable common stock and capital in excess of $0.001 par value. Zero, 1,349,628 and zero shares included in issued and outstanding below, respectively
—
2,707,488
—
Equity:
SunSi Energies Inc. stockholders' equity:
Preferred stock, $0.001 par value. 25,000,000 shares authorized; zero shares
issued and outstanding
—
—
—
Common stock, $0.001 par value. 75,000,000 shares authorized; 30,005,628, 29,436,928 and
SunSi Energies Inc. (“the Company” or “SunSi”) was incorporated in the State of Nevada on January 30, 2007. SunSi through its operations in China (“China” or “PRC”) is a specialty chemical manufacturer and distributor whose focus is to acquire and develop a portfolio of high quality trichlorosilane (“TCS”) producing facilities and distribution rights that possess a potential for future growth and expansion. TCS is a chemical primarily used in the production of polysilicon, which is an essential raw material in the production of solar cells for photovoltaic (PV) panels that convert sunlight to electricity. Prior to December 9, 2010 when the
Company acquired 90% of Zibo Baokai Commerce and Trade Co., Ltd. (“Baokai”), SunSi was a Development Stage Company as defined by ASC Topic 915. After the purchase of Baokai, the Company emerged from development stage status and started generating revenues.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation
The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) and are expressed in U.S. Dollars.
Change of Year End Reporting Period
Prior to December 7, 2011, the Company’s fiscal year-end was May 31. On December 8, 2011, the Company changed its year-end to December 31. As a result this Report is filed under the Securities and Exchange Commission’s (“SEC”) guidelines 210.3-06. This Report includes the following information:
Audited statements of operations, equity (deficit) and cash flows for the seven months ended December 31, 2011 and years ended May 31, 2011 and 2010.
The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiary SunSi Energies Hong Kong Ltd. (“SunSi HK”), SunSi HK's 90% owned subsidiary Baokai and SunSi HK's 60% owned subsidiary Wendeng He Xie Silicon Industry Co., Ltd. (“Wendeng”). All intercompany accounts have been eliminated in consolidation. As a result of the acquisitions of Baokai in December 2010 and Wendeng in March 2011, the Company transitioned from a development stage company to planned operations. Consequently, the need to disclose certain historical data which has previously been presented in company filings is no longer necessary.
F-7
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company continually evaluates its estimates, including but not limited to those related to the valuation of accounts receivable, inventories, deferred income taxes, goodwill and intangible assets, and the estimation on the useful lives of property, plant and equipment. The Company bases its estimates on historical experience, known or expected trends
and various other assumptions that are believed to be reasonable given the quality of information available as of the date of these financial statements. The results of these assumptions provide the basis for making estimates about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates.
The Company believes that the following critical accounting policies govern its more significant judgments and estimates used in the preparation of its consolidated financial statements:
Financial Instruments
The Company considers all highly liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents are stated at cost and consist solely of bank deposits held in the United States, Hong Kong and the PRC (“China”). The carrying amount of cash and cash equivalents approximates fair value.
As of December 31, 2011, $487,868 of the cash and cash equivalents were in banks in China; the Wendeng branch of Industrial & Commercial Bank of China and a Central District, Hong Kong branch of HSBC Bank. The remittance of these funds out of China is subject to exchange control restrictions imposed by the Chinese government. Deposits in banks in the PRC are not insured by any government entity or agency, and are consequently exposed to risk of loss. Management believes the probability of a bank failure, causing loss to the Company, is remote.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. As of December 31, 2011, May 31, 2011 and May 31, 2010, substantially all of the Company’s cash and cash equivalents were held by major financial institutions located in the United States, Hong Kong and the PRC, which management believes are of high credit quality.
With respect to accounts receivable, the Company extends credit based on an evaluation of the customer’s financial condition. The Company generally does not require collateral for trade receivables and maintains an allowance for doubtful accounts of accounts receivable.
As of December 31, 2011, three customers accounted for approximately 11%, 22% and 65%, respectively, or approximately 98% of total accounts receivable. These same customers also accounted for approximately 3%, 50% and 23%, respectively, of the Company’s revenues, or approximately 76% of revenues for the seven month period ended December 31, 2011.
As of May 31, 2011, four customers accounted for approximately 14%, 19%, 29% and 37%, respectively, or approximately 99% of total accounts receivable. These same customers also accounted for approximately 5%, 10%, 15% and 62%, respectively, of the Company’s revenues, or approximately 92% of revenues for the period ended May 31, 2011.
F-8
The Company did not have any accounts receivable, nor had it recorded any sales, as of May 31, 2010.
Allowance for doubtful accounts
The Company establishes an allowance for doubtful accounts based on management’s assessment of the collectability of trade receivables. A considerable amount of judgment is required in assessing the amount of the allowance. The Company makes judgments about the creditworthiness of each customer based on ongoing credit evaluations, and monitors current economic trends that might impact the level of credit losses in the future. If the financial condition of the customers were to deteriorate, resulting in their inability to make payments, a specific allowance will be required.
