ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION The following discussion of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto and in conjunction with the Management's Discussion and Analysis set forth in our Annual Report on Form 10-KSB for the year ended December 31, 2005.
FORWARD-LOOKING STATEMENTS
The following discussion relates to future events and expectations and as such constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The words "believes," "anticipates," "plans," "expects," and similar expressions are intended to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance or achievements of us to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements and to vary significantly from reporting period to reporting period. These forward-looking statements were based on various factors and were derived utilizing numerous important assumptions and other factors that could cause actual results to differ materially from those in the forward-looking statements, including, but not limited to: risks and uncertainties related to the need for additional funds doing business in Asia, political risks in China and the volatility of the price of our common stock. Other factors and assumptions not identified above were also involved in the derivation of these forward-looking statements, and the failure of such other assumptions to be realized, as well as other factors, may also cause actual results to differ materially from those projected. We assume no obligation to update these forward looking statements to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements.
GENERAL
The Company, through Nano Superlattice Technology, Inc. - Taiwan, is in the business of developing and producing nano-scale coating technology to be applied to various mechanical tools and metal surfaces for sales to manufacturers in the computer, mechanical and molding industries. Nanotechnology, or molecular manufacturing, is a technological process designed to allow products to be manufactured lighter, stronger, cheaper, cleaner and more precisely than they would otherwise be.
The Company operates in an industry characterized by rapid technological changes. It will need additional investments and funding in order to complete the development and improvements necessary for the development and production of the nano-scale coating technology.
The Company's business strategy is to increase its market share by first focusing on providing its superlattice nano-coating technology service to manufacturers in domestic markets, expanding into Mainland China markets, and further expanding into international markets. Since nanotechnology has a vast application range, the Company also intends to conduct further research into the many additional uses for nanotechnology with the goal of becoming an internationally recognized nanotechnology design center.
In the future, the Company expects to expand the number and type of industries it is able to service. The Company anticipates working with the developmental needs of Taiwan's semiconductor, precision machinery and telecommunication industries to establish micro-component production, equipment and inspection technology, and micro-system assembly and testing technology. The Company also plans to integrate the design technologies of mechanical, optical, electronic, magnetic, and micro systems to be applied in future products.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
This discussion and analysis of our financial condition and results of operations are based on our financial statements that have been prepared under accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could materially differ from those
estimates. We have disclosed all significant accounting policies in Note B to the consolidated financial statements included in this Form 10-QSB.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Form 10-QSB. The following discussion contains forward-looking statements. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that may cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, those discussed in "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2005, and elsewhere in this Form 10-QSB.
The following table presents the consolidated results of the Company for the three and nine months ended September 30, 2006 and 2005. The discussion following the table compares the results for the three and nine months ended September 30, 2006 with those for the three and nine months ended September 30, 2005.
Three Months Ended, Nine Months Ended, ---------------------------------------- ---------------------------------------- September 30, 2006 September 30, 2005 September 30, 2006 September 30, 2005 ------------------ ------------------ ------------------ ------------------ Sales, net $ 2,154,703 $ 1,752,313 $ 7,117,323 $ 3,683,208
General and administrative expenses 283,132 417,176 1,110,572 1,148,475 ----------- ----------- ----------- -----------
Income (Loss) from operations 298,627 264,124 54,815 (169,158) ----------- ----------- ----------- -----------
Other (Income) expense: Interest income (23,747) (72) (24,327) (727) Collection of bad debts -- 4,651 -- (544,145) Other income (203,865) 435,860 (203,865) 435,860 (Gain) loss of currency exchange (24) (280) (266) (25,290) Interest expense 76,917 29,623 177,970 70,337 Other expenses -- (2,114) -- 81,231 Minority interest 9,070 (3,030) (3,181) (2,716) ----------- ----------- ----------- -----------
Total other (income) expense (141,649) 464,638 (47,307) 14,550 ----------- ----------- ----------- -----------
Income (Loss) before income taxes 440,276 (200,514) 102,122 (183,708)
Provision for income taxes (62) (7,543) 11,258 -- ----------- ----------- ----------- -----------
Net income (loss) $ 440,338 $ (192,971) $ 90,864 $ (183,708) =========== =========== =========== ===========
THREE MONTHS ENDED SEPTEMBER 30, 2006 AND SEPTEMBER 30, 2005
NET SALES. Net sales for the three months ended September 30, 2006 were $2,154,703 compared to $1,752,313 for the three months ended September 30, 2005. The increase in net sales was due to a general increase in business to existing and new customers and the introduction of new nano-coating products during the 2006 period, as compared to sales volume in the 2005 period, which was affected by the Company's shift from sales of relatively original products such as cable wire and computer accessories to research and development of nano-scale coating technology.
