Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview and 2011 Highlights
In November 2011, the reverse acquisition of Rotoblock by Daifu was completed. This transaction provides the Company with the opportunity to become the leading medical waste management company in PRC, by leveraging our existing leadership position as a medical waste technology provider to expand the company from a solution provider to service-solution provider.
Results of Operations
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
Sales for the year ended December 31, 2011 were $1.7 million compared to $3.2 million for the year ended December 31, 2010, which is an decrease of $1.5 million. The decrease was due to fewer high priced contracts in 2011 where we had five installations compared with six installations in 2010.
Cost of Goods Sold decreased by $1 million from $2.1 millions for the year ended December 31, 2010 to $1.1 million for the year ended December 31, 2011. This decrease was due to fewer installations in 2011. As a percentage of sales the cost of goods sold was 62% and 67% for the year ended December 31, 2011 and 2010 respectively.
Gross profit decreased by $412,000 from $1.1 millions for the year ended December 31, 2010 to $645,000 for the year ended December 31, 2011. This decrease related principally as a result of a lower sales volume of high margin installations in the year ended December 31, 2011.
Sales and distribution expenses increased by $22,000 for the year ended December 31, 2011 compared to the year ended December 31, 2010. The primary reason for the increase was the transfer of staff person salary from general and administrative expenses to sales and marketing in 2011.
Administrative and other operating costs decreased by approximately $61,000 from $1.3 million for the year ended December 31, 2010 to $1.2 million for the year ended December 31, 2011. The decrease was partially due to the transfer of a staff's salary to selling expenses per above and offset by the inclusion of Rotoblock since acquisition of $45,000 in addition expenses. In the year ended December 31, 2010, we had certain equity compensation expenses that were not incurred in 2011.
Other income of $1.8 million in 2011 is primarily due to the cancellation of two sales contract by customers where installation deposits of approximately $1.7 million was forfeited to us.
Financial expense increased from $3,361 for the year ended December 31, 2010 to $8,582 for the year ended December 31, 2011. The increase was primarily due to interest accrued on the $2 million convertible debt.
Interest income decreased slightly from $1,782 in 2010 to $1,132 in 2011 due to less overall Company balances in bank savings accounts.
Net Income (loss). Net Income for the year ended December 31, 2011 was $ 764,000 compared to a net loss of $715,000 for the year ended December 31, 2010.
Liquidity and Capital Resources
In assessing our liquidity, we monitor and analyze our cash on-hand, liquidation value of our investment in securities, and our operating and capital expenditure commitments. Our principal liquidity needs are to meet our working capital requirements, operating expenses and capital expenditure obligations.
Our principal sources of liquidity consist of our existing cash on hand, bank loans, our investment in securities with Samyang Optics, Ltd of $990,000. As of December 31, 2011, we had a loan of $410,000 due to American Pacific Medical Group Limited, a related party of daifuWaste Group, with loan interest rate at 7% per annum, from January 1, 2012.
We will require additional capital to expand our current operations. In particular, we require additional capital to expand our customer base by the addition of qualified sales and professional staff to execute on our business plan and pursue our efforts in the research and development.
We intend to fund our long term liquidity needs related to operations through the incurrence of indebtedness, equity financing or a combination of both. Although we believe that these sources will provide sufficient liquidity for us to meet our future liquidity and capital obligations, our ability to fund these needs will depend on our future performance, which will be subject in part to general economic, financial, regulatory and other factors beyond our control, including trends in our industry and technological developments. However, we may not be able to obtain this additional financing on terms acceptable to us or at all.
We used cash in operations of $61,042 and $888,728 during the years ended December 31, 2011 and 2010 respectively. Cash used in operations in 2011 was the result of the net income incurred for the year of $764,385, plus the addition of non-cash expenses of $98,864. In 2011, non-cash expenses were due to depreciation and amortization, non-cash interest and stock based compensation. Cash used in operations in 2010 was the result of the net loss of $715,391, offset by non-cash expenses of $164,980. In 2010, non-cash expenses were due to depreciation and amortization and stock based compensation for certain equity instruments.
In 2011, the net change in operating assets and liabilities resulted in a cash decrease of $924,291. The change was primarily due to the following: a decrease in other receivables and prepayments of $501,176 as a result of payments to suppliers and a decrease in customer's deposits offset by an increase in other payables and accrued liabilities of $877,136 as a result of accruals of $340,000 for executive pay, a loan from Pacific Medical Group Limited of $410,000 and Vat Taxes of $80,000.
In 2010, the net change in operating assets and liabilities resulted in a cash decrease of $338,317. The change was primarily due to the following: an increase of $295,720 in accounts receivable for project revenue earned but not paid, a decrease in the inventory of $478,669 for materials used in completed projects, increase in other receivables and prepayments of $633,897 for guaranteed customer deposits and deposits to suppliers and a increase in other receivables and accrued liabilities of $474,387 due to accruals of $230,000 for executive pay and a $150,000 accrual for VAT taxes.
Investing activities used cash of $217,406 and $0 during the year ended December 31, 2011 and 2010, respectively.
In 2011, the cash was invested to acquire a 35% share interest in a MWT center in Qinghai Province. The center is expected to start business in the second quarter of 2012.
Financing activities used cash of $138,627 and $50,414 during the year ended December 31, 2011 and 2010 respectively. In 2011, restricted cash in the amount of $4.1 million was released to redeem all of our outstanding preferred stock for $4.3 million. The company also received $100,000 in cash from the exercise of stock options.
In 2010, we used cash of $50,414 to secure performance on a certain installation.
We had cash and cash equivalents of $144,000 at December 31, 2011 as compared to $566,000 at December 31, 2010. We had a working capital deficit of $2.6 million at December 31, 2011 versus working capital of $3.1 millions at December 31, 2010.
We believe that our currently available working capital should be adequate to sustain our operations at our current levels through at least the next twelve months.
Critical Accounting Policies and Use of Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which have been prepared in conformity with U.S. generally accepted accounting principles which requires our management to make estimates and assumptions affecting the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as revenues and expenses during the reporting period. The amounts estimated could differ from actual results.
Critical Accounting Policies and Use of Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which have been prepared in conformity with U.S. generally accepted accounting principles which requires our management to make estimates and assumptions affecting the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as revenues and expenses during the reporting period. The amounts estimated could differ from actual results.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements or contractual or commercial commitments.
