Form 10-Q for KINGOLD JEWELRY, INC.
12-Aug-2010
Quarterly Report
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion of our financial condition and results of operations should be read together with the financial statements and related notes included in this Report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in those forward-looking statements as a result of certain factors, including, but not limited to, those contained in the discussion on forward-looking statements that follows this section.
Our Business
We are engaged in the production and sales of 24 Karat gold jewelry and ornaments in the PRC under the Kingold brand through a variable interest entity relationship with Wuhan Kingold Jewelry Company Limited, a PRC corporation. All of our sales are made within the central part of the PRC including Hubei, Hunan, Henan, Jiangxi, Anhui and Sichuan Provinces.
We have historically sold our products directly to distributors, retailers and other wholesalers, who then sell our products to consumers through retail counters located in both department stores and other traditional stand-alone jewelry stores. We sell our products to our customers at a price that reflects the market price of the base material (24K gold), plus a mark-up reflecting our design fees and processing fees. Typically this mark-up ranges from 4-6% of the price of the base material.
We aim to become an increasingly important participant in the PRC's gold jewelry design and manufacturing sector. In addition to expanding our design and manufacturing capabilities, our goal is to provide a large variety of gold products in unique styles and superior quality under our nationwide well-known brand, Kingold.
We have been a member of the Shanghai Gold Exchange since 2003. Although the Chinese government eliminated the absolute restriction on trading gold in general, the right to purchase gold directly from the Shanghai Gold Exchange is limited. There were only 162 members of the Shanghai Gold Exchange throughout China in 2008. Non-members who want to purchase gold must deal with members at a higher purchase price compared to that for members.
Results of Operations
The following table sets forth information from our statements of operations (unaudited) for the three months and six months ended June 30, 2010 and 2009 in U.S. dollars:
For the three months ended For the six months ended
June 30, June 30,
2010 2009 2010 2009
NET SALES $ 107,843,982 $ 60,418,354 $ 168,356,310 $ 98,479,024
COST OF SALES
Cost of sales (100,568,471 ) (57,277,251 ) (154,782,581 ) (91,939,064 )
Depreciation (276,269 ) (278,334 ) (555,084 ) (556,603 )
Total cost of sales (100,844,740 ) (57,555,585 ) (155,337,665 ) (92,495,667 )
GROSS PROFIT 6,999,242 2,862,769 13,018,645 5,983,357
OPERATING EXPENSES
Selling, general and administrative
expenses 742,564 440,871 1,125,566 835,938
Depreciation 29,614 29,741 56,277 59,442
Amortization 2,769 2,767 5,538 5,532
Total Operating Expenses 774,947 473,379 1,187,381 900,912
INCOME FROM OPERATIONS 6,224,295 2,389,390 11,831,264 5,082,445
OTHER INCOME (EXPENSES)
Other income 2,294 966 4,052 966
Interest income 1,126 (273 ) 2,307 24
Interest expense (134,568 ) (246,247 ) (269,536 ) (510,504 )
Total Other Expenses, net (131,148 ) (245,554 ) (263,177 ) (509,514 )
INCOME FROM OPERATIONS BEFORE TAXES 6,093,147 2,143,835 11,568,087 4,572,931
PROVISION FOR INCOME TAXES (1,590,197 ) (536,657 ) (2,946,095 ) (1,144,622 )
NET INCOME $ 4,502,950 $ 1,607,179 $ 8,621,992 $ 3,428,309
Less: net income attribute to the
noncontrolling interest (198,934 ) (156,118 ) (369,084 ) (231,460 )
NET INCOME ATTRIBUTABLE TO COMMON
STOCKHOLDERS $ 4,304,016 $ 1,451,061 $ 8,252,908 $ 3,196,849
Three Months and Six Months Ended June 30, 2010 Compared to Three Months and Six Months Ended June 30, 2009
Net Sales
Net sales for the three months ended June 30, 2010 increased to $107.8 million, an increase of $47.4 million, or 78.5%, from net sales of $60.4 million for the three months ended June 30, 2009. The increase in net sales was primarily the result of an increase in our production, continued success in marketing of our products.