COST OF SALES. Cost of sales for the three months ended September 30, 2006 was $1,572,944 or 73.0% of net sales, as compared to $1,071,013 or 61.1% of net sales, for the three months ended September 30, 2005. The increase in cost of sales as compared to net sales was due to the increase in sales and the increase in direct labor and manufacturing expenses of nano-scale coating technology products.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses for the three months ended September 30, 2006 were $283,132 or 13.1% of net sales, as compared to $417,176 or 23.8% of net sales, for the three months ended September 30, 2005. The decrease in general and administrative expenses was due to decrease in depreciation expense. The decrease in general and administrative expenses as compared to net sales was because other fixed overhead, including salaries and rent, constituting a major portion of administrative expenses, remained relatively constant as compared to increase in net sales.
INCOME (LOSS) FROM OPERATIONS. Income (loss) from operations for the three months ended September 30, 2006 was $298,627 as compared to $264,124 for the three months ended September 30, 2005. This change was primarily the result of the reasons described above during the three months ended September 30, 2006.
OTHER (INCOME) EXPENSE. Other (income) expense for the three months ended September 30, 2006 was $(141,649) as compared to $464,638 for the three months ended September 30, 2005. This change is primarily attributable to the gain on the sale of water chiller machinery in the quarter ended September 30, 2005.
NET INCOME (LOSS). Net income (loss) for the three months ended September 30, 2006 was $440,338 as compared to income of $(192,971) for the three months ended September 30, 2005 primarily for the reasons described above.
NINE MONTHS ENDED SEPTEMBER 30, 2006 AND SEPTEMBER 30, 2005
NET SALES. Net sales for the nine months ended September 30, 2006 were $7,117,323 compared to $3,683,208 for the nine months ended September 30, 2005. The increase in net sales was due to a general increase in business to existing and new customers and the introduction of new nano-coating products during the 2006 period, as compared to sales volume in the 2005 period, which was affected by the Company's shift from sales of relatively original products such as cable wire and computer accessories to research and development of nano-scale coating technology.
COST OF SALES. Cost of sales for the nine months ended September 30, 2006 was $5,951,936, or 83.6% of net sales, as compared to $2,703,891 or 73.4% of net sales, for the nine months ended September 30, 2005. The increase in cost of sales as compared to net sales was due to the increase in sales and the increase in direct labor and manufacturing expenses of nano-scale coating technology products.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses for the nine months ended September 30, 2006 were $1,110,572 or 15.6% of net sales, as compared to $1,148,475 or 31.2% of net sales, for the nine months ended September 30, 2005. The decrease in general and administrative expenses as compared to net sales was because other fixed overhead, including salaries and rent, constituting a major portion of administrative expenses, remained relatively constant as compared to increase in net sales.
INCOME (LOSS) FROM OPERATIONS. Income (loss) from operations for the nine months ended September 30, 2006 was $54,815 as compared to $(169,158) for the nine months ended September 30, 2005. This change was primarily the result of the reasons described above during the nine months ended September 30, 2006.
OTHER (INCOME) EXPENSE. Other (income) expense for the nine months ended September 30, 2006 was $(47,307) as compared to $14,550 for the nine months ended September 30, 2005. This change is primarily attributable to the recovery of bad debt and the gain on the sale of water chiller machinery in the quarter ended September 30, 2005.
NET INCOME (LOSS). Net income (loss) for the nine months ended September 30, 2006 was $90,864 as compared to income of $(183,708) for the nine months ended September 30, 2005, primarily for the reasons described above.
