10QSB 1 p0572-10qsb.htm FORM 10-QSB FOR QUARTER ENDED MARCH 31, 2005 Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-QSB
(Mark One)
 
x
 
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2005
     
o
 
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the transition period from __________ to __________
 
Commission file number:  0-31047
 
CHINA ENERGY SAVINGS TECHNOLOGY, INC.
(Exact name of small business issuer as specified in its charter)
 
Nevada
 

86-0995730
(State or other jurisdiction of
 
(I.R.S. Employer Identification No.)
incorporation or organization)
 
 
 
Central Plaza, 18 Harbour Road,
Suite 3203A, 32nd Floor
Hong Kong, China
(Address of principal executive offices)
 
(852) 2588-1228
(Issuer’s telephone number)
 
 
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject such filing requirements for the past 90 days. Yes x No o
 
State the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Common Stock Outstanding as of  May 23, 2005:  24,702,502 shares
 
Transitional Small Business Disclosure Format (check one): Yes o No x

TABLE OF CONTENTS
TO QUARTERLY REPORT ON FORM 10-QSB
FOR PERIOD ENDED MARCH 31, 2005
 
   
Page
     
PART I FINANCIAL INFORMATION
 3
     
Item 1. Financial Statements
 3
 
 4
 
 5
 
 6
 
 7
 
 8
Item 2. Management's Discussion and Analysis or Plan of Operation
 23
Item 3. Controls and Procedures
 28
     
PART II OTHER INFORMATION 
 29
     
Item 1. Legal Proceedings
 29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 29
Item 3. Defaults Upon Senior Securities
 29
Item 4. Submission of Matters to a Vote of Security Holders
 29
Item 5. Other Information
 29
Item 6. Exhibits and Reports on Form 8-K
 30
     
Signatures 
 31
     
 

CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2005 AND SEPTEMBER 30, 2004

ASSETS
 
   
March 31
 
September 30
 
   
2005
 
2004
 
   
Unaudited
 
Audited
 
CURRENT ASSETS:
         
Cash
 
$
21,577,653
 
$
18,442,862
 
Accounts receivable, trade, net of allowance for doubtful accounts of $768,151 and $768,151 as of March 31, 2005 and September 30, 2004, respectively
   
15,446,880
   
6,580,525
 
Current maturities of notes receivable, net
   
2,724,372
   
3,727,540
 
Inventories
   
5,286,503
   
4,329,552
 
Prepaid expenses
   
2,962,216
   
1,529,955
 
Due from related parties
   
1,179,376
   
1,257,130
 
Total current assets
   
49,177,000
   
35,867,564
 
               
PLANT AND EQUIPMENT, net
   
498,849
   
528,344
 
               
OTHER ASSETS:
             
Long-term loan receivable
   
1,764,376
   
 
Long-term notes receivable, net
   
6,488,530
   
7,087,692
 
Other receivables
   
460,610
   
778,880
 
Total other assets
   
8,713,516
   
7,866,572
 
               
 Total assets
 
$
58,389,365
 
$
44,262,480
 
               
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
             
Accounts payable and accrued expenses
 
$
1,669,422
 
$
2,719,554
 
Current portion of note payable
   
12,974
   
12,799
 
Other payables
   
394,877
   
551,528
 
Customer deposits
   
3,000,705
   
1,752,216
 
Taxes payable
   
3,195,486
   
1,892,676
 
Total current liabilities
   
8,273,464
   
6,928,773
 
               
LONG-TERM LIABILITIES:
             
Note payable, net
   
4,585
   
7,895
 
Total liabilities
   
8,278,049
   
6,936,668
 
               
MINORITY INTEREST
   
17,538,959
   
18,662,906
 
     
       
SHAREHOLDERS' EQUITY:
   
       
Preferred stock, $0.001 par value, 10,000,000 shares authorized, none issued and outstanding 
   
   
 
Common stock, $0.001 par value, 50,000,000 shares authorized, 24,599,753 and 12,968,401 shares issued and outstanding as of March 31, 2005 and September 30, 2004, respectively
   
24,600
   
12,968
 
Additional paid-in capital
   
20,067,348
   
8,655,339
 
Statutory reserves
   
324,583
   
324,583
 
Deferred compensation
   
(4,234,612
)
 
 
Retained earnings
   
16,387,098
   
9,666,676
 
Accumulated other comprehensive income
   
3,340
   
3,340
 
Total shareholders' equity
   
32,572,357
   
18,662,906
 
Total liabilities and shareholders' equity
 
$
58,389,365
 
$
44,262,480
 
               
The accompanying notes are an integral part of this statement.

CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME (LOSS)
FOR THE THREE AND SIX MONTHS ENDED MARCH 31, 2005 AND 2004

   
Three Months Ended
 
Six Months Ended
 
   
March 31
 
March 31
 
March 31
 
March 31
 
   
2005
 
2004
 
2005
 
2004
 
   
Unaudited
 
Unaudited
 
Unaudited
 
Unaudited
 
                           
REVENUES
 
$
11,175,617
 
$
8,818,742
 
$
22,884,307
 
$
20,320,207
 
                           
COST OF GOOD SOLD
   
4,254,122
   
3,234,882
   
9,145,530
   
10,682,628
 
                           
GROSS PROFIT
   
6,921,495
   
5,583,860
   
13,738,777
   
9,637,579
 
                           
OPERATING EXPENSES
                         
Operating expenses
   
667,515
   
347,596
   
1,280,215
   
1,159,689
 
Selling, general and administrative expenses
   
536,098
   
169,554
   
1,507,937
   
224,408
 
 Total Operating Expenses
   
1,203,613
   
517,150
   
2,788,152
   
1,384,097
 
                           
INCOME FROM OPERATIONS
   
5,717,882
   
5,066,710
   
10,950,625
   
8,253,482
 
                           
OTHER INCOME (EXPENSE)
                         
Interest income
   
392,042
   
   
740,221
   
777,692
 
Interest expense
   
4,277
   
   
3,763
   
(169
)
Other income (expense)
   
(605
)
 
(3,677
)
 
(2,882
)
 
(3,677
)
Other income
   
649
   
   
649
   
5,537
 
 Total Other Income
   
396,363
   
(3,677
)
 
741,751
   
779,383
 
                           
INCOME BEFORE INCOME TAXES AND MINORITY INTEREST
   
6,114,245
   
5,063,033
   
11,692,376
   
9,032,865
 
                           
LESS PROVISION FOR INCOME TAXES
   
   
   
   
(678,971
)
                           
INCOME BEFORE MINORITY INTEREST
   
6,114,245
   
5,063,033
   
11,692,376
   
8,353,894
 
                           
MINORITY INTEREST
   
2,252,101
   
2,531,517
   
4,971,954
   
4,176,947
 
                           
NET INCOME
   
3,862,144
   
2,531,516
   
6,720,422
   
4,176,947
 
                           
OTHER COMPREHENSIVE INCOME (LOSS):
                         
Foreign currency translation adjustment
   
   
12,715
   
   
(500
)
                           
COMPREHENSIVE INCOME
 
$
3,862,144
 
$
2,544,231
 
$
6,720,422
 
$
4,176,447
 
                           
Net income per share - basic and diluted
 
$
0.18
 
$
0.22
 
$
0.37
 
$
0.36
 
                           
Weighted average number of shares outstanding - basic and diluted
   
21,910,462
   
11,598,081
   
18,339,801
   
11,598,081
 
                           
 
The accompanying notes are an integral part of this statement.


CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED MARCH 31, 2005 AND 2004
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
 
 
Additional
 
 
 
 
 
Unappropriated
 
other
 
 
 
 
 
Number
 
Common
 
Paid-in
 
Statutory
 
Deferred
 
Retained
 
comprehensive
 
 
 
 
 
of shares
 
stock
 
capital
 
Reserves
 
Compensation
 
Earnings
 
income (loss)
 
Totals
 
                                                   
BALANCE, September 30, 2003, unaudited 
   
100
 
$
11
 
$
666,666
 
$
329,489
       
$
$3,996,754
 
$
(1,142
)
$
4,991,778
 
Net income 
   
   
   
   
   
   
4,176,947
   
   
4,176,947
 
Foreign currency translation adjustments
   
   
   
   
   
   
   
(500
)
 
(500
)
 Change in statutory reserves
                     
(4,906
) 
                     (4,906
) 
                                                   
BALANCE, March 31, 2004, unaudited
   
100
   
11
   
666,666
   
324,583
   
   
8,173,701
   
(1,642
)
 
9,163,319
 
Net income
   
   
   
   
   
   
1,492,975
         
1,492,975
 
Foreign currency translation adjustments
   
   
   
   
   
   
   
