The last time that I put such long texts on this blog, but YES still undervalued if you ask me. I have to confess after reading the 10-Q I am positive about the management decisions they made and I still believe that an EPS of $ 0.10 is almost a fact.
Results of Operations
The recent global recession reduced demand for capital goods in China. Since late 2008, this situation has had a negative impact on both of our business segments. In the first quarter of 2010, which ended on March 31, 2010, the effect of the recession was most dramatic in our equipment distribution business, where revenues declined by 73% to $147,168 during the first quarter of 2010 from $536,904 during the first quarter of 2009 (which was, in turn, 45% lower than in the first quarter of 2008). The decline in equipment distribution reflected delays in the construction of new manufacturing facilities in China, as potential customers wait to see whether demand for their products is revived. The decline reversed a surge in equipment sales that we had experienced in 2008, and reduced this business segment to a 7% contribution to our overall revenue during the first quarter of 2010, a level below even the 13% level we experienced in 2007 and 2006. The future of this business segment will depend, in part, on the success of the economic stimulus initiated by the Government of China. I would say DISINVEST.
Revenue from our printing business, on the other hand, was modestly higher, increasing by 9% to $2,027,210 during the first quarter of 2010, compared to $1,860,077 during the first quarter of 2009. The printing segment of our business had declined in 2008 and 2009, in part due to the weakening of the Chinese banking industry, as many of our customers were conserving cash pending stabilization of the international credit markets. The decline also occurred because we moved our entire production operation to a larger facility at the end of 2008. The move necessitated delays in production, while our equipment was in transit, which in turn interfered with our sales effort, as our customers delayed orders until we could demonstrate that our facilities were up and running. Today, however, our new facility is fully operational, and we expect the traditional growth of our printing business to be renewed.
Over the longer term, the continued revenue growth in our printing services business will require further capital investment. As China’s banking industry rapidly modernizes, our customers demand additional product offerings similar to those available to the banking industry in Europe and the U.S. Our ability to meet that demand will determine the long term growth of our business. Immediately, the development of these new products will require substantial capital investment. For that purpose, we secured a $2.9 million collateralized loan during the third quarter of 2009, and applied $748,379 to improvements in our plant and equipment during the second half of the year. The growth in first quarter printing revenue indicates a first step toward realizing the benefit of that investment. In addition, our backlog of firm orders at March 31, 2010 for 2010 delivery was approximately double the backlog level at March 31, 2009, indicating that we should be able to sustain growth for the remainder of the current year.
The 37.3% gross margin realized by our subsidiary, Harbin Golden Sea, on sales in the first three months of 2010 was only slightly better than the 36.5% gross margin realized in first three months of 2009. The gross margin was adversely affected by the decline of our equipment business, which operated at a loss during the first quarter of 2010. However, margins from our printing business also remained lower than optimal. Our business plan contemplates that gross margin from printing services will average approximately 45%, albeit within a range of 35% to 50%, depending on the components of the business.
We operated substantially more efficiently during the first quarter of 2010 that during the prior year’s quarter. Total expenses during the first quarter of 2010 were $220,280, a 46% decline from the $407,181 in operating expenses that we incurred during the first quarter of 2009. The decline was attributable to our continuing efforts to achieve efficiencies in our operations, leading to a decrease of $50,277 in our selling and distribution expenses and $136,624 in our general and administrative expenses for the three months ended March 31, 2010 compared to the three months ended March 31, 2009. When demand for our products returns to prior levels, we will endeavor to maintain the efficiencies that we implemented during the current slow period.
Our increased efficiency was sufficient to offset the reduction in our revenues from the first quarter of 2009 to the first quarter of 2010. Income from operations, therefore, increased by 26%, from $468,772 to $590,808. During the third quarter of 2009, however, we obtained a one-year bank loan in the amount of $2.9 million, secured by a portion of our real property. This caused us to incur $39,206 in finance costs in the first quarter of 2010, compared to only $198 in the first quarter of 2009. We will continue to incur finance costs related to the loan until it matures in the third quarter of 2010, and thereafter if we decide to refinance the loan.
