U. S. Securities and Exchange Commission
Washington, D. C. 20549
For the transition period from _____ to _____
Commission File No. 0-54205
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes [ ] No [X]
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. (Check One)
Large accelerated filer Accelerated filer _ Non-accelerated filer Smaller reporting company [X]
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date:
January 10, 2013
Common Voting Stock: 31,327,741
HUAYUE ELECTRONICS, INC.
QUARTERLY REPORT ON FORM 10Q
FOR THE FISCAL QUARTER ENDED NOVEMBER 30, 2012
TABLE OF CONTENTS
See Notes to Consolidated Financial Statements
See Notes to Consolidated Financial Statements
See Notes to Consolidated Financial Statements
NOTE 1 – ORGANIZATION AND OPERATIONS
Huayue Electronics, Inc. (“Huayue Electronics” or the “Company”) was incorporated under the laws of the State of Delaware on January 13, 2005. The Company was initially named “HXT Holdings, Inc.,” but changed its name to Huayue Electronics, Inc. on November 2, 2011.
On September 2, 2011, Huayue Electronics acquired all of the outstanding capital stock of China Metal Holding, Inc. (“China Metal”), a privately owned corporation formed in the State of Delaware, United States of America, by merging HXT Acquisition Corp., a newly formed Delaware corporation that was wholly owned by the Company, into China Metal. China Metal is a holding company whose only asset, held through a subsidiary, is 100% of the registered capital of Changzhou Huayue Electronics Company, Limited (“Changzhou Huayue”), a limited liability company organized under the laws of the People’s Republic of China (“China” or “PRC”).
Changzhou Huayue has been engaged since its formation in developing, manufacturing and selling electrolytic capacitors. Since 2008 Changzhou Huayue has also been engaged in developing, manufacturing and selling energy efficient lighting products, including both high frequency induction lights and light bulbs utilizing a light emitting diode (“LED”). Changzhou Huayue’s offices and manufacturing facilities are located in China.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The consolidated financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). The financial statements reflect the financial position of the Company and its subsidiary, Changzhou Huayue Electronic Co., Ltd., as of November 30, 2012 and May 31, 2012 and the results of operations and cash flows of the Company and its subsidiary, Changzhou Huayue Electronic Co., Ltd., for the three months and six months ended November 30, 2012 and 2011.
Principles of consolidation
The consolidated financial statements include the financial statements of China Metal Holding, Inc. and Changzhou Huayue Electronics Co., Ltd. All inter-company transactions and balances are eliminated in consolidation.
Use of estimates
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant accounting estimates reflected in the Company’s consolidated financial statements include: the allowance for bad debt, the valuation of inventory, and estimated useful lives and impairment of property and equipment.
Cash and cash equivalents
For purposes of the statement of cash flow, the Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Accounts Receivable and Allowance for Bad Debt
Accounts receivable are stated at net realizable value. An allowance for doubtful accounts is established based on the management’s assessment of the recoverability of accounts and other receivables. A considerable amount of judgment is required in assessing the realization of these receivables, including the current credit worthiness of each customer and the related aging analysis.
Inventory is primarily composed of raw materials and packing materials for manufacturing, work in process, and finished goods. Inventories are valued at the lower of cost or market with cost determined on a weighted average basis. Management compares the cost of inventory with the market value and an allowance is made for writing down the inventory to its market value, if lower than cost.
Machinery and equipment
Machinery and equipment are stated at cost. The cost of an asset comprises its purchase price and any directly attributable costs of bringing the asset to its present working condition and locations for its intended use. Depreciation is calculated using the straight-line method over the following useful lives:
Expenditures for maintenance and repairs are charged to expense as incurred. Additions, renewals and betterments are capitalized.
The Company’s revenue recognition policies are in compliance with Staff Accounting Bulletin (“SAB”) 104, included in the Codification as ASC 605, Revenue Recognition. Sales revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are recorded as customer deposits.
Revenue from the sale of goods or services is recognized at the time that goods are delivered or services are rendered. Receipts in advance for goods to be delivered or services to be rendered in a subsequent period are carried forward as customer deposit.