Bad debts are written off when identified. The Company extends unsecured credit to customers ranging from one month in the normal course of business. The Company does not accrue interest on trade accounts receivable. Historically, losses from uncollectible accounts have not significantly deviated from the specific allowance estimated by the management. This specific provisioning policy has not changed since establishment and the management considers that the aforementioned specific provisioning policy is adequate and does not expect to change this established policy in the near future.
Inventory
Inventories are stated at the lower of cost or market value. Cost is determined on weighted average basis and includes all expenditures incurred in bringing the goods in a saleable condition to the point of sale. The Company’s inventory reserve requirements generally fluctuate based on projected demands and market conditions. In determining the adequate level of inventories to have on hand, management makes judgments as to the projected inventory demands as compared to the current or committed inventory levels. Inventory quantities and condition are reviewed regularly and provisions for excess or obsolete inventory are recorded based on the condition of inventory and the Company’s forecast of future demand and market conditions.
As of December 31, 2011, the Company recorded provisions for excess or obsolete inventory of $82,706 related to its Wendeng segment. No provisions for excess or obsolete inventory were made as of May 31, 2011. The Company did not have any inventory, nor had it recorded any reserves, as of May 31, 2010.
Intangible assets
Customer relationships are stated at cost less accumulated amortization. Amortization is provided using the straight-line method over the assets estimated useful life; determined to be three years.
Land use rights are stated at cost less accumulated amortization. Amortization is provided using the straight-line method over the terms of 50 years. The lease term is obtained from the relevant PRC land authority.
Property, plant and equipment
Property, plant and equipment is stated at cost less accumulated depreciation. Cost represents the purchase price of the asset and other costs incurred to bring the asset into its existing use.
F-9
The property, plant and equipment of the Company will be depreciated with straight-line method according to the following estimated residual value and service life.
Service life (year)
Estimated
residual rate %
Annual
depreciation rate %
Building
20
5
2.05
Furniture and equipment
5
5
3.17
Machines and equipment
10
5
7.34
Automotive equipment
5
5
10.93
Office equipment
5
5
8.64
The residual value and service life of property, plant and equipment will be reviewed on each balance sheet date, and adjusted if necessary.
The Company capitalizes the interest expenses incurred before property, plant and equipment are built and installed to the usable state, and capitalizes other loan interest expenses.
Construction in progress
The value of construction in progress comprises buildings and plants under construction, as well as machines and equipment being installed and commissioned, specifically comprises the costs of property, plant and equipment and other direct costs, relevant interest accrued during the construction period and profits and losses from foreign exchange transactions.
Depreciation will not start until the construction in progress is completed and put into operation.
Impairment of Assets
The Company reviews long-lived assets and certain identifiable intangibles held and used for possible impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In evaluating the fair value and future benefits of its long-lived assets, management performs an analysis of the anticipated undiscounted future net cash flows of the individual assets over the remaining depreciation or amortization period. The Company recognizes an impairment loss if the carrying value of the asset exceeds the expected future cash flows.
Each year, the Company performs a transitional test for impairment of goodwill and other indefinite-lived intangible assets. This test is performed by comparing, at the reporting unit level, the carrying value of goodwill to its fair value. The Company assesses fair value based upon its best estimate of the present value of future cash flows that it expects to generate by the reporting unit. The Company’s annual fair value assessment is performed each December 31 on subsidiaries with material goodwill on their respective balance sheets. However, changes in expectations as to the present value
of the reporting unit’s future cash flows might impact subsequent years’ assessments of impairment.
F-10
Goodwill and Intangible Assets
Under ASC 350, the Company is required to perform an annual impairment test of the Company’s goodwill and indefinite-lived intangibles. On an annual basis, management assesses the composition of the Company’s assets and liabilities, as well as the events that have occurred and the circumstances that have changed since the most recent fair value determination. If events occur or circumstances change that would more likely than not reduce the fair value of goodwill and indefinite-lived intangibles below their carrying amounts, they will be tested for impairment. The Company will recognize
an impairment charge if the carrying value of the asset exceeds the fair value determination. The impairment test that the Company has selected historically consisted of a ten year discounted cash flow analysis including the determination of a terminal value, and requires management to make various assumptions and estimates including revenue growth, future profitability, peer group comparisons, and a discount rate which management believes are reasonable.
The impairment test involves a two-step approach. Under the first step, the Company determines the fair value of each reporting subsidiary to which goodwill has been assigned. The Company then compares the fair value of each reporting subsidiary to its carrying value, including goodwill. The Company estimates the fair value of each reporting subsidiary by estimating the present value of the reporting subsidiaries' future cash flows. If the fair value exceeds the carrying value, no impairment loss is recognized. If the carrying value exceeds the fair value, the goodwill of the
reporting unit is considered potentially impaired and the second step is completed in order to measure the impairment loss.