4,982
   
4,982
 
Shares issued in connection with the recapitalization
   
12,338,301
   
12,327
   
(12,327
)
 
   
   
   
   
 
Shares issued for employee compensation
   
630,000
    630    
8,001,000
                           
8,001,630
 
                                                   
BALANCE, September 30, 2004, audited
   
12,968,401
   
12,968
   
8,655,339
   
324,583
   
   
9,666,676
   
3,340
   
18,662,906
 
Net income
   
   
   
   
   
   
6,720,422
   
   
6,720,422
 
Stock issued for the acquisition of additional 15% investment in Starway Management Limited
   
3,346,100
   
3,346
   
6,092,555
   
   
   
   
   
6,095,901
 
Stock issued for the acquisition of the 35% investment in Starway Management Limited
   
7,807,569
   
7,808
   
(7,808
)
 
   
   
   
   
 
Stock issued for services
   
477,683
   
478
   
5,327,262
         
(4,234,612
)
             
1,093,128
 
                                                   
BALANCE, March 31, 2005, unaudited
   
24,599,753
 
$
24,600
 
$
20,067,348
 
$
324,583
 
$
(4,234,612
)
$
16,387,098
 
$
3,340
 
$
32,572,357
 
                                                   
 
The accompanying notes are an integral part of this statement.


CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 2005 AND 2004

   
March 31
 
March 31
 
   
2005
 
2004
 
   
Unaudited
 
Unaudited
 
CASH FLOWS FROM OPERATING ACTIVITIES:
         
Net income
 
$
6,720,422
 
$
4,176,947
 
Adjustments to reconcile net income to cash provided by (used in) operating activities:
             
Minority interest income
   
4,971,954
   
4,172,043
 
Depreciation and amortization
   
33,252
   
40,906
 
Decrease in statutory reserve
   
   
(4,910
)
Stock issued for services
   
1,093,128
   
 
Change in operating assets and liabilities:
             
(Increase) decrease in assets:
             
Accounts receivable
   
(8,866,355
)
 
(337,715
)
Long-term notes receivable
   
1,602,330
   
(2,329,972
)
Amount due from related parties
   
77,755
   
(46,102
)
Inventories
   
(956,951
)
 
(323,355
)
Prepaid expenses
   
(1,432,261
)
 
(596,870
)
Other receivables
   
318,270
   
(82,555
)
Other assets
   
   
64,617
 
Increase (decrease) in liabilities:
             
Accounts payable and accrued expenses
   
(1,050,132
)
 
(305,008
)
Other payable
   
(156,651
)
 
 
Customer deposits
   
1,248,489
   
233,314
 
Tax payable
   
1,302,810
   
1,690,964
 
 Net cash provided by (used in) operating activities
   
4,906,060
   
6,352,304
 
               
CASH FLOWS FROM INVESTING ACTIVITIES:
             
Purchase of equipment
   
(3,758
)
 
 
 Net cash used in investing activities
   
(3,758
)
 
 
               
CASH FLOWS FROM FINANCING ACTIVITIES:
             
Long-term loan receivable
   
(1,764,376
)
 
 
Proceeds (payments) on loans payable - related parties
   
   
(237,821
)
Proceeds from notes payable
   
175
   
12,638
 
Payments on notes payable
   
(3,310
)
 
(12,877
)
 Net cash (used in) provided by financing activities
   
(1,767,511
)
 
(238,060
)
               
EFFECT OF EXCHANGE RATE ON CASH
   
   
(500
)
               
INCREASE (DECREASE) IN CASH
   
3,134,791
   
6,113,744
 
               
CASH, beginning of period
   
18,442,862
   
181,283
 
               
CASH, end of period
 
$
21,577,653
 
$
6,295,027
 
               
 
The accompanying notes are an integral part of this statement.
 
6

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 2005 AND 2004
(Continued)
 
   
March 31
 
March 31
 
   
2005
 
2004
 
   
Unaudited
 
Unaudited
 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest expense
 
$
$
855
 
               
NON-CASH TRANSACTIONS:
             
Stock issued to acquire additional interest in Starway Management Limited
 
$
6,095,901
 
$
 
               
Stock issued for services
 
$
5,327,740
 
$
 
               
 
The accompanying notes are an integral part of this statement.
 
AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 

Note 1 - Organization
 
Organization

On August 23, 2004, China Energy Savings Technology, Inc. (the “Company”) formally changed its name from Rim Holdings Inc. to China Energy Savings Technology, Inc.