Prepaid account represents the payments made and recorded in advance for goods and services received. The Company makes advances for raw materials purchased from certain domestic vendors. In order to maintain a long-term relationship with the vendors, the Company frequently needs to make advances from one and one-half months to three months ahead. The prepaid account was $3,181,292 as of November 30, 2012 and $2,389,547 as of May 31, 2012.
Impairment of long-lived assets
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. An impairment loss, measured based on the fair value of the asset, is recognized if expected future undiscounted cash flows are less than the carrying amount of the assets.
The Company accounts for income tax under the asset and liability method as stipulated by Accounting Standards Codification (“ASC”) 740, formerly Statement of Financial Accounting Standards (”SFAS”) No. 109, “Accounting for Income Taxes”, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of the events that have been included in the financial statements or tax returns. Deferred income taxes will be recognized if significant temporary differences between tax and financial statements occur. Valuation allowances are established against net deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized. The deferred tax asset at November 30, 2012 and May 31, 2012 were $39,573 and $39,226, respectively.
Sales revenue represents the invoiced value of goods, net of a 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% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing their finished product.
The Company recorded $142,340 and $134,962 VAT payable net of payments in the financial statements as of November 30, 2012 and May 31, 2012, respectively.
Advertising costs for newspaper and television are expensed as incurred. The Company incurred no advertising costs for the three months ended November 30, 2012 and incurred $6,610 advertising costs for the three months ended November 30, 2011.
The Company incurred advertising costs of $184 and $8,509 for the six months ended November 30, 2012 and 2011, respectively.
Mailing and handling costs
The Company accounts for mailing and handling fees in accordance with the FASB ASC 605-45 (Emerging Issues Task Force (EITF) Issue No. 00-10, Accounting for Shipping and Handling Fees and Costs). T he Company includes shipping and handling fees billed to customers in net revenues. Amounts incurred by the Company for freight are included in cost of goods sold. For the three months ended November 30, 2012 and 2011, the Company incurred $1,127 and $5,663 mailing and handling costs, respectively. For the six months ended November 30, 2012 and 2011, the Company incurred $8,251 and $6,494 mailing and handling costs, respectively.
Risks and uncertainties
The Company’s operations are carried out in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, and by the general state of the PRC’s economy. The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in the North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
Fair value of financial instruments
For certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities and short-term debt, the carrying amounts approximate their fair values due to their short maturities.
As of November 30, 2012, the Company did not identify any financial instruments that are required to be presented on the balance sheet at fair value other than those whose carrying amounts approximate fair value due to their short maturities.
Foreign currency translation
The accounts of the Company’s Chinese subsidiary are maintained in the RMB and the accounts of the U.S. parent company are maintained in the USD. The accounts of the Chinese subsidiary were translated into USD in accordance with Accounting Standards Codification (“ASC”) Topic 830 “Foreign Currency Matters,” with the RMB as the functional currency for the Chinese subsidiary. According to Topic 830, all assets and liabilities were translated at the exchange rate on the balance sheet date; stockholders’ equity is translated at historical rates and statement of income items are translated at the weighted average exchange rate for the period. The resulting translation adjustments are reported under other comprehensive income in accordance with ASC Topic 220, “Comprehensive Income.” Gains and losses resulting from the translations of foreign currency transactions and balances are reflected in the statements of income.
Translation adjustments resulting from this process amounted to $335,047 and $91,744 as of November 30, 2012 and May 31, 2012, respectively.
The following exchange rates were adopted to translate the amounts from RMB into United States dollars (“USD$”) for the respective years:
Subsidiaries incorporated in China are required to make appropriations to reserve funds, based on after-tax net income determined in accordance with generally accepted accounting principles of the People’s Republic of China (“PRC GAAP”). Effective January 1, 2006, the Company is only required to contribute to one statutory reserve fund at 10% of net income after tax per annum, and any contributions are not to exceed 50% of the respective companies’ registered capital.
As of November 30, 2012, the Company has appropriated USD $31,263 to the statutory reserve.
New accounting pronouncements
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.
