CADC China Advanced Constr Matls Group (MM)

ITEM 1. FINANCIAL STATEMENTS.

Revenue . Our revenue is primarily generated from sales of our advanced ready-mix concrete products. For the three months ended December 31, 2017, we generated revenue of approximately $10.3 million, as compared to approximately $14.7 million during the three months ended December 31, 2016, a decrease of approximately $4.5 million, or 30%. The decrease in revenue was principally due to our customers’ suspension or production limitation policies enforced by certain districts of the local government on November 15, 2017, which prohibits construction jobsites from producing industrial wastes or dusts to aggravate winter haze weather during the winter time. We expect to increase our production back to normal levels on March 15, 2018 after the suspension and production limitation is uplifted from our customers. In addition, the decrease in revenue was offset by an increased selling unit price by 27.7% resulting from the turnaround of the concrete industry. In late 2017, the local government has shut down a number of small and non-qualified concrete manufactures, which led to less competition in the industry and drove up the selling price of the concrete as the supply of concrete was reduced.

Cost of Revenue . Cost of revenue, which consists of direct labor, rentals, depreciation, other overhead and raw materials, including inbound freight charges, was approximately $8.3 million for the three months ended December 31, 2017, as compared to approximately $15.6 million for the three months ended December 31, 2016, a decrease of approximately $7.3 million, or 47%. The decrease in cost of revenue was primarily associated with the decrease of production volume by 52.8% and was offset by the increase of unit production costs of 10.3%, which was mainly caused by the unit price inflation of our raw materials, such as cement, sand, gravel, breeze and additive during the three months ended December 31, 2017, as compared to the same period in 2016.

Gross Profit (Loss) . Gross profit was approximately $1.9 million for the three months ended December 31, 2017, as compared to approximately $0.9 million in gross loss for the three months ended December 31, 2016, a positive change of approximately $2.8 million, which was primarily a result of large increase in unit selling prices at a higher rate than the increase of unit production cost during the three months ended December 31, 2017, as compared to the same period in 2016 as the reasons as discussed above.

Recovery of (Provision for) Doubtful Accounts . We had recovered doubtful accounts of approximately $0.9 million for the three months ended December 31, 2017, as compared to provision for doubtful accounts charges of approximately $2.3 million during the three months ended December 31, 2016, a change of approximately $3.1 million, or 138%. The change was attributable to the fact that less accounts receivable and prepayments became over 180 days past due and less other receivables became over one year past due during the three months ended December 31, 2017, as compared to the same period in 2016, and we have correspondingly adjusted our allowance for doubtful accounts in accordance with our allowance policy.

At the end of each quarter, we conduct an aging analysis of each customer’s arrears to determine whether the allowance for doubtful accounts is adequate. In establishing the allowance for doubtful accounts, we consider historical experience, the economic environment, trends in the construction industry, expected collectability of amounts receivable that are past due, and the expected collectability of overdue receivables. An estimate of doubtful accounts is recorded when collection of the full amount is no longer probable. Known bad debts are written off against the allowance for doubtful accounts when identified. After reviewing individual balances, we provide a provision of 15% for accounts receivable past due more than 180 days but less than one year, 40% for accounts receivable past due from one to two years, 75% for accounts receivable past due beyond two years, 100% for accounts receivable past due beyond three years, plus additional amounts as necessary.

As of December 31, 2017, our accounts and notes receivable aging are as follows:

Selling, General and Administrative Expenses . Selling, general and administrative expenses consist of sales commissions, advertising and marketing costs, office rent and expenses, costs associated with staff and support personnel who manage our business activities, and professional fees paid. We incurred selling, general and administrative expenses of approximately $1.4 million for the three months ended December 31, 2017, as compared to approximately $1.2 million for the three months ended December 31, 2016, an increase of approximately $0.2 million. The increase was primarily due to a $0.1 million increase in consulting expense and $0.2 million increase in salaries, repairs, rent and other various G&A expenses, which was partially offset by a $0.1 million decrease in office, utilities and meals and entertainment expenses as compared to the three months ended December 31, 2016.

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Research and Development (“R&D”) Expenses . Research and development expenses were approximately $0.7 million for the three months ended December 31, 2017, as compared to $0.6 million for the same period in 2016.