Under the second step, the Company calculates the implied fair value of goodwill by deducting the fair value of all tangible and intangible net assets, including any unrecognized intangible assets, of the reporting unit from the fair value of the reporting unit, as determined in the first step. The Company then compares the implied fair value of goodwill to the carrying value of goodwill. If the implied fair value of goodwill is less than the carrying value of goodwill, the Company recognizes an impairment loss equal to the difference.
Income Taxes
The Company accounts for income taxes under FASB ASC 740 Accounting for Income Taxes. Under FASB ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under FASB ASC 740, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. FASB ASC 740-10-05 Accounting for Uncertainty in Income Taxes prescribes a recognition threshold and a measurement attribute for the financial statement
recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities.
The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. We assess the validity of our conclusions regarding uncertain tax positions on a quarterly basis to determine if facts or circumstances have arisen that might cause us to change our judgment regarding the likelihood of a tax position’s sustainability under audit. We have determined that there were no uncertain tax positions for the periods ended December 31, 2011, May 31, 2011, and May 31, 2010.
Basic and Diluted Net Income (Loss) Per Share
The Company computes net income (loss) per share in accordance with ASC 260 “Earnings per Share”. ASC 260 requires presentation of both basic and diluted earnings per share (EPS) on the face of the income statement. Basic EPS is computed by dividing net income (loss) available to common stockholders (numerator) by the weighted average number of shares outstanding (denominator) during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options or warrants. Diluted EPS excludes all dilutive potential shares if their effect is anti-dilutive.
F-11
Fair value of financial instruments
The Company adopted FASB ASC 820 on June 1, 2010. The adoption of FASB ASC 820 did not materially impact the Company's financial position, results of operations or cash flows. FASB ASC 820 requires the disclosure of the estimated fair value of financial instruments including those financial instruments for which the fair value option was not elected. The carrying amounts of both the financial assets and liabilities approximate to their fair values due to short maturities or the applicable interest rates approximate the current market rates.
Revenue Recognition
Revenue from the sales of the Company’s products is recognized upon customer acceptance. This occurs at the time of delivery to the customer, provided persuasive evidence of an arrangement exists, such as a signed sales contract. The significant risks and rewards of ownership are transferred to the customers at the time when the products are delivered and there is no significant post-delivery obligation to the Company. In addition, the sales price is fixed or determinable and collection is reasonably assured. The Company does not provide customers with contractual rights of return
for products. When there are significant post-delivery performance obligations, revenue is recognized only after such obligations are fulfilled. The Company evaluates the terms of the sales agreement with its customer in order to determine whether any significant post-delivery performance obligations exist. Currently, the sales do not include any terms which may impose any significant post-delivery performance obligations on the Company.
Revenue from the sales of the Company’s products represents the invoiced value of goods, net of the value-added tax (VAT). All of the Company’s products that are sold in the PRC are subject to a Chinese value-added tax at a rate of 17 percent of the gross sales price. This VAT may be offset by the VAT paid by the Company on raw and other materials that are included in the cost of producing the Company’s finished products.
Advertising expenses
Advertising costs are expensed as incurred.
Shipping and handling costs
All shipping and handling costs are included in cost of sales expenses.
Foreign Currency Translation
The Company’s functional and reporting currency is the United States dollar. Transactions may occur in Renminbi (“RMB”) dollars and management has adopted ASC 830 “Foreign Currency Matters”. The RMB is not freely convertible into foreign currencies. Monetary assets denominated in foreign currencies are translated using the exchange rate prevailing at the balance sheet date. Average monthly rates are used to translate revenues and expenses. The Company has not, to the date of these financial statements, entered into derivative instruments to offset the impact of foreign currency fluctuations.
Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchanges rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods.
F-12
Assets and liabilities of the Company’s operations are translated into the reporting currency, United States dollars, at the exchange rate in effect at the balance sheet dates. Revenue and expenses are translated at average rates in effect during the reporting periods. Equity transactions are recorded at the historical rate when the transaction occurred. The resulting translation adjustment is reflected as accumulated other comprehensive income, a separate component of stockholders' equity in the statement of stockholders' equity.
Comprehensive Gain or Loss
ASC 220 “Comprehensive Income,” establishes standards for the reporting and display of comprehensive income and its components in the financial statements. As of December 31, 2011 and May 31, 2011, the Company determined that it had items that represented components of comprehensive income and, therefore, has included a schedule of comprehensive income in the financial statements. As of May 31, 2010, the Company did not have any such items.
3.
