XINYINHAI TECHNOLOGY (XNYH) $ 0,10 EPS this year becomes tough

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 six months of 2010, which ended on June 30, 2010, the effect of the recession was most dramatic in our equipment distribution business, where revenues declined by 67% to $249,971 during the first six months of 2010 ($102,803 in the second quarter) from $758,670 during the first six months of 2009 ($221,766 in the second quarter of 2009). Revenue in the first six months of 2009 was, in turn, 69% lower than in the first six months of 2008.

This two year slide in equipment distribution reflects 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 6% contribution to our overall revenue during the first six months 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.

Revenue from our printing business, on the other hand, was modestly higher overall, increasing by 2% to $3,813,388 during the first six months of 2010, compared to $3,749,970 during the first six months of 2009. Second quarter revenues fell, however, by 5% from printing revenue in the second 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. The negative effect of the recession on the Chinese banking industry, however, has slowed the placement of orders for our printing products, as banks are wary of building up excessive inventory of supplies.
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 modest growth in our printing revenue for the first six months of 2010 indicates a first step toward realizing the benefit of that investment.

The 36.9% gross margin realized by our subsidiary, Harbin Golden Sea, on sales in the first six months of 2010 was only slightly better than the 36.2% gross margin realized in first six months of 2009. The gross margin was adversely affected by the decline of our equipment business, which operated at a loss during the first six months 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.

As the Chinese banking industry is moving towards stabilization, our expectation is that we will be able to revive our sales growth and return our printing operations to the levels of profitability that they sustained prior to the international credit crisis.

Although our general and administrative expenses spiked in the second quarter of 2010, this represented a balance to particularly low expenses in the first quarter, reflecting uneven timing of expense realization. Overall, we operated more efficiently during the first six months of 2010 that during the first half of the prior year. Total operating expenses during the first six months of 2010 were $509,818, a 26% decline from the $691,663 in operating expenses that we incurred during the first six months of 2009. The decline was attributable to our continuing efforts to achieve efficiencies in our operations, leading to a decrease of $69,605 in our selling and distribution expenses and $112,240 in our general and administrative expenses for the six months ended June 30, 2010 compared to the six months ended June 30, 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 six months of 2009 to the first six months of 2010. Income from operations, therefore, increased by 5%, from $941,796 in the first six months of 2009 to $988,250 in the first six months of 2010. During the second quarter, however, our income from operations fell by 16% from $472,025 in the second quarter of 2009 to $397,643 in the second quarter of 2010.

During the third quarter of 2009 we obtained a $2.9 million bank loan, which we repaid during the second quarter of 2010. The finance charges attributable to the bank loan, $102,521 in the six months ended June 30, 2010 and $63,315 in the three months ended June 30, 2010, offset the gains we had made in the six month period. Our net income before income taxes and provision for noncontrolling interests, therefore, fell during the six month period ended June 30, 2010 from $949,166 to $891,739.

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 six months of 2009, causing an expense of $122,675, and at an 11% rate in the first six months of 2010, cause an expense of $103,520. In 2011 our income will be taxed at the national rate of 25%.

The operations of our subsidiary, Harbin Golden Sea, produced $806,430 in income during the first six months of 2010 and $307,550 in the second quarter of 2010. However, because we own only 90% of Harbin Golden Sea, we deducted “noncontrolling interests” of $80,643 and $30,755, respectively, 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 six months of 2010 was $707,576, representing $.04 per share, a 4% decrease from the net income we achieved in the first six months of 2009. Net income for the quarter ended June 30, 2010 was $267,613 ($.01 per share), which was 27% lower than during the quarter ended June 30, 2009.

After repaying our bank loan, we held $0.3 million in cash and equivalents at June 30, 2010. We have no debt payment obligations and are cash positive in our operations. Moreover, since we are operating profitably and hold over $5.4 million in fixed assets free of lien, we expect to be able to secure bank financing when our operations warrant capital expansion. 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.

Remarkable that they still can manage a profitable business. With a book value of $0.79 and $0.04 in the pocket for H1 it will be difficult to achieve an EPS of $0.10, but it is not impossible.

POSITION: LONG