Income (Loss) from Operations. We had income from operations of approximately $0.7 million and incurred loss of approximately $5.0 million for the three months ended December 31, 2017 and 2016, respectively. This change of approximately $5.7 million from loss to income was primarily due to a $2.8 million increase in gross profit, a $3.1 million decrease in provision for doubtful accounts expenses, and was offset by a $0.2 million increase in selling, general and administrative expenses and research and development expenses.

Other Expense, Net . Our other expense consists of interest income (expense), finance expense and other non-operating income (expense). We had other expense of approximately $0.2 million and $0.1 million during the three months ended December 31, 2017 and 2016, respectively. We earned interest income of approximately $2,000 and $3,500 for the three months ended December 31, 2017 and 2016, respectively. We incurred interest expense of approximately $0.2 million for each of the three months ended December 31, 2017 and 2016. We incurred finance expense of approximately $600 and $97,000 for the three months ended December 31, 2017 and 2016, respectively.

Provision for Income Taxes. We did not incur provision for income taxes for the three months ended December 31, 2017, because we had net operating losses on deferred tax assets for which we previously provided 100% allowance to be utilized during the period. We did not incur provision for income for the three months ended December 31, 2016 as we did not generate any income for tax provision and provided 100% allowance from net operating losses on deferred tax assets.

On December 22, 2017, the “Tax Cuts and Jobs Act” (“The Act”) was enacted. Under the provisions of the Act, the U.S. corporate tax rate decreased from 35% to 21%. As we have a June 30 fiscal year-end, the lower corporate income tax rate will be phased in, resulting in a U.S. statutory federal rate of approximately 28% for our fiscal year ending June 30, 2018, and 21% for subsequent fiscal years. Accordingly, we have remeasure our deferred tax assets on net operating loss carryforward in the U.S at the lower enacted cooperated tax rate of 21%. However, this remeasurment has no effect on our income tax expenses as we have provided a 100% valuation allowance on our deferred tax assets previously.

Additionally, the Tax Act imposes a one-time transition tax on deemed repatriation of historical earnings of foreign subsidiaries, and future foreign earnings are subject to U.S. taxation. The change in rate has caused us to remeasure all U.S. deferred income tax assets and liabilities for temporary differences and NOL carryforwards and recorded one time income tax payable to be paid in 8 years. However, this one-time transition tax has no effect on our income tax expenses as we have no undistributed foreign earnings prior to December 31, 2017 which we have cumulative foreign losses as of December 31, 2017.

Net Income (Loss). We had net profit of approximately $0.5 million for the three months ended December 31, 2017, as compared to a net loss of approximately $5.1 million for the three months ended December 31, 2016, a positive change in the amount of approximately $5.6 million. Such change was the result of the combination of the changes as discussed above.

Comparison of the six months ended December 31, 2017 and 2016

The following table sets forth key components of our results of operations for the six months ended December 31, 2017 and 2016, in US dollars:

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Revenue . Our revenue is primarily generated from sales of our advanced ready-mix concrete products. For the six months ended December 31, 2017, we generated revenue of approximately $24.0 million, as compared to approximately $22.2 million during the six months ended December 31, 2016, an increase of approximately $1.8 million, or 8%. The increase in revenue was principally due to increased selling unit price by 27.7% resulting from the turnaround of the concrete industry. In late 2017, the local government has shut down a number of small and non-qualified concrete manufactures, which led to less competition in the industry and drove up the selling price of the concrete as the supply of concrete was reduced. The increase in revenue was offset by 16.6% decrease of sales volume due to our customers’ suspension or production limitation policy enforced by certain districts of the local government on November 15, 2017, which prohibits construction jobsites from producing industrial wastes or dusts to aggravate winter haze weather during the winter time. We expect to increase our productions back to normal level on March 15, 2018 after the suspension and production limitation is uplifted from our customers.

Cost of Revenue . Cost of revenue, which consists of direct labor, rentals, depreciation, other overhead and raw materials, including inbound freight charges, was approximately $20.7 million for the six months ended December 31, 2017, as compared to approximately $24.1 million for the six months ended December 31, 2016, an decrease of approximately $3.4 million, or 14%. The decrease in cost of revenue was primarily associated with the decrease in our sales volume and offset by the slight increase of unit production costs of 1.3% for the six months ended December 31, 2017, as compared to the same period in 2016.