THE EFFECT OF RECENTLY ISSUED ACCOUNTING STANDARDS
The following Accounting Standards Codification Updates have been issued, or will become effective, after the end of the period covered by these financial statements. The Company has reviewed all recently issued, but not yet effective, accounting pronouncements and does not believe the future adoption of any such pronouncements may be expected to cause a material impact on its financial condition or the results of its operations.
Pronouncement
Issued
Title
ASU No. 2010-25
September 2010
Plan Accounting—Defined Contribution Pension Plans (Topic 962) Reporting Loans to Participants by Defined Contribution Pension Plans EITF consensus
ASU No. 2010-26
October 2010
Financial Services—Insurance (Topic 944) Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts EITF consensus
ASU No. 2010-27
December 2010
Other Expenses (Topic 720) Fees Paid to the Federal Government by Pharmaceutical Manufacturers EITF consensus
ASU No. 2010-28
December 2010
Intangibles—Goodwill and Other (Topic 350) When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts EITF consensus
ASU No. 2010-29
December 2010
Business Combinations (Topic 805) Disclosure of Supplementary Pro Forma Information for Business Combinations EITF consensus
ASU No. 2011-01
January 2011
Receivables (Topic 310) Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20
ASU No. 2011-02
April 2011
Receivables (Topic 310) A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring
ASU No. 2011-03
April 2011
Transfers and Servicing (Topic 860) Reconsideration of Effective Control for Repurchase Agreements
ASU No. 2011-04
May 2011
Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs
ASU No. 2011-05
June 2011
Comprehensive Income (Topic 220): Presentation of Comprehensive Income
ASU No. 2011-06
July 2011
Other Expenses (Topic 720): Fees Paid to the Federal Government by. Health Insurers
ASU No. 2011-07
July 2011
Health Care Entities (Topic 954): Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities
ASU No. 2011-08
September 2011
Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment
ASU No. 2011-09
September 2011
Compensation – Retirement Benefits – Multiemployer Plans (Subtopic 715-80): Disclosures about an Employer’s Participation in a Multiemployer Plan
ASU No. 2011-10
December 2011
Property, Plant, and Equipment (Topic 360): Derecognition of in Substance Real Estate – a Scope Clarification (a consensus of the FASB Emerging Issues Task Force)
ASU No. 2011-11
December 2011
Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities
ASU No. 2011-12
December 2011
Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05
To the extent appropriate, the guidance in the above Accounting Standards Codification Updates is already reflected in our financial statements and management does not anticipate that these accounting pronouncements will have any future effect on our financial statements.
As of December 31, 2011, three customers accounted for approximately 11%, 22% and 65%, respectively, or approximately 98% of total accounts receivable. These same customers also accounted for approximately 3%, 50% and 23%, respectively, of the Company’s revenues, or approximately 76% of revenues for the seven month period ended December 31, 2011.
As of May 31, 2011, four customers accounted for approximately 14%, 19%, 29% and 37%, respectively, or approximately 99% of total accounts receivable. These same customers also accounted for approximately 5%, 10%, 15% and 62%, respectively, of the Company’s revenues, or approximately 92% of revenues for the period ended May 31, 2011.
The Company did not have any accounts receivable, nor had it recorded any sales, as of May 31, 2010.
Advances made to suppliers are for the purchase of raw materials which are expected to be recovered in one year. During the seven month period ended December 31, 2011, the Company recorded a provision for bad debts of $9,314 related to its advances to suppliers. Prepaid expenses and other assets represent normal course prepayments made by the Wendeng segment.
Depreciation expense for the seven months ended December 31, 2011 and the years ended May 31, 2011 and 2010 was approximately $365,959 , $121,652, and $-0-, respectively.
Differences may arise in the amount of depreciation expense reported in the Company's operating results when compared to the corresponding change in accumulated depreciation due to foreign currency translation. These translation adjustments are reflected in accumulated other comprehensive income, a separate component of the Company's stockholders' equity.
9.
BUSINESS COMBINATIONS
During 2011, the Company completed its acquisitions of equity interests in both Zibo Baokai Commerce and Trade Co., Ltd. and Wendeng He Xie Silicon Industry Co., Ltd. These acquisitions were accounted for as business combinations under the acquisition method of accounting.
F-16
Acquisition of Zibo Baokai Commerce and Trade Co., Ltd.
Description of Transaction
On December 8, 2010, SunSi HK acquired a 90% equity interest in Zibo Baokai Commerce and Trade Co., Ltd (“Baokai”) for cash consideration of $263,647. As part of the closing, Baokai was re-formed as a joint venture business under Chinese law and issued a new business license.
Founded in January 2008, Baokai is located in the city of Zibo in the Shandong province of the People’s Republic of China. Baokai maintains the right to distribute the trichlorosilane production of Zibo Baoyun Chemical Plant both domestically and internationally. Trichlorosilane (“TCS”), a chemical primarily used in the production of polysilicon, is an essential raw material used in the production of solar cells.