On June 30, 2004 (the “Closing Date”) Rim Holdings Inc., a Nevada corporation (“Rim”) and Eurofaith Holdings, Inc., a British Virgin Islands corporation (“Eurofaith”), entered a Stock Purchase Agreement (the “Eurofaith Stock Purchase Agreement”). Pursuant to the Eurofaith Stock Purchase Agreement, Rim acquired 50% of the outstanding shares of Starway Management Ltd., a British Virgin Islands company (“Starway”) from Eurofaith (the “Acquisition”). The purchase price for such stock was $120,000,000 payable by Rim’s issuance of a convertible promissory note on the Closing Date. The note may be convertible into 223,073,380 shares of the Rim’s common stock upon maturity at the discretion of Rim. Eurofaith may also convert at any time prior to the maturity. On June 30, 2004, the fair value of the convertible note payable was discounted to the fair value of the equity interest acquired of $6,633,440. On August 26, 2004 this note was converted into 6,900,000 shares.

Immediately after the closing of this transaction, Rim redeemed 1,000,000 shares of its common stock from Christina M. Strauch in exchange for all of the shares of Rimmer Computer, Inc., an Arizona corporation (“Rimmer”).

Prior to the transaction, Rim was a holding company holding all of the shares of Rimmer. Rimmer is an approved technical service provider for computer hardware and software system manufacturers. All of Rimmer’s customers are currently located in the Phoenix, Arizona area. Since the closing, Rim’s primary operations consist of the operations of Starway.

As a result, the transaction was treated for accounting purposes as a recapitalization by the accounting acquirer Starway Management Limited. This stock issuance represents 50% of the issued and outstanding stock of Starway Management Limited at the time of issuance. The acquisition of Starway Management Limited by the Company was accounted for as a recapitalization of Starway Management Limited, pursuant to which the accounting basis of Starway Management Limited continued unchanged subsequent to the transaction date. Starway Management Limited will be the historical financial statements of the Company and its subsidiaries Shenzhen Dicken Industrial Development Limited and Shenzhen Dicken Technology Development Limited. The financial statements have been restated to reflect the recapitalization as if the transaction happened as of January 1, 2002.

On November 17, 2004, the Company acquired an additional 15% of Starway Management Limited to bring its stock ownership to 65% as of December 31, 2004, as further described in note 16. On February 1, 2005, the Company acquired the remaining 35% of Starway Management Limited, as described in note 17, and Starway Management Limited became a wholly owned subsidiary of the Company at that time.
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 

Note 1 - Organization, (continued)

Starway was incorporated in the British Virgin Islands on September 15, 1998. Starway owns all of the equity interests in Shenzhen Dicken Industrial Development Limited, a company incorporated in the People’s Republic of China on November 20, 1996 (SDID) which in turn owns all of the equity interest in Shenzhen Dicken Technology Development Limited, a company incorporated in the People’s Republic of China on November 9, 1999 (SDTD). In 2003, Eurofaith, the shareholder of SDID exchanged 100% of the common shares of SDID for 100 shares of Starway.

Activities

Starway through its two subsidiaries SDTD and SDID is a People’s Republic of China based marketer, distributor and manufacturer of energy saving products for use in commercial and industrial settings. SDID is a foreign-owned enterprise and responsible for the operation and sales of its products. SDTD is a wholly-owned subsidiary of SDID and is a limited liability company incorporated in the PRC and is responsible for the development of energy saving projects of Shenzhen Dicken Group. The Company through its subsidiaries mainly sells their products within the People’s Republic of China.

Note 2 - Summary of significant accounting policies

Basis of Presentation

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The accompany consolidated financial statements include the accounts of Starway Management Limited, Shenzhen Dicken Technology Development Limited and Shenzhen Dicken Industrial Development Limited, (collectively the “Company”). All material intercompany transactions and balances have been eliminated in the consolidation.

Use of Estimates

In preparing financial statements in conformity with generally accepted accounting principles, management is required 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 revenues and expenses during the reported period. Actual results could differ from those estimates.

Cash and Cash Equivalents

For purposes of the cash flow statements, the Company considers all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents.
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 

Note 2 - Summary of significant accounting policies, (continued)

Notes Receivable

The Company carries its notes receivable at the net present value of the notes, net of allowance for doubtful accounts.

Inventory

Inventory is stated at the lower of cost or market value, cost being determined on a first-in, first-out (FIFO) method.