Gross Profit (Loss) . Gross profit was approximately $3.3 million for the six months ended December 31, 2017, as compared to approximately $1.9 million of gross loss for the six months ended December 31, 2016, a positive change of approximately $5.2 million, which was primarily due to the increase of our selling price of concrete at a higher rate than the slight increase of unit production cost during the six months ended December 31, 2017 as compared to the same period in 2016 as the reasons as discussed above.

Recovery of (provision for) Doubtful Accounts . We recovered doubtful accounts charge of approximately $0.7 million for the six months ended December 31, 2017 as compared to provision of doubtful accounts charge of approximately $4.4 million during the six months ended December 31, 2016, a change of approximately $5.1 million, or 116%. The change was attributable to the fact that less accounts receivable have become over 720 days past due during the six months ended December 31, 2017 as compared to the same period in 2016 and we have correspondingly decreased our provision for doubtful accounts in accordance with our allowance policy. At the end of each quarter, we conduct an aging analysis of each customer’s arrears to determine whether the allowance for doubtful accounts is adequate. In establishing the allowance for doubtful accounts, we consider the historical experience, the economy, trends in the construction industry, expected collectability of amounts receivable that are past due and the expected collectability of overdue receivables. An estimate of doubtful accounts is recorded when collection of the full amount is no longer probable. Known bad debts are written off against allowance for doubtful accounts when identified. After reviewing individual balances, we provide a provision of 15% for accounts receivable past due more than 180 days but less than one year, 40% for accounts receivable past due from one to two years, 75% for accounts receivable past due beyond two years, 100% for accounts receivable past due beyond three years, plus additional amounts as necessary.

Selling, General and Administrative Expenses . Selling, general and administrative expenses consist of sales commissions, advertising and marketing costs, office rent and expenses, costs associated with staff and support personnel who manage our business activities, and professional fees paid to third parties. We incurred selling, general and administrative expenses of approximately $2.8 million for the six months ended December 31, 2017 as compared to approximately $3.1 million for the six months ended December 31, 2016, a decrease of approximately $0.3 million. The decrease was primarily due to a $0.3 million decrease in stock compensation expense, $0.1 million decrease in meals and entertainment expense, $0.3 million decrease in other various G&A expenses, and was offset by a $0.1 million increase in consulting expense and a $0.3 million increase in salaries, repairs and rent as compared to the six months ended December 31, 2016.

Research and Development Expenses . Research and development expenses were approximately $0.8 million for the six months ended December 31, 2017 as compared to $0.7 million for the same period in 2016. We increased its research and development expenditures during this period as we determined to improve its competitive advantage with respect to its products.

Loss from Operations. We incurred a loss from operations of approximately $79,000 and $10.5 million for the six months ended December 31, 2017 and 2016, respectively. Such decrease of approximately $10.4 million in loss from operations was primarily due to a $5.2 million increase in gross profit and a $0.1 million increase in research and development expenses, and was offset by a $5.1 million decrease in provision of doubtful accounts and a $0.3 million decrease in selling, general and administration expenses.

Other Income (Expense), Net . Our other income (expense) consists of interest income (expense), finance expense and other non-operating income (expense). We had other expense of approximately $0.6 million and $0.5 million during the six months ended December 31, 2017 and 2016, respectively. We earned interest income of approximately $4,000 and $12,000 for the six months ended December 31, 2017 and 2016, respectively. Approximately $0.6 million and $0.4 million of interest expense was recorded for the six months ended December 31, 2017 and 2016, and approximately $2,000 and $0.3 million of finance expense was recorded for the six months ended December 31, 2017 and 2016.

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Provision for Income Taxes. We did not incur provision for income for the six months ended December 31, 2017 and 2016 as we did not generate any income for tax provision and provided 100% allowance from net operating losses on deferred tax assets.

On December 22, 2017, the “Tax Cuts and Jobs Act” (“The Act”) was enacted. Under the provisions of the Act, the U.S. corporate tax rate decreased from 35% to 21%. As we have a June 30 fiscal year-end, the lower corporate income tax rate will be phased in, resulting in a U.S. statutory federal rate of approximately 28% for our fiscal year ending June 30, 2018, and 21% for subsequent fiscal years. Accordingly, we have remeasure our deferred tax assets on net operating loss carryforward in the U.S at the lower enacted cooperated tax rate of 21%. However, this remeasurment has no effect on our income tax expenses as we have provided a 100% valuation allowance on our deferred tax assets previously.