Net sales for the six months ended June 30, 2010 increased to $168.4 million, an increase of $69.9 million, or 71%, from net sales of $ 98.5 million for the six months ended June 30, 2009. The increase in net sales was primarily the result of an increase in our production, continued success in marketing of our products.
Cost of sales
Cost of sales for the three months ended June 30, 2010 increased to $100.6 million, an increase of $43.3 million, or 75.6% from $57.3 million for the same period in 2009. The increase was primarily due to the increase in the cost of gold and the increased amount of gold we needed to purchase in order to fulfill our increased sales volume for the three months ended June 30, 2010.
Cost of sales for the six months ended June 30, 2010 increased to $154.8 million, an increase of $62.9 million, or 68.4% from $91.9 million for the same period in 2009. The increase was primarily due to the increase in the cost of gold and the increased amount of gold we needed to purchase to fulfill our increased sales volume for the six months ended June 30, 2010.
Gross profit
Gross profit for the three months ended June 30, 2010 increased to $7 million, an increase of $4.1 million, or 141%, from $2.9 million for the same period in 2009. Accordingly, gross margin for the three months ended June 30, 2010 was 6.49%, compared to 4.8% for the same period in 2009. The increase in our gross profit and the increase in our gross margin were primarily due to the increase in production and sales volume of gold, and processing fees. In addition, since 2009, we have continued to focus on the production of gold jewelry rather than other jewelry products, and to focus on production of our proprietary brands rather than custom production for customers. Our increased gross margin reflects this shift in focus.
Gross profit for the six months ended June 30, 2010 increased to $13 million, an increase of $7 million, or 117%, from $6 million for the same period in 2009.
Accordingly, gross margin for the six months ended June 30, 2010 was 7.72%, compared to 6.09% for the same period in 2009. The increase in our gross profit and the increase in our gross margin were primarily due to the increase in production and sales volume of gold, and processing fees. In addition, since 2009, we have continued to focus on the production of gold jewelry rather than other jewelry products, and to focus on production of our proprietary brands rather than custom production for customers. Our increased gross margin reflects this shift in focus.
Expenses
Total operating expenses for the three months ended June 30, 2010 were $0.77 million, an increase of $0.3 million or 63.8%, from $0.47 million for the same period in 2009. The increase in operating expenses was primarily due to increase administration expenses associated with operating a public company in the United States.
Total operating expenses for the six months ended June 30, 2010 were $1.19 million, an increase of $0.29 million or 32.2%, from $0.9 million for the same period in 2009. The increase in operating expenses was primarily due to increase administration expenses associated with operating a public company in the United States.
Interest expenses were $0.13 million for three months ended June 30, 2010, a decrease of $0.11 million or 45.4%, from $.24 million for same period in 2009. The decrease in interest expense was primarily a result of a decrease of average loan balance for the three months ended June 30, 2010.
Interest expenses were $0.27 million for six months ended June 30, 2010, a decrease of $0.24 million or 47%, from $0.51 million for same period in 2009. The decrease in interest expense was primarily a result of a decrease of average loan balance for the six months ended June 30, 2010.
Provision for income tax expense was approximately $1.6 million for the three months ended June 30, 2010, an increase of $1.1million, or 220%, from approximately $0.5million for the same period in 2009. The increase was primarily due to our increase in gross profit during the first three months of 2010.
Provision for income tax expense was approximately $2.9 million for the six months ended June 30, 2010, an increase of $1.8 million, or 163%, from approximately $1.1 million for the same period in 2009. The increase was primarily due to our increase in gross profit during the first three months of 2010.
Net income attributable to common stockholders increased to $4.3 million for the three months ended June 30, 2010 from $1.5 million for the same period in 2009, an increase of $2.8 million, or 197%.
Net income attributable to common stockholders increased to $8.3 million for the six months ended June 30, 2010 from $3.2 million for the same period in 2009, an increase of $5.1 million, or 159%.