Plant and Equipment

The Company’s plant and equipment are stated at cost. Depreciation is provided over the estimated useful lives of the respective assets on a straight-line basis from five to fifteen years.

Intangibles

Under the Statement of Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, all goodwill and certain intangible assets determined to have indefinite lives will not be amortized but will be tested for impairment at least annually. Intangible assets other than goodwill will be amortized over their useful lives of 10 years and reviewed for impairment in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets”.

Impairment of Long-Lived Assets

Per SFAS No. 144, long-lived assets will be analyzed annually for indications of impairment. Impairment of long-lived assets is assessed by the Company whenever there is an indication that the carrying amount of the asset may not be recovered. Recoverability if these assets are determined by comparing the forecasted undiscounted cash flows generated by those assets to the assets’ net carrying value. The amount of impairment loss, if any, is measured as the difference between the net book value of the assets and the estimated fair value of the related assets.

The Company evaluates the recoverability of long-lived assets by measuring the carrying amount of the assets against the estimated undiscounted future cash flows associated with them. At the time such flows of certain long-lived assets are not sufficient to recover the carrying value of such assets, the assets are adjusted to their fair values.

Revenue and Deferred Revenue Recognition

The Company recognizes product sales under the following two types of contracts:

1.
Equipment sale contract - Under the Equipment sale contract, the Company recognizes revenue when persuasive evidence of an arrangement exists, the sales price to the buyer is fixed or determinable, collectability is reasonably assured, delivery has occurred and accepted by the buyers.
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
Note 2 - Summary of significant accounting policies, (continued)

Revenue and Deferred Revenue Recognition (continued)

2.
Energy savings sharing contract - Under this contract, the Company grants customers extended payment terms under contracts of sale. These contracts are generally for a period of one to five years at prevailing interest rates and are collateralized by the related equipment, which if repossessed, may be less than the receivable balance outstanding. The Company recognizes revenue under profit sharing agreements when the amounts are fixed and determinable and collectability is reasonably assured. Amounts received by the Company in excess of the original estimated cost savings on the contract is recorded as interest income.

Product Development Costs

Product development costs incurred in the process of developing product improvements and enhancements or new products are charged to expense as incurred. Statement of Financial Accounting Standards ("SFAS") No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed, requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on the Company's product development process, technological feasibility is established upon the completion of a working model. Costs incurred by the Company between the completion of the working model and the point at which the product is ready for general release have been insignificant.

Foreign Currency Translation

The functional currency of the Company is the Chinese Renminbi. The financial statements of the Company are translated to United States dollars using year-end exchange rates as to assets and liabilities and average exchange rates as to revenues and expenses. Capital accounts are translated at their historical exchange rates when the capital transaction occurred. Net gains and losses resulting from foreign exchange translations are included in the statements of operations and stockholders’ equity as other comprehensive income.

Comprehensive Income (Loss)

The foreign currency translation gain or loss resulting from the translation of the financial statements expressed in Chinese Renminbi to United States dollars is reported as other comprehensive income (loss) in the statement of income and stockholders’ equity.

Income Taxes

The Company accounts for income taxes under the Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“Statement 109”).
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 

Note 2 - Summary of significant accounting policies, (continued)

Income Taxes (continued)

Under Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company is organized in the British Virgin Islands and the People’s Republic of China and no tax benefit is expected from the tax credits in the future. The Company located its factories in a special economic region in China. This economic region allows foreign enterprises a two-year income tax exemption and a 50% income tax reduction for the following three years. The Company was approved as a wholly owned foreign enterprise in 2004. The Company has income tax exemption for 2004 and 2005 and 50% income tax reduction for 2006, 2007 and 2008.

Fair Value of Financial Instruments

The carrying amounts of the Company’s financial instruments including accounts receivable, stockholder loans and notes payable approximate fair value due to the relatively short period to maturity of these instruments.

The fair value of short-term and long-term notes receivable was determined using a discounted cash flow analysis based on the Company’s borrowing rate. At December 31, 2004 and September 30, 2004, the carrying value of these notes approximated their fair value.

Earnings Per Share

The Company reports earnings per share in accordance with the provisions of SFAS No. 128, "Earnings Per Share." SFAS No. 128 requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. There are no differences between Basic and Diluted EPS for the periods ended March 31, 2005 and 2004.