Additionally, the Tax Act imposes a one-time transition tax on deemed repatriation of historical earnings of foreign subsidiaries, and future foreign earnings are subject to U.S. taxation. The change in rate has caused us to remeasure all U.S. deferred income tax assets and liabilities for temporary differences and NOL carryforwards and recorded one time income tax payable to be paid in 8 years. However, this one-time transition tax has no effect on our income tax expenses as we have no undistributed foreign earnings prior to December 31, 2017 which we have cumulative foreign losses as of December 31, 2017.

Net Loss. We incurred net loss of approximately $79,000 for the six months ended December 31, 2017, as compared to a net loss of approximately $10.5 million for the six months ended December 31, 2016, a positive change in the amount of $10.4 million. Such change was the result of the combination of the changes as discussed above.

Liquidity and Capital Resources

As of December 31, 2017, we had cash and cash equivalents of approximately $1.1 million, which was held by subsidiaries located outside the U.S. We would be required to accrue and pay U.S. taxes if we were to repatriate these funds. Any company which is registered in mainland PRC must apply to the State Foreign Exchange Administration for approval in order to remit foreign currency to any foreign country. We currently do not intend to repatriate to the U.S. the cash and short-term investments held by our foreign subsidiaries. However, if we were to repatriate funds to the U.S., we would assess the feasibility and plan any transfer in accordance with foreign exchange regulations, taking into account tax consequences. As we conduct all of our operations in the PRC, the restriction on the conversion of cash and short-term investments held in RMB to other currencies should not affect our liquidity.

In assessing our liquidity, we monitor and analyze our cash on-hand and our operating and capital expenditure commitments. Our liquidity needs are to meet our working capital requirements, operating expenses and capital expenditure obligations.

We engage in the production of advanced construction materials for large-scale infrastructure, commercial and residential developments. Our business is capital intensive and we are highly leveraged. Debt financing in the form of short-term bank loans, loans from related parties and bank acceptance notes, have been utilized to finance our working capital requirements and capital expenditures. Working capital was approximately $8.6 million as of December 31, 2017, as compared to $7.5 million as of June 30, 2017. As of December 31, 2017, in addition to cash on-hand, we also have other current assets mainly composed of accounts receivable and prepayments.

Although we believe that we can realize our current assets, our ability to repay our current obligations will depend on the future realization of our current assets. Management has considered historical experience, the economic environment, trends in the construction industry, the expected collectability of accounts receivable and the realization of the prepayments on inventory, and provided for an allowance for doubtful accounts as of December 31, 2017. We expect to realize balances net of allowance within the normal operating cycle of a twelve-month period. If we are unable to realize our current assets within the normal twelve-month operating cycle, we may have to consider supplementing our available sources of funds through the following:

Based on the above considerations, management is of the opinion that we have sufficient funds to meet our working capital requirements and debt obligations as they become due. However, there is no assurance that management will be successful in their plans. There are a number of factors that could potentially arise that could undermine the Company’s plans, such as changes in the demand for our products, economic conditions, competitive pricing in the concrete-mix industry, our operating results not continuing to deteriorate and our bank and shareholders being able to provide continued financial support.

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The following table provides summary information about our net cash flow for financial statement periods presented in this report:

Principal demands for liquidity are for working capital and general corporate purposes.

Operating Activities. Net cash provided by operating activities totaled approximately $2.3 million for the six months ended December 31, 2017, which was attributable to a net loss of $79,000 and net cash provided by operating activities of $2.4 million, including adjustments for $0.6 million of depreciation and $0.7 million of recovery of doubtful accounts. Net cash from changes in operating assets and liabilities resulted in a net cash inflow, which mainly included cash inflow for reduction of accounts receivable of $0.6 million, excluding non-cash offset of $2.0 million, increase of other receivables of $0.3 million, reduction of prepayments and advances of $8.8 million as we have already secured enough materials for production, reduction of prepayments – related party of $1.8 million, addition of $0.5 million in customer deposits, addition of $0.1 million in accrued liabilities and taxes payable, and addition of $0.4 million other payables-shareholders, and was primarily offset by purchase of inventories of $0.1 million, payments of accounts payable $6.1 million, excluding a non-cash offset of $2.0 million, and payments of other payables of $3.8 million.

Investing Activities . Net cash used in investing activities was approximately $45,000 for the six months ended December 31, 2017, which was primarily attributable to the purchase of equipment.

