Results of Operations:
Revenues:
The company’s revenues include revenues from sales of energy recovery systems (products), and provision of design services and EPC services. The decrease in revenues was mainly attributable to a reduction in order completions in terms of number and size between quarters, primarily as the result of the order-based business model of the company and the impact of the recent economic downturn. During the first quarter of 2009, the company completed 6 product orders and there was no design service revenue recognized. During the same period of 2008, the company completed 18 product orders with a large order which amounted to $1,837,507 and recognized $736,588 in service revenue from a large design service order. The revenue from these two orders in total amounted to $2,574,095 and accounted for 88.1% of the variance between the two quarters. Management expects that revenues will pick up in the remaining periods of 2009 as many of the company’s target customers in China have resumed their plant expansion or retrofit plans as the result of China’s recent stimulus package. The company believes that it is among the few competitors in the industry with the necessary design and engineering capabilities to satisfy the recent growing market demand for larger energy recovery systems and to undertake EPC projects for the whole plants.
Cost of Revenue:
Cost of Revenue was $1,200,355 for the three months ended March 31, 2009, as compared to $3,132,996 for the three months ended March 31, 2008, a decrease of $1,932,641 or 61.7%. As a percentage of revenues, cost of revenue increased from 74.9% for the three months ended March 31, 2008 to 95.1% for the three months ended March 31, 2009, an increase of 20.2%. The increase of percentage of revenues is mainly due to the significant increase of the per unit cost for overhead fixed costs due to lower volume of product revenue as well as an increase of salaries as a result of company-wide gradual salary increases beginning in April 2008 which are included in the overhead costs. Another cause has been the decrease in sales prices due to the recent economic downturn. During the three months ended March 31, 2009, prices of various steel-made materials decreased on average by 2.4%. Based on the current market situation, management expects that the prices of steel-made raw materials, which are the main raw materials for manufacturing the company’s products, will keep relevantly stable, if not decreasing further, for the rest of 2009 as a result of recent changes in the overall market conditions.
Gross Profit:
As a result, gross profit was $61,893 for the three months ended March 31, 2009 as compared to $1,049,476 for the three months ended March 31, 2008, a decrease of $987,583 or 94.1%. The decrease in the company’s gross margin is mainly attributable to the decrease in sales prices and sales volume as a result of the economic downturn as well as the increase in cost of revenue as a percentage of revenues.
Cost of Revenue:
Cost of Revenue was $1,200,355 for the three months ended March 31, 2009, as compared to $3,132,996 for the three months ended March 31, 2008, a decrease of $1,932,641 or 61.7%. As a percentage of revenues, cost of revenue increased from 74.9% for the three months ended March 31, 2008 to 95.1% for the three months ended March 31, 2009, an increase of 20.2%. The increase of percentage of revenues is mainly due to the significant increase of the per unit cost for overhead fixed costs due to lower volume of product revenue as well as an increase of salaries as a result of company-wide gradual salary increases beginning in April 2008 which are included in the overhead costs. Another cause has been the decrease in sales prices due to the recent economic downturn. During the three months ended March 31, 2009, prices of various steel-made materials decreased on average by 2.4%. Based on the current market situation, management expects that the prices of steel-made raw materials, which are the main raw materials for manufacturing the company’s products, will keep relevantly stable, if not decreasing further, for the rest of 2009 as a result of recent changes in the overall market conditions.
Gross Profit:
As a result, gross profit was $61,893 for the three months ended March 31, 2009 as compared to $1,049,476 for the three months ended March 31, 2008, a decrease of $987,583 or 94.1%. The decrease in the company’s gross margin is mainly attributable to the decrease in sales prices and sales volume as a result of the economic downturn as well as the increase in cost of revenue as a percentage of revenues.
Income (loss) from Operations:
As a result of the above, loss from operations totaled $1,478,698 for the three months ended March 31, 2009, as compared to the income of $853,957 for the same period in 2008, a decrease of $2,332,655 or 273.2%.
Loss (income) on Change in Fair Value of Warrants;
On January 1, 2009, the company adopted EITF 07-5, it reclassified from additional paid-in capital, as a gain of cumulative effect adjustment of $693,426 beginning retained earnings and $2,933,556 to non-current warrants payables to recognize the fair value of such warrants on such date. The fair value of these warrants increased to $3,067,364 as of March 31, 2009. As such, the company recognized a $133,808 loss from the change in fair value of these warrants for the three months ended March 31, 2009.
Interest Expenses (Income):
Net interest income was $1,194 for the three months ended March 31, 2009. During this period, interest income generated from cash in the company’s bank accounts was $3,114 and interest expense was $1,920. As compared to net interest expense of $1,573 for the three months ended March 31, 2008, an increase of $2,767. The increase is mainly attributable to the increase of interest income and the decrease of interest expense as a result of repaying bank loan by about $381,420 in January 2009.
Income (loss) before Provision for Income Taxes:
As a result of the foregoing, loss before provision for income taxes was $1,637,225 for the three months ended March 31, 2009, as compared to gain before provision for income tax which amounted to $853,991 for the same period in 2008, a decrease of $2,491,216 or 291.7%.
Provision for Income Taxes:
The normal applicable income tax rates for the company’s operating entities in China are 15% and 25%. Pursuant to the PRC income tax laws, Shanghai Engineering is subject to enterprise income tax at a statutory rate of 15% as a high technology entity, while other entities were subject to the 25% income tax rate. For the three months ended March 31, 2009 and 2008, the company recorded $167,015 of PRC income tax benefit as deferred tax asset and reserved $141,280 income tax provision, respectively. The deferred tax assets were fully reserved from the net operation loss of Shanghai Engineering and Vessel Works Division for the three months ended March 31, 2009 which was carried forward as management believes it is likely that those assets will be realized in the future.