The acquisition was accounted for as a business combination under the acquisition method of accounting in accordance with generally accepted accounting principles.
Fair Value of Consideration Transferred and Recording of Assets Acquired, Liabilities Assumed and Noncontrolling Interests
The following table summarizes the acquisition date fair value of the consideration transferred, identifiable assets acquired, liabilities assumed and noncontrolling interests including an amount for goodwill:
Consideration:
Cash and cash equivalents
$
263,647
Fair value of total consideration transferred
263,647
Recognized amount of identifiable assets acquired and liabilities assumed:
Total identifiable net assets
$
—
Noncontrolling interest in Baokai
(29,294
)
Goodwill
292,941
$
263,647
Goodwill represents the future economic benefit arising from other assets acquired that could not be individually identified and separately recognized. The goodwill arising from the acquisition is attributable to the general reputation of the business. The goodwill is not expected to be deductible for tax purposes.
Purchase price related to Baokai acquisition, unpaid
$
163,647
$
213,647
$
—
Acquisition of Wendeng He Xie Silicon Industry Co., Ltd.
Description of Transaction
On March 18, 2011, SunSi HK acquired a 60% equity interest in Wendeng He Xie Silicon Industry Co., Ltd. (“Wendeng”) in exchange for total consideration of approximately $5.8 million comprised of the following:
(1)
$445,075 of cash consideration;
(2)
1,349,628 restricted shares of SunSi common stock, such shares carry an optional right of redemption whereby the Company shall buy such shares back from shareholder if shareholder exercises the option within six months at a price equivalent to RMB 18,000,000 on the transfer date; and
(3)
1,574,566 restricted shares of SunSi common stock, transferred by an affiliate of SunSi.
As part of the closing, Wendeng was re-formed as a joint venture business under Chinese law and issued a new business license.
Founded in April 2008, Wendeng is located in Weihai City in the Shandong province of the People’s Republic of China. Wendeng manufactures and distributes trichlorosilane, a chemical primarily used in the production of polysilicon, which is an essential raw material used in the production of solar cells. All of Wendeng’s sales are to destinations with the People’s Republic of China.
The acquisition was accounted for as a business combination under the acquisition method of accounting in accordance with generally accepted accounting principles.
Fair Value of Consideration Transferred and Recording of Assets Acquired, Liabilities Assumed and Noncontrolling Interests
F-18
The following table summarizes the acquisition date fair value of the consideration transferred, identifiable assets acquired, liabilities assumed and noncontrolling interests including an amount for goodwill:
Consideration:
Cash and cash equivalents
$
445,075
Common stock, 1,574,566 shares of SunSi common stock (1)
2,645,271
Redeemable common stock, 1,349,628 shares of SunSi common stock (2)
2,708,838
Fair value of total consideration transferred
$
5,799,184
Recognized amount of identifiable assets acquired and liabilities assumed:
Financial assets
$
3,613,721
Inventory
473,354
Other current assets
309,329
Related party receivables
1,131,548
Property, plant and equipment
7,392,976
Identifiable intangible assets:
Land use leasehold
1,559,070
Customer relationships
1,534,000
Financial liabilities
(10,294,200
)
Total identifiable net assets
5,719,798
Noncontrolling interest in Wendeng
(2,927,000
)
Goodwill
3,006,386
$
5,799,184
(1)
The $1.68 per share price was determined by reference to recent private placement shares issued, less a discount for marketability. This fair value measurement is based on significant inputs that are not observable in the market and thus represents a Level 3 measurement as defined in ASC Topic 820.
(2)
Represents the redeemable option price granted by SunSi to the shareholder.
The Company utilized an alternative valuation method for the restricted common stock issued due to the limited public trading volume of its common stock prior to the measurement date. The recent average daily trading volume of the Company’s common shares was below levels considered by management to be representative of an active market.
F-19
Goodwill represents the future economic benefit arising from other assets acquired that could not be individually identified and separately recognized. The goodwill arising from the acquisition is attributable to the general reputation of the business and the collective experience of the management and employees. The goodwill is not expected to be deductible for tax purposes.
Below is a summary of the methodologies and significant assumptions used in estimating the fair value of intangible assets and noncontrolling interests.
●
Intangible assets — The fair value of the acquired intangible assets was determined using a variety of valuation approaches. In estimating the fair value of the acquired intangible assets, the Company utilized the valuation methodology determined to be most appropriate for the individual intangible asset being valued as described below. The acquired intangible assets include the following:
Valuation
Method
Estimated
Fair Value
Estimated
Useful Lives (1)
(years)
Customer relationships
Multi-Period
$
1,534,000
3
Excess Earnings (2)
Total acquired intangible assets
$
1,534,000
(1)
Determination of the estimated useful lives of the individual categories of intangible assets was based on the nature of the applicable intangible asset and the expected future cash flows to be derived from the intangible asset. Amortization of intangible assets with definite lives is recognized over the shorter of the respective lives of the agreement or the period of time the assets are expected to contribute to future cash flows.