Financing Activities . Net cash used in financing activities totaled approximately $1.5 million for the six months ended December 31, 2017, which was primarily attributable to $16.1 million for the repayments of bank loans and bank guarantees, $14.3 million for the repayments of notes payable, and was offset by $24.6 million new bank loans and bank guarantees, and releases of $4.3 million of restricted cash.

Cash and cash equivalents . As of December 31, 2017, we had cash and cash equivalents of approximately $1.1 million as compared to approximately $0.2 million as of June 30, 2017. We believe that our cash and revenues from ongoing operations, in addition to the close management of our accounts payable and accounts receivable and our ability to obtain loan financing, will be sufficient to meet our liquidity and capital requirements for all of our ongoing operations. However, we may need to raise additional capital if we undertake any plans for expansion.

Loan Facilities . We had a total of approximately $27.1 million and $31.7 million outstanding on loans and credit facilities as of December 31 and June 30, 2017, respectively. See Note 6 to our unaudited condensed consolidated financial statements included elsewhere in this report.

Critical Accounting Policies and Estimates

While our significant accounting policies are more fully described in Note 2 to our unaudited condensed consolidated financial statements included elsewhere in this report, we believe that the following accounting policies are the most critical to aid you in fully understanding and evaluating this management discussion and analysis:

Principles of consolidation

The accompanying unaudited condensed consolidated financial statements include the financial statements of China ACM and its wholly owned subsidiaries, BVI-ACM, China-ACMH, and its variable interest entity Xin Ao (collectively, the “Company”). All significant inter-company transactions and balances have been eliminated in consolidation. In accordance with FASB ASC 810, Consolidation of Variable Interest Entities, variable interest entities, or VIEs, are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability. All VIEs with which the Company is involved must be evaluated to determine the primary beneficiary of the risks and rewards of the VIE. The primary beneficiary is required to consolidate the VIE for financial reporting purposes. In connection with the adoption of this ASC810, the Company concludes that Xin Ao is a VIE and China ACM is the primary beneficiary. The financial statements of Xin Ao is consolidated with China ACM’s financial statements.

Use of estimates and assumptions

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. The significant estimates and assumptions made in the preparation of the Company’s unaudited condensed consolidated financial statements include allowance for doubtful accounts, deferred taxes, and prepayments and advances, stock-based compensation, and fair value and useful lives of property, plant and equipment. Actual results could be materially different from those estimates.

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Revenue recognition

Revenue is realized or realizable and earned when four criteria are met:

The Company sells its concrete products primarily to major local construction companies. Sales agreements are signed with each customer. The agreements list all terms and conditions with the exception of delivery date and quantity, which are evidenced separately in purchase orders. The purchase price of products is fixed in the agreement and customers are not permitted to renegotiate after the contracts have been signed. Each agreement includes a cancellation clause if the Company or the customers breach the contract terms specified in the agreement.

The Company recognizes revenue when title and ownership of the goods are transferred upon shipment to the customer by the Company and collectability of payment is reasonably assured.

The Company includes the shipping and handling fee in both revenue and cost of revenue.

Financial instruments

US GAAP regarding fair value of financial instruments and related fair value measurements define fair value, establish a three-level valuation hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The three levels of inputs are defined as follows:

Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets;

Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument;

Level 3 inputs to the valuation methodology are unobservable.

Financial instruments included in current assets and current liabilities are reported in the unaudited condensed consolidated balance sheets at face value or cost, which approximate fair value because of the short period of time between the origination of such instruments and their expected realization and their current market rates of interest.

Accounts receivable

We extend unsecured credit to our customers in the normal course of business, Accounts are considered past due after 30 days. In establishing the required allowance for doubtful accounts, management considers historical experience, the economic environment, trends in the construction industry, and the expected collectability of the overdue receivable. Management reviews its accounts receivable each reporting period to determine if the allowance for doubtful accounts is adequate. An estimate for doubtful accounts is recorded when collection of the full amount is no longer probable. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovering is considered remote. We provide a provision of 15% of the allowance for doubtful accounts for accounts receivable balance that are past due more than 180 days but less than one year, 40% of the allowance for doubtful accounts for accounts receivable past due from one to two years, 75% of the allowance for doubtful accounts for accounts receivable past due beyond two years, 100% of the allowance for doubtful accounts for accounts receivable past due beyond three years, plus additional amount as necessary, which our collection department had determined the collection of the full amount is remote with the approval from our management to provide a 100% provision allowance for doubtful accounts. Our management have continued to evaluate the reasonableness of the valuation allowance policy and update it if necessary.