The Company provides an allowance for doubtful accounts related to its receivables. The receivables and allowance balances at November 30, 2012 and May 31, 2012 are as follows:
NOTE 5 – OTHER RECEIVABLE
The other receivable consisted of the follows:
Inventory consists of finished goods, work-in-process, and raw materials. No allowance for inventory was reserved as of November 30, 2012 and May 31, 2012.
The components of inventories as of November 30, 2012 and May 31, 2012 were as follows:
The components of plant, property and equipment as of November 30, 2012 and May 31, 2012 were as follows:
The depreciation expense for the three months ended November 30, 2012 and 2011 was $25,540 and $29,425, respectively.
The depreciation expense for the six months ended November 30, 2012 and 2011 was $54,013 and $67,245, respectively
NOTE 8 - RELATED PARTY TRANSACTIONS AND BALANCES
An individual or entity is considered to be a related party if the person or the entity has the ability, directly or indirectly, to control the other party or exercise significant influence over the other party in making financial and operational decisions. An individual or entity is also considered to be related if the person or the entity is subject to common control or common significant influence.
The related parties of the company are comprised as follows:
(i) Due from Related Party:
Due from Related Parties, at November 30, 2012 and May 31, 2012, consisted of the following balances:
(ii) Due to Related Parties
Due to Related Parties at November 30, 2012 and May 31, 2012 consisted of the follows:
NOTE 11 – NOTES PAYABLE
All notes payable were due within one year and bear 6% annual interest rate on the maturity date.
Tax payable at November 30, 2012 and May 31, 2012 are as follows:
The Company’s other payable, at November 30, 2012 and May 31, 2012, consisted of the follows:
NOTE 14 - INCOME TAXES
For the six months ended November 30, 2012 and 2011, Changzhou Huayue Electronics Co., Ltd recorded income tax provisions of $249,272 and $11,928 respectively.
(i) The components of income (loss) before income tax expense are as follows:
(ii) The components of the income tax benefit (expense) are as follows:
(iii) The following table summarizes deferred taxes resulting from differences between financial accounting basis and tax basis of assets and liabilities:
Changzhou Huayue Electronics Co., Ltd is subject to the Enterprise Income Tax (“EIT”) at a statutory rate of 25%. However, according to P.R. China tax law, the effective tax rate for the bad debt expense deduction is only 15%. The Company recognized $39,573 current deferred tax assets at enacted 15% tax deduction rate for the temporary differences between the financial reporting bases and the tax bases of its allowance for accounts receivable.
The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate resolution.
NOTE 15 – COMMON STOCK AND ADDITIONAL PAID IN CAPITAL
On July 26, 2012, the Company received $300,065 cash payment from its shareholders. The cash receipt was recorded as addition to the paid in capital. On July 25, 2012, Ms. Li Xinmei contributed $2,698,230 to the Company. The contribution was recognized as additional paid in capital. Ms. Li is a member of the Board of Directors, spouse of the CEO, and a principal shareholder of the Company. Both transactions did not increase the outstanding shares of the common stock.
On November 21, 2012, the Company’s Board of Directors approved and authorized the sale of 1,260,000 shares at $2.50 per share to Ms. Li Xinmei. The Company received total proceeds of $3,150,000 from Ms. Li Xinmei in the quarter ended November 30, 2012.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS
Forward-Looking Statements: No Assurances Intended
In addition to historical information, this Quarterly Report contains forward-looking statements, which are generally identifiable by use of the words “believes,” “expects,” “intends,” “anticipates,” “plans to,” “estimates,” “projects,” or similar expressions. These forward-looking statements represent Management’s belief as to the future of Huayue Electronics, Inc. Whether those beliefs become reality will depend on many factors that are not under Management’s control. Many risks and uncertainties exist that could cause actual results to differ materially from those reflected in these forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in Section 1A titled “Risk Factors” in the Company’s Annual Report on Form 10-K filed on August 28, 2012. Readers are cautioned not to place undue reliance on these forward-looking statements. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements.
Outline of Our Business
Huayue Electronics, Inc. is a Delaware corporation that functions as a holding company. Through a wholly-owned subsidiary, we own all of the registered capital of Changzhou Huayue Electronic Co., Ltd. (“Changzhou Huayue”), a corporation organized and located in The People’s Republic of China (“PRC”). Since 1999 Changzhou Huayue has been engaged in the production and sale of electrolytic capacitors. Since 2008, however, the growing portion of our business has been the production and sale of energy efficient lighting products. In the most recent fiscal quarter, over 93% of our sales revenue came from lighting products.