Net cash used in operating activities. Net cash used in operating activities was $2.8 million for the six months ended June 30, 2010, compared to net cash provided by operating activities of $16.6 million for the same period in 2009, primarily because we had purchased a significant amount of gold during the six month period ended June 30, 2010 anticipating a price hike. Compared with our inventory balance as of December 31, 2009, our inventory increase by $12.8 million by the end of June 30, 2010.
Net cash used in investing activities. Net cash used in investing activities amounted to only $16,198 for the six months ended June 30, 2010, compared to net cash used in investing activities of $9,906 for the six months ended June 30, 2009. The slight increase in net cash used in investing activities was as a result of a small increase in the purchase of property and equipment.
Net cash used in financing activities. Net cash provided by financing activities was $1.5 million for the six months ended June 30, 2010, compared to net cash provided by investing activities of $1.7 million for the six months ended June 30, 2009. The small decrease in net cash provided by financing activities was as a result of an increase in our payoff of bank financing.
Off-Balance Sheet Arrangements
We do not have any material off-balance sheet transactions.
At June 30, 2010, we had outstanding bank loans in the amount of $8.8 million. Our loans are secured by real property and/or guaranteed by a non-related third party guarantor who charges us a commission.
Liquidity and Capital Resources
At June 30, 2010, we had $6.6 million in cash and cash equivalents. We have historically financed our operations with cash flows generated from operations, as well as through the borrowing of short-term bank loans and contribution from stockholders and investment from investors.
We believe that our current cash and cash flow from operations will be sufficient to meet our anticipated cash needs, including our cash needs for working capital, for the next 12 months. We may, however, require additional cash resources due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. On December 23, 2009, we received gross proceeds of approximately $5.1 million in a private placement transaction. Pursuant to subscription agreements entered into with the investors, we sold an aggregate of 10,240,966 shares of common stock at a price of $0.498 per share.
We are required to contribute a portion of our employees' total salaries to the Chinese government's social insurance funds, including pension insurance, medical insurance, unemployment insurance, job injuries insurance, and maternity insurance, in accordance with relevant regulations. We expect that the amount of our contribution to the government's social insurance funds will increase in the future as we expand our workforce and operations and commence contributions to an employee housing fund.
The ability of Vogue-Show to pay dividends may be restricted due to the PRC's foreign exchange control policies and our availability of cash. A majority of our revenue being earned and currency received is denominated in RMB. We may be unable to distribute any dividends outside of China due to PRC exchange control regulations that restrict our ability to convert RMB into U.S. Dollars. Accordingly, Vogue-Show's funds may not be readily available to us to satisfy obligations which have been incurred outside the PRC, which could adversely affect our business and prospects or our ability to meet our cash obligations.
Our ability to maintain sufficient liquidity depends partially on our ability to achieve anticipated levels of revenue, while continuing to control costs. If we do not have sufficient available cash, we would have to seek additional debt or equity financing through other external sources, which may not be available on acceptable terms, or at all. Failure to maintain financing arrangements on acceptable terms would have a material adverse effect on our business, results of operations and financial condition.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America and the Company's discussion and analysis of its financial condition and operating results require the Company's management to make judgments, assumptions, and estimates that affect the amounts reported in its condensed consolidated financial statements and accompanying notes. Note 2, "Summary of Significant Accounting Policies" of this Form 10-Q and in the Notes to Consolidated Financial Statements in the Company's 2009 Form 10-K describes the significant accounting policies and methods used in the preparation of the Company's condensed consolidated financial statements. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates and such differences may be material.
Management believes the Company's critical accounting policies and estimates are those related to revenue recognition, allowance for doubtful accounts, inventory valuation and inventory purchase commitments and provision for income taxes. Management considers these policies critical because they are both important to the portrayal of the Company's financial condition and operating results, and they require management to make judgments and estimates about inherently uncertain matters. Actual results could differ from these estimates. Periodically, the Company's senior management will review all significant estimates and assumptions affecting the financial statements and record the effect of any necessary adjustments.
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