(2)
The multi-period excess earnings method estimates an intangible asset’s value based on the present value of the prospective net cash flows (or excess earnings) attributable to it. The value attributed to these intangibles was based on projected net cash inflows from existing contracts or customer relationships. This fair value measurement is based on significant inputs that are not observable in the market and thus represents a Level 3 measurement as defined in ASC Topic 820.
Some of the more significant estimates and assumptions inherent in determining the fair value of the customer relationships are associated with forecasting cash flows and profitability. The primary assumptions used were generally based upon the present value of anticipated cash flows, assuming a three year customer attrition rate, discounted to present value at a 25% rate.
●
Noncontrolling interests — The fair value of the noncontrolling interests of $2.9 million was estimated by applying the income approach. This fair value measurement is based on significant inputs that are not observable in the market and thus represents a Level 3 measurement as defined in ASC Topic 820. Key assumptions include (i) a compound annual sales growth rate of 33% for the five year period after the measurement date, (ii) a weighted average cost of capital of 19%, (iii) a terminal value based on a long-term sustainable growth rate of 3.5% and (iv) adjustments for lack of control and lack of marketability that market participants would consider when estimating the fair value of the noncontrolling interest in Wendeng.
Goodwill represents the excess of cost over fair value of assets of businesses acquired. Goodwill acquired in a business combination is not amortized. The Company evaluates the carrying amount of goodwill for impairment annually on December 31 and whenever events or circumstances indicate impairment may have occurred.
When evaluating whether goodwill is impaired, the Company compares the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s carrying amount, including goodwill. The fair value of the reporting unit is estimated using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies’ data. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the implied fair value of reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess
of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value.
Due to the inability to meet anticipated sales growth, the Company assessed the acquired goodwill associated with its related business units for impairment as of December 31, 2011. Based on the discounted cash flows model utilizing estimated future earnings and cash flows, the fair value of the reporting units was less than the carrying value of the acquired goodwill. The Company’s evaluation of goodwill resulted in a total impairment charge of $2,800,000; of which $2,487,567 was attributed to Wendeng and $312,433 was attributed to Baokai.
The components of the Company’s intangible assets are approximately as follows:
Total intangible assets subject to amortization, net
$
3,142,997
$
3,025,489
$
—
F-21
Amortization expense for intangible assets during the seven months ended December 31, 2011 and the years ended May 31, 2011 and 2010 was approximately $329,582, $111,373, and $-0-, respectively.
Differences may arise in the amount of amortization expense reported in the Company's operating results when compared to the corresponding change in accumulated amortization due to foreign currency translation. These translation adjustments are reflected in accumulated other comprehensive income, a separate component of the Company's stockholders' equity.
The following table provides information regarding estimated amortization expense for intangible assets subject to amortization for each of the following years ending December 31:
2012
$
564,996
2013
564,996
2014
152,966
2015
40,081
2016
40,081
Thereafter
1,779,877
$
3,142,997
11.
RELATED PARTY RECEIVABLE
Related party receivables consisted of the following :
The amount represents trade receivables due from a related party; an entity in which a shareholder of the Company maintains an equity interest. The receivable is interest-free, unsecured and payable in accordance with the Company’s standard trade terms.
During the year ended May 31, 2010, the Company owed $230,981 from advances made by two non-affiliated stockholders that helped fund the Company’s operations until proceeds from private stock offerings were received. These advances were made on an interest free basis and were repaid in full during the fiscal year ended May 31, 2011.
Advances from minority shareholder of noncontrolling interest (Wendeng)
$
5,501,598
$
5,321,502
$
—
Purchase consideration due minority shareholder of noncontrolling interest (Baokai)
163,647
213,647
—
Due to officer
—
—
5,671
Total
$
5,665,245
$
5,535,149
$
5,671
The minority shareholder of the Company’s Wendeng subsidiary made a series of advances, both pre and post-acquisition, to fund capital expenditures and plant expansion. These advances were made on an interest-free basis, are unsecured and payable on demand.
The amount due to the minority shareholder of its Baokai subsidiary represents unpaid purchase consideration from the Company’s December 8, 2010 acquisition (see Note 9 – Business Combinations). This amount bears no interest, is unsecured and payable on demand.
The components of the net deferred tax asset at December 31, 2011, May 31, 2011, and May 31, 2010, the statutory tax rate, the effective tax rate and the elected amount of the valuation allowance are indicated below:
Potential benefits of income tax losses are not recognized in the accounts until realization is more likely than not. The Company has incurred a net operating loss of approximately $2,267,000 which expires in 2031. Pursuant to ASC 740 the Company is required to compute tax asset benefits for net operating losses carried forward. Potential benefit of net operating losses have not been recognized in these financial statements because the Company cannot be assured it is more likely than not it will utilize the net operating losses carried forward in future years.