We first entered the market for energy efficient lighting in 2008 with a line of induction lights. In contrast to traditional lamps, induction lights do not involve either filaments or electrodes, and no electrical connection goes on inside the glass tube. Instead, energy is transferred through the glass tube solely by electromagnetic induction. Power to create the light is transferred from outside the glass tube by means of a magnetic field. As with a conventional fluorescent lamp, the power excites mercury or a mercury alloy, producing ultraviolet light which hits the phosphors resulting in visible light.
Our participation in the market for induction lighting benefits from our intellectual property. From 2008 to 2010, we obtained 60 patents from the PRC government relating to the induction lighting business, of which 33 are currently in use. Our induction lighting products also benefit from representing high quality at a low cost. The incorporation of smart cards into our lamps provides constant power control and the ability to automatically adjust brightness. We have the facilities to mass produce 300 watt induction lamps with long lives that do not require frequent maintenance, as backed up by our warranties.
After several years of research and development, in 2011 we added a line of LED lights to our product offerings. An LED light contains diodes comprised of a negatively charged semiconductor paired with a positively charged semiconductor. When exposed to a power source, the diode becomes electrically unbalanced, which causes its electrons to seek a different energy level, thus emitting light. The primary advantage of LED lights is efficiency: energy waste is reduced by 50% to 90% compared to conventional incandescent bulbs. In addition, LED lights have a far longer lifetime than conventional lights, are environmentally friendly, and do not produce the infrared radiation that makes incandescent bulbs hot to the touch.
For most of the past four years, our induction lights have been sold directly by our sales staff, as the primary market for our high-wattage bulbs consists of government and industrial applications such as high bays, roadways, tunnels and public facilities, where direct contact with the end user is important. In 2011 and 2012 we experimented with using sales agents to sell induction lights, but found the process less efficient than selling via our 32 person direct sales force. Our electrolytic capacitors are also sole directly by our sales staff, as we have a long-standing group of customers for those products.
The target market for our LED products consists of residential, office and garage applications. So with the introduction of our line of LED products in 2011, we began to develop a marketing network dedicated to distribution of our LED lights, in order to maximize distribution of these consumer products. We currently have 390 agents registered as participants in our marketing program. During 2013 we plan to organize these participants into a network of dedicated franchise stores located in urban areas throughout China. Changzhou Huayue believes that this strategic decision will enable us to expand our market throughout China in the coming year.
Results of Operations
Our operations during the second quarter of fiscal 2013 continued our growth trend. Sales revenue totaled $4,795,580 for the three months ended November 30, 2012, a nearly fourfold increase over revenue of $986,281 in the three months ended November 30, 2011. For the six months ended November 30, 2012, the 102% increase in sales is likewise sharp, albeit not as dramatic as second quarter sales. However, sales in the quarter ended August 31, 2011 included a transaction arranged prior to the September 2011, when we became a public company. $1,493,830 of the sales revenue in that prior quarter was attributable to a sale to a related party (Changzhou Teweile Energy Saving Lighting Technology Co., Ltd.) in which Changzhou Huayue sold goods to Changzhou Teweile at a loss of $109,193, permitting Changzhou Teweile to resell the goods to the ultimate customer at a profit. In the period since we became a public company, there have been no other sales at discount to market, and it is management’s plan that such related party transactions will not be replicated in the future, except in circumstances where the benefit to Changzhou Huayue equals or exceeds the benefit it would receive from an arms-length transaction.
Even if the loss-sale to Changzhou Teweile in 2011 is taken into account, the growth in sales from the first half of fiscal 2012 to the first half of fiscal 2013 was marked. The primary reason for the improvement is the conversion of our marketing program from direct sales to sales through agents. In the first half of fiscal 2012, the agency program was still in its start-up phase. The marked improvement in sales in the first half of fiscal 2013 indicates that the new agents are gaining traction in their marketing efforts.