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Accounting for long-lived assets

We classify our long-lived assets into: (i) machinery and equipment; (ii) transportation equipment; (iii) office and equipment; and (iv) buildings and improvements.

Long-lived assets held and used by us are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be fully recoverable. It is possible that these assets could become impaired as a result of technological or other industry changes. If circumstances require a long-lived asset or asset group to be tested for possible impairment, we first compare undiscounted cash flows expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques, including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.

If the value of an asset is determined to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are reported at the lower of the carrying amount or the fair value, less disposition costs.

There was no impairment charge for the six months ended December 31, 2017, and 2016.

Competitive pricing pressures and changes in interest rates could materially and adversely affect the Company’s estimates of future net cash flows to be generated by long-lived assets, and thus could result in future impairment losses

Income taxes

We account for income taxes in accordance with ASC 740, Income Taxes, which requires us to use the assets and liability method of accounting for income taxes. Under the assets and liability method, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between financial statement carrying amounts and the tax bases of existing assets and liabilities and operating loss and tax credit carry forward. Under this accounting standard, the effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if it is more likely than not that some portion, or all of, a deferred tax asset will not be realized.

ASC 740-10, Accounting for Uncertainty in Income Taxes, defines uncertainty in income taxes and the evaluation of a tax position as a two-step process. The first step is to determine whether it is more likely than not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position. The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50 percent likelihood of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met. Penalties and interest incurred related to underpayment of income tax are classified as income tax expense in the period incurred.

United States federal, state and local income tax returns prior to 2015 are not subject to examination by any applicable tax authorities. PRC tax returns filed in 2017 and prior year are subject to examination by any applicable tax authorities.

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, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to our stockholders.

Recently issued accounting pronouncements

Refer to Note 2 of the unaudited condensed consolidated financial statements for a discussion of recent accounting standards and pronouncements.

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Interest Rate Risk

We are exposed to interest rate risk while we have short-term bank loans outstanding. Although interest rates for our short-term loans are typically fixed for the terms of the loans, the terms are typically twelve months and interest rates are subject to change upon renewal. Interest rates are approximately 4.35% or 5.66% for RMB bank loans with a term of twelve months or less.

Credit Risk

The Company is exposed to credit risk from its cash in bank and fixed deposits, and accounts receivable, other receivables and advances on equipment purchases. The credit risk on cash in bank and fixed deposits is limited because the counterparties are recognized financial institutions. However, the Company’s cash in bank deposited in the financial institutions in the PRC is not insured. Accounts receivable, other receivables and advances on inventory purchases are subjected to credit evaluations. An allowance has been made for estimated unrecoverable amounts which have been determined by reference to past default experience and the current economic environment.

Foreign Exchange Risk

The value of the RMB against the U.S. dollar and other currencies is affected by, among other things, changes in the PRC’s political and economic conditions. The RMB does not fluctuate with the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. In August 2016, the PRC’s currency dropped by a cumulative 4.4% against the U.S. dollar on hopes of boosting the domestic economy, making PRC exports cheaper and imports into the PRC more expensive by that amount. The effect on trade can be substantial. The RMB started to appreciate in the year 2017 and the trend of appreciation fluctuated during the six months ended December 31, 2017. Compared with the lowest point from RMB versus U.S. dollars in 2016, the RMB has depreciated by 1.7% compared to the exchange rate as of December 31, 2017. Moreover, it is possible that in the future, PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.

Because substantially all of our earnings and cash assets are denominated in RMB, but our reporting currency is the U.S. dollar, fluctuations in the exchange rate between the U.S. dollar and the RMB will affect our balance sheet and our earnings per share in U.S. dollars. In addition, appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we might issue in the future that will be exchanged into U.S. dollars and earnings from, and the value of, any dollar-denominated investments we make in the future.

Very limited hedging transactions are available in the PRC to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.

Most of the transactions of the Company are settled in RMB and U.S. dollars. In the opinion of the directors, the Company is not exposed to significant foreign currency risk.

Inflation

Inflationary factors, such as increases in the cost of raw materials and overhead costs, could impair our operating results. Inflation has had a material impact on our financial position or results of operations for the six months ended December 31, 2017, a high rate of inflation in the future may have a continued adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of sales revenue if the selling prices of our products do not increase with these increased costs.