As a result of its operations recorded at the Baokai and Wendeng segments, the Company has recorded a tax benefit of $81,572 for the seven months ended December 31, 2011 and a tax provision of $256,227 for the year ended May 31, 2011 based upon the estimated effective tax rate for the Baokai subsidiary for the year ending May 31, 2011. Pursuant to the new PRC’s enterprise income tax (“EIT”) law, the Company is subject to EIT at the statutory rate of 25%. Income taxes in the statements of operations and comprehensive income represent current taxes for the periods ended May
31, 2011 and May 31, 2010. The effective income tax rate has no material difference with the PRC statutory income tax rate of 25% for the seven month period ended December 31, 2011 or the years ended May 31, 2011, and May 31, 2010.
The Company had no material adjustments to its liabilities for unrecognized income tax benefits according to the provision of FASB ASC 740. The Company has recorded no deferred tax assets or liabilities as of December 31, 2011, May 31, 2011, and May 31, 2010, since nearly all differences in tax basis and financial statement carrying values are permanent differences.
The following table summarizes the issuance of all unsecured, convertible debentures during the seven month period ended December 31, 2011 and the years ended May 31, 2011 and 2010:
Issue Date
Interest Rate
Face Value
Maturity Date
Conversion Rate of
Face Value to Common Shares
10/15/2011
9%
$
100,000
10/15/2014
0.25
Total
$
100,000
On October 15, 2011, the Company completed the private placement of an unsecured, convertible debenture in the amount of $100,000. The debenture carries an interest of 9% per annum, payable semiannually each April 15 and October 15, for a three-year term with a fixed conversion price of $4.00 per share, or 25,000 shares of the Company’s common stock.
The Company is authorized to issue 25,000,000 shares of preferred stock at a par value of $0.001. At December 31, 2011, May 31, 2011, and May 31, 2010, no shares of preferred stock were issued or outstanding.
The Company is authorized to issue 75,000,000 shares of common stock at a par value of $0.001. At December 31, 2011, May 31, 2011, and May 31, 2010, shares of common stock totaling 30,005,628, 29,436,928 and 27,312,500 were issued and outstanding, respectively.
Since September 10, 2009, the Company has conducted a private placement of its common stock at a price of $2.00 per share and a maximum issuance of 8,000,000 shares. During the seven month period ended December 31, 2011, the Company accepted subscription agreements from investors and correspondingly issued 507,500 shares of its common stock pursuant to this offering, and received $1,015,000 in gross proceeds. The cost of this issuance was $101,500. During the years ended December 31, 2011 and 2010, the
Company accepted subscription agreements from investors and correspondingly issued 711,000 and 552,000 shares, respectively, of its common stock pursuant to this offering, and received $1,422,000 and $1,105,000 in gross proceeds, respectively. The costs of these issuances were $142,000 and $110,500, respectively.
On September 5, 2011, the Company closed this offering and commenced a new offering of 3,000,000 shares at $3.00 per share. As of December 31, 2011, the Company accepted subscription agreements from investors and correspondingly issued 40,000 shares of its common stock pursuant to this new offering, and received $120,000 in gross proceeds. The cost of this issuance was $12,000.
During the seven month period ended December 31, 2011, the Company issued 21,200 shares of common stock in exchange for consulting, professional and other services rendered. The value of these services aggregated $69,600. During the year ended May 31, 2011, the Company issued 63,800 shares of common stock in exchange for consulting, professional and other services rendered. The value of these services aggregated $114,192. No shares of the Company’s common stock were issued in exchange for consulting, professional and other services rendered during 2010.
On June 13, 2011, SunSi Energies Hong Kong Limited executed an addendum to its agreement with Mr. Dongqiang Liu, the 40% minority shareholder of Wendeng, for the purpose of amending the terms to the equity transfer agreement dated November 22, 2010, as amended on December 15, 2010, between the parties for the purchase of a 60% equity interest in Wendeng.
Under the terms of the original agreement, the Company would have had an obligation, upon receiving formal notice, to buy back 1,349,628 shares of its common stock at a value of RMB 18,000,000 (approximately USD $2.00 per share) from Mr. Liu. The addendum cancelled any potential obligation that the Company would have to buy back the shares and confirmed that all purchase consideration was fully paid.
As a result, the Company reclassified the value of the common shares subjected to this buyback provision, approximately $2.7 million, as additional paid-in capital. These shares were presented as redeemable common stock at May 31, 2011
F-26
19.
COMMITMENTS
SunSi Energies Inc. entered into various engagement agreements for advisory and consulting services on a non-exclusive basis to obtain equity capital. In the event that the Company completes a financing from a funding source provided by one of the consultants, then such consultant will receive a finders or referral fee at closing ranging from seven percent (7%) to ten percent (10%) of the amount received by the Company. The total financing sought is in the amount of $9.0 million in equity. The maximum potential amount of fees that can be paid amounts to $0.9 million. The terms and condition of financing are subject to Company approval.