The margins on our sales improved significantly in the second quarter and first half of fiscal 2013, both as compared to the comparable periods of fiscal 2012 and as compared to the entirely of fiscal 2012. The improvement as compared to the first half of fiscal 2012 (39% vs. 7%) is in large part attributable to the loss-sale that accounted for 31% of revenue in that six month period. However, our gross margin for the year ended May 31, 2012 was itself only 13%, primarily due to our policy of seeking market position by introducing lighting products while they are still in the final development stages. The 42% gross margin achieved in the second quarter of fiscal 2013 and the 39% achieved in the first half of fiscal 2013 are indicative of our maturing position in the lighting market, which permits us to demand higher profits on our lighting sales.
Our selling expenses remain insignificant - $17,432 in the six months ended November 30, 2012 - due to our reliance on a network of independent sales agents. General and administrative expenses increased by 60% from $57,347 in the second quarter of fiscal 2012 to $91,716 in the second quarter of fiscal 2013, and by 99% in the first half of fiscal 2013. The primary reasons for the increase in G&A expenses were our efforts to promote our new lighting products, as well as an increase in the required contribution to the national pension fund. General and administrative expenses will continue to increase in the coming year, as we assume the obligations attendant to being a U.S. public company, including legal and accounting expenses and other expenses related to the nurturing of our new shareholder base.
As a result of our improved gross profit and the relatively small increase in our G&A expenses, our income from operations increased from $83,218 in the quarter ended November 30, 2011 to $1,918,702 in the quarter ended November 30, 2012, and from $146,822 in the six months ended November 30, 2011 to $2,508,790 in the six months ended November 30, 2012.
We rely on short-term bank debt for our liquidity, with the result that interest expenses often exceed our total operating expenses. Interest expense (net of interest income) of $180,311 in the first six months of fiscal 2013 exceeded the $178,411 recorded in the first six months of fiscal 2012 primarily due to increases in interest rates. As discussed below, we hope to access the international capital markets to obtain equity funding to pay off the debt and reduce this cost and our exposure to increasing interest rates.
Our net profit before tax for the quarter ended November 30, 2012 was $1,892,630, a significant improvement over the quarter ended November 30, 2011 when we barely broke even. China imposes a national corporate income tax rate of 25%. Currently, however, a portion of our net pre-tax income is deferred in accordance with Chinese tax regulations that favor technology companies in their growth stage. As a result, we accrued only $276,382 for income tax in the quarter ended November 30, 2012. As a result, our net income for the quarter was $1,616,248. For the six months ended November 30, 2012 our net income of $2,029,293 was a marked improvement over the net income of $35,785 we recorded in the six months ended November 30, 2011.
Our business operates primarily in Chinese Renminbi (“RMB”), but we report our results in our SEC filings in U.S. Dollars. The conversion of our accounts from RMB to Dollars will result in translation adjustments. While our net income will be added to the retained earnings on our balance sheet, the translation adjustments will be added to a line item labeled “accumulated other comprehensive income,” since they will be more reflective of changes in the relative values of U.S. and PRC currencies than the success of our business. The amount added to “accumulated other comprehensive income” was $245,673 during the six months ended November 30, 2012. During the six months ended November 30, 2011, when the exchange rate was less volatile, our accumulated other comprehensive income increased by $24,205.
Liquidity and Capital Resources
Until recently the operations of the Company had been funded by contributions and short-term loans from our founder, Mr. Shudong Pan, his family, and entities related to them. In recent periods, however, we have developed bank lending relationships, which are now our primary source of liquidity. Today, our current liabilities are in large part made up of short term debt and notes payable to Chinese banks. Most of these debts have been guaranteed by related entities or secured by property owned by related parties. The proceeds of these loans have been utilized primarily to finance the development of our lighting business and the expanded sales effort for the new LED lighting products.
As is common in China, all of our bank borrowing is done on a short-term basis. As a result, the entire amount of $5,226,778 that we owed to lending institutions at November 30, 2012 has been classified as short-term debt, although we have every reason to believe that the institutions will replace the loans as they come due. Because our debts are all classified as short-term, at November 30, 2012 we had only $9,278,392 in working capital, despite cash contributions to capital during the first half of fiscal 2013 that totaled $6,148,295.