Our income before income taxes and noncontrolling interests for the first quarter of 2010, therefore, was $554,096, compared to $478,144 in the first quarter of 2009. Commencing in 2008, we became subject to preferential Chinese income tax rates of 9% for 2008, 10% for 2009 and 11% for 2010, respectively. As a result of this government allowance, we were taxed at a 10% rate in the first quarter of 2009, causing an expense of $64,674, and at an 11% rate in the first quarter of 2010, cause an expense of $64,245. In 2011 our income will be taxed at the national rate of 25%.
The operations of our subsidiary, Harbin Golden Sea, produced $498,880 in income during the first quarter of 2010. However, because we own only 90% of Harbin Golden Sea, we deducted a “noncontrolling interest” of $49,888 before recognizing net income on our Consolidated Statements of Income and Comprehensive Income. After that deduction and taking into account the income and expenses incurred by the parent corporation, our net income for the first quarter of 2010 was $439,963, representing $.023 per share, a 20% increase from the net income we achieved in the first quarter of 2009.
Liquidity and Capital Resources
Since our subsidiary, Harbin Golden Sea, was organized in 1998, the growth of its operations has been funded by contributions to capital by our Chairman, Mrs. Tian. With the $2.4 million that she invested, Harbin Golden Sea built its facilities and funded its operations, resulting in profitable operations for the past several years. As a result, at March 31, 2010, we had working capital totaling $8,561,560 (an increase of $547,027 since the end of 2009) and no long-term liabilities.
However, Harbin Golden Sea’s business plan calls for significant investment in the growth of Harbin Golden Sea during the next twelve months. We are purchasing new equipment for our new production facility. We also plan to invest in the development of additional product lines. To accomplish those goals, during the third quarter of 2009, we obtained a $2.9 million bank loan collateralized by our real property. The loan bears interest at 5.31% per annum and is due in the third quarter of 2010. We are utilizing the borrowed funds to implement the capital improvements necessary for our growth. Because the loan amount is substantially less than the value of our real property and because we are operating profitably, we expect to be able to refinance the loan when it matures.
Until our sales return to pre-recession levels, a rapid expansion of our facilities would only increase depreciation expense and operational inefficiency. For that reason, the largest portion of our working capital is now invested in developing strategic relationships that will, we hope, benefit us in the future. Within the Chinese business community, the extension of interest-free loans is a normal method of securing good relations and future opportunities. For that reason, as of March 31, 2010, we have extended a total of $5,264,672 in short-term, interest-free loans to parties that have no other affiliation with Harbin Golden Sea or its management. The largest loan, $4,767,750, has been made to Heilongjiang Jindi Real Estate Development Co., Ltd., in anticipation of future benefits to our real estate assets. We also had relatively small loans outstanding to a trading company and a company in the pharmaceutical industry. All of the loans are due within six months after we fund the loan.
Our operations during the first quarter of 2010 used $167,698 in net cash. The disparity between our net income and net cash from operations was primarily attributable to the fact that during the quarter we increased our inventories by $347,942 in anticipation of near-term growth, and also increased our outstanding trade receivables by $698,553. The increase in our trade receivables was primarily a reflection of the timing of sales, and did not reflect any adjustment in our credit policies. We anticipate, therefore, that our trade receivables will increase or decrease in future periods in proportion to the increases or decreases in our sale revenue.
With the proceeds of our bank loan, we held $2.0 million in cash and equivalents at March 31, 2010. We will have no debt payment obligations until the bank line comes due in the third quarter. And, in accordance with customary banking practice in China, we expect that the bank loan will be extended when it reaches maturity, provided that our financial results are satisfactory to the bank. For that reason, we expect our liquidity will be sufficient in the next year to fund our ongoing operations as well as our near-term growth.
POSITION: LONG (ENTRY $ 0.34)