The terms of the sale lease-back agreement referenced below required the Company to transfer the piece of equipment to the lessor free of any liens or security interests. Since the equipment sold and leased back had been previously pledged to a Taiwan bank in connection with a line of credit, the Company is in default of the lease-back agreement. If, as a result of the breach of this agreement, the Company lost use of the equipment, such loss could materially affect the Company's financial condition and results of operations in that the Company's business could be disrupted until such time as the Company could replace the equipment or secure other alternatives.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $410,275 at September 30, 2006 and $1,274,842 at December 31, 2005. Our total current assets were $4,680,312 at September 30, 2006 as compared to $4,306,741 at December 31, 2005. Our total current liabilities were $5,513,354 at September 30, 2006 as compared to $4,037,304 at December 31, 2005. On July 29, 2005 we collateralized a line of credit with the Arc Bond Sputtering Machine, which we later sold to a third party, in violation of the credit agreement, and immediately leased back the equipment and assumed an obligation from the lessor in the amount of $1,042,032. As a result of having sold equipment to the lessor subject to a lien, we are currently in default of both the line of credit, for having sold the pledged equipment, and the sale-leaseback agreement. A total amount due under both agreements as a result of the defaults is $1,203,321. Repayment of such amounts could materially affect our liquidity position.
We had working capital at September 30, 2006 of $(833,042) compared with working capital of $269,437 at December 31, 2005. This decrease in working capital was due to an increase in accounts payable and accrued expenses resulting from the introduction of new, higher volume products, partially offset by an increase in accounts and notes receivable. During the nine months ended September 30, 2006, net cash provided by operations was $787,995. Net cash used in investing activities was $1,514,595, for equipment purchases, and net cash used in financing activities was $146,202, which consisted of repayment of loans, partially offset by new borrowings. Net change in cash and cash equivalents was $(864,567) during the nine months ended September 30, 2006.
CAPITAL EXPENDITURES. Total capital expenditures during the nine months ended September 30, 2006 was $1,870,246.
The Company believes that, so long as the amounts due under the credit line and the sale lease back transactions can be deferred, its short-term financial needs will be met by existing working capital for at least the next twelve months, after which time we will need to obtain additional financing. We can make no assurances that we will be able to obtain additional financing, or that if we do obtain such financing, that the terms of such financing will be commercially reasonable. If we obtain additional financing, the terms of such financing may require us to sell our equity securities or enter into convertible debt arrangements. The sale of additional equity or convertible debt could result in additional dilution to our stockholders. The outcome of these uncertainties cannot be assured.
We have suffered recurring losses from operations, cash deficiencies and the inability to meet our maturing obligations without selling operating assets and restructuring debts. These issues may raise substantial concern about our ability to continue as a going concern. We may raise additional funding through borrowings from financial institutions and defer the amounts due under the credit line and sales lease back transaction. Management believes that actions presently being taken to obtain additional funding provide the opportunity for us to continue as a going concern.
CURRENCY EXCHANGE FLUCTUATIONS
As of September 30, 2006, the accounts of Nano Taiwan were maintained, and their financial statements were expressed, in New Taiwan Dollars (NTD). Such financial statements were translated into U.S. Dollars (USD) in accordance with Statement of Financial Accounts Standards ("SFAS") No. 52, "Foreign Currency Translation", with the NTD as the functional currency. According to the Statement, all assets and liabilities were translated at the current exchange rate, stockholder's equity is translated at the historical rates and income statement items are translated at the weighted average exchange rate for the period. The resulting translation adjustments are reported under cumulative foreign-exchange translation adjustment in the stockholders' equity.
As of September 30, 2006 and December 31, 2005, the exchange rates between NTD and the USD was NTD$1 = USD$0.03023 and NTD$1 = USD$0.03044, respectively. The weighted-average rate of exchange between NTD and USD was NTD$1 = USD$0.03086 and NTD$1 = USD$0.03117, respectively. Total translation adjustment recognized as of September 30, 2006 and December 31, 2005 is $138,052 and $177,254, respectively.
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