The largest component of our current assets was our accounts receivable. Accounts receivable of $8,894,884 at November 30, 2012, are large relative to recent revenue. Some of the increase is attributable to sales of induction lights made in connection with government lighting programs, payment for which is delayed pending completion of bureaucratic approval processes. In addition, in our efforts to achieve a substantial beachhead in the market for energy efficient lighting, we offer certain customers ninety days after delivery to make payment to us. In general, we do so only after we are assured that the customer has the capability and intent to make payment. This practice reduces our liquidity to some extent, but helps us develop long-term, repeat customers. As our lighting business matures, however, we will move toward more conventional payment terms.
The next largest component of our current assets was our prepaid expenses. In China, to secure a guaranteed supply of raw materials and components, it is common practice to make prepayments to your principal suppliers, often to the extent of several months’ requirements. That security is the purpose for the $3,181,292 prepaid account on our November 30, 2012 balance sheet.
The amount due from related parties occurred because, in order to optimize our cash resources, Changzhou Huayue buys some of its raw materials from related parties, and sells a large portion of its finished goods to related parties. As a result, at November 30, 2012 we owed $82,212 to entities controlled by our CEO and his family, and those or other such entities owed $896,411 to us. Our plan is that as our business expands and our cash flows become more stable, we will reduce or eliminate the incidence of related party sales. As a result, during the six months ended November 30, 2012, our due from related parties account was reduced by $493,663.
Included in our current liabilities at November 30, 2012 was an “other payable” of $297,693. This represented an overnight loan that we secured to fund our bank deposit obligation. A significant portion of the bank loans that we have obtained require us, at the end of each month, to maintain deposits with lender equal to a percentage, typically 50%, of the amount loaned. At November 30, 2012, to meet that obligation we borrowed on an overnight basis the funds recorded as “other payable.”
Cash used in operations during the six months ended November 30, 2012 was $2,932,796, despite our net income of $2,029,293 during the period. The primary reason for the disparity was the increase of $5,204,894 in our accounts receivable.
Despite the significant use of cash in operations during the quarter, our cash balance at November 30, 2012 was $1,107,812, slightly greater than at the May 31, 2012 end of our prior fiscal year. The presence of cash in our accounts was the result of capital contributions totaling $5,848,230 by Li Xinmei, a member of our Board. In addition, the prior shareholders of our subsidiary, China Metal Holding, Inc., contributed $300,065, which was required to satisfy the Chinese government regulations applicable to the acquisition of Changzhou Huayue by China Metal Holding. The cash balance that resulted should provide us sufficient liquidity to fund our operations for the coming year.
Our business plan is based on obtaining long term financing of $10 million during the next year. $6 million of this amount would be used to build a new production and distribution center for energy efficient lighting, and $4 million would be used to provide additional liquidity. A further capital raise of $20 million is projected for the following year. We hope to raise the new funds through the sale of equity in the Company, although this may prove not to be feasible. If we are forced to finance our capital needs through the issuance of debt or long term borrowing, the interest rates we pay and our interest cost of financing would increase. However, we believe that the incremental sales supported by the increased production capacity financed by the borrowing will more than offset these added expenses.
We believe growth of our production capacity is critical. If we are unable to raise additional funds through any means, we will be forced to postpone our expansion plans and the growth and profitability of the Company would be reduced.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition or results of operations.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. Our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule13a-15(e) promulgated by the Securities and Exchange Commission) as of November 30, 2012. The evaluation revealed that there are material weaknesses in our disclosure controls, specifically:
Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company’s system of disclosure controls and procedures was not effective as of November 30, 2012.
Changes in Internal Controls. There was no change in internal controls over financial reporting (as defined in Rule 13a-15(f) promulgated under the Securities Exchange Act or 1934) identified in connection with the evaluation described in the preceding paragraph that occurred during the Company’s second fiscal quarter that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.
PART II - OTHER INFORMATION
There have been no material changes from the risk factors included in Section 1A of our Annual Report on Form 10-K filed on August 28, 2012.
The Company did not repurchase any of its equity securities that were registered under Section 12 of the Securities Exchange Act during the 2nd quarter of fiscal 2013.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.