On November 10, 2009 and February 9, 2010, the Company entered in agreements with its Director of Business Development and Chief Executive Officer, respectively, to pay each of these individuals $60,000 per year plus any documented out of pocket business expenses. Additionally, the Company entered into an agreement on May 15, 2009 to pay a representative in China $60,000 per year.
20.
SEGMENT INFORMATION
As a result of the acquisition of its equity interest in Wendeng, the Company reassessed its requirement for segment reporting based on the operating and reporting structure of the combined company.
The Company utilized several criteria, including (i) the Company’s organizational structure, (ii) the manner in which the Company’s operations are managed, (iii) the criteria used by the Company’s Chief Executive Officer, the Chief Operating Decision Maker (“CODM”), to evaluate segment performance and (iv) the availability of separate financial information, as a basis to identify its operating segments.
The Company determined that it has two reportable business segments, Baokai and Wendeng. The Baokai segment consists of the business of Zibo Baokai Commerce and Trade Co., Ltd., a company based in the Shandong province of the People’s Republic of China that distributes the trichlorosilane production of Zibo Baoyun Chemical Plant. The Wendeng segment consists of the operations of Wendeng He Xie Silicon Industry Co., Ltd., a company based in the Shandong province of the People’s Republic of China that directly manufactures and sells trichlorosilane.
The accounting policies of the reportable segments are the same as those described in Note 2 to the consolidated financial statements. The Company’s CODM reviews financial information presented on a consolidated basis, accompanied by disaggregated information by segment for purpose of evaluating financial performance.
F-27
Segment Results
The following table sets forth the results of operations by segment for the seven months ended December 31, 2011 and 2010 and the years ended May 31, 2011 and 2010:
As of December 31, 2011, the Company’s evaluation of goodwill resulting in a total impairment charge of $2,800,000; of which $312,433 was attributed to Baokai and $2,487,567 was attributed to Wendeng.
Depreciation and amortization expense for Wendeng totaled $122,652 and $110,373, respectively for the seven month period ended December 31, 2011 and year ended May 31, 2011. Capital expenditures for Wendeng totaled $470,310 and $184,725, respectively for the seven month period ended December 31, 2011 and year ended May 31, 2011.
Baokai and Corporate did not record any depreciation or amortization expense, nor did they incur any capital expenditures for the seven month period ended December 31, 2011 or year ended May 31, 2011.
For the seven month period ended December 31, 2011, one customer accounted for approximately 98% of Baokai's sales. For the seven month period ended December 31, 2011, two customers accounted for approximately 70% of Wendeng’s sales. Concentration levels amongst these two customers were 20% and 50% of Wendeng’s total sales. No other customer accounted for more than 10% of either segment’s revenue for seven month period ended December 31, 2011.
For the year ended May 31, 2011, one customer accounted for approximately 97% of Baokai's sales. For the year ended May 31, 2011, four customers accounted for approximately 94% of Wendeng’s sales. Concentration levels amongst these four customers ranged from 10% to 42% of Wendeng’s total sales. No other customer accounted for more than 10% of either segment’s revenue for years ended May 31, 2011.
At May 31, 2011, one customer accounted for approximately 100% of Baokai’s accounts receivable. At May 31, 2011, three customers accounted for approximately 97% of Baokai’s accounts receivable. Concentration levels amongst these three customers ranged from 22% to 45% of Wendeng’s total trade receivables. No other single customer accounted for 10% or more of either segment’s trade accounts receivable at May 31, 2011.
The Company did not own equity interests in either subsidiary, or segment, during the year ended May 31, 2010.
Geographic Information
All of the Company’s long-lived assets During the seven months period ended December 31, 2011, the Company made one sale valued at approximately $188,000 to Russia. All of the Company’s other revenues, as determined by shipping destination, are located within the People’s Republic of China.
21.
DEFINED CONTRIBUTION PLAN
Pursuant to the relevant PRC regulations, the Company is required to make contributions at a rate of 28% of employees’ salaries and wages to a defined contribution retirement plan organized by a state-sponsored social insurance plan in respect of the retirement benefits for the Company’s employees in the PRC. The only obligation of the Company with respect to the retirement plan is to make the required contributions under the plan. No forfeited contribution is available to reduce the contribution payable in the future years. The defined contribution plan contributions were charged to the statements of operations.
22.
SUBSEQUENT EVENTS
Subsequent to December 31, 2011, the Company has received $50,000 from the sale of 25,000 shares of common stock.
The Company has evaluated subsequent events from the balance sheet through the date the financial statements were issued, and determined there are no other events to disclose.
F-30
Dates Referenced Herein and Documents Incorporated by Reference