On February 1, 2005, The Company acquired the remaining 35% interest (the"Acquisition") in Starway Management Limited ("Starway) from Sky Beyond Investments Limited ("Sky Beyond") by issuing a total of 7,807,569 shares of common stock of the Company. However management of the Company has learned that the stock sale between Sky Beyond and Golden Resorts Group Limited was subject to approval by the shareholders of Golden Resorts. As of May 18, 2005, the shareholder meeting to approve the sale has not been held. The Company and Sky Beyond believe that the Company’s acquisition of the 35% in Starway has been legally completed. However the Company is in the process of investigating this matter and is taking a conservative approach in reflecting this acquisition in the financial statements of the Company.
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
Note 2 - Summary of significant accounting policies, (continued)

Earnings Per Share (continued)

As of March 31, 2005, the Company has decided not to reflect the additional earnings and additional paid in capital of the acquisition of the remaining 35% interest in Starway. However since the 7,807,569 shares have been issued in this transaction the par value of the stock has been reflected in the shareholders’ equity statement and the shares has been reflected in the earnings per share calculation as issued. If 100% of the income was to be reflected in the income statement at the date of acquisition, the Company’s earnings per share for the periods would have been adjusted to the amounts indicated below:

   
Three months ended
March 31, 2005
 
Three months ended
March 31, 2004
 
Six months ended
March 31, 2005
 
Six months ended
March 31, 2004
 
                           
Net Income
                         
Net income as reported
 
$
3,862,144
 
$
2,531,516
 
$
6,720,422
 
$
4,176,947
 
Add income attributed to minority interest
   
1,534,770
   
   
1,534,770
   
 
Adjusted net income after recognizing 100% subsidiary income
 
$
5,396,914
 
$
2,531,516
 
$
8,255,192
 
$
4,176,947
 
                           
Basic and Diluted EPS
                         
Net income per share - as reported
 
$
0.18
 
$
0.22
 
$
0.37
 
$
0.36
 
Add earnings per share attributed to minority interest
   
0.07
   
   
0.08
   
 
Adjusted earnings per share
 
$
0.25
 
$
0.22
 
$
0.45
 
$
0.36
 
                           

Concentrations and credit risks

For the period ended March 31, 2005 and 2004, 100% of the Company’s sales were to companies located in the PRC. At March 31, 2005 and September 30, 2004 all the Company’s assets were located in the PRC.

The Company’s operations may be adversely affected by significant political, economic and social uncertainties in China. Although the Chinese government has pursued economic reform policies in the past, there is no assurance that the Chinese government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affect China’s political, economic and social conditions. There is also no guarantee that the Chinese government’s pursuit of economic reforms will be consistent or effective.
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 

Note 2 - Summary of significant accounting policies, (continued)

Cash in bank accounts

Cash includes cash on hand and demand deposits in accounts maintained with state-owned banks within the People’s Republic of China. The total cash balance in state-owned banks at March 31, 2005 and September 30, 2004 amounted to $21,577,653 and $18,269,919, respectively of which no deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts.
 
Note 3 - Consolidated financial statements and condensed footnotes
 
The interim condensed consolidated financial statements presented herein have been prepared by the Company and include the unaudited accounts of the Company and its subsidiaries. All significant inter-company accounts and transactions have been eliminated in the consolidation.
 
These condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and the instructions to Form 10-QSB and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in financial statements presented in accordance with generally accepted accounting principles have been condensed or omitted. Management of the Company believes the disclosures made are adequate to make the information presented not misleading.
 
The condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements for the period ended September 30, 2004 and notes thereto included in the Company’s Form 10-KSB/A, dated January 30, 2005.
 
In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position of the Company as of March 31, 2005 and the results of operations for the three months and six months ended March 31, 2005 and 2004, respectively. Interim results are not necessarily indicative of full year performance because of the impact of seasonal and short-term variations.
 
Note 4 - Accounts receivable

Accounts receivable as of March 31, 2005 and September 30, 2004 consisted of the following:

   
March 31,
 
 September 30,
 
   
2005
 
 2004
 
           
Accounts receivable
 
$
16,215,031
 
$
7,348,676
 
Less: allowance for doubtful accounts
   
768,151
   
768,151
 
               
Totals
 
$
15,446,880
 
$
6,580,525
 
               
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 

Note 5 - Notes receivable

The notes receivable represent amounts due on Energy Savings Sharing contracts. The Company carries its notes receivable at the net present value of the notes. The notes receivable are secured by the related equipment. The notes receivable amounted to the following:

   
March 31,
 
September 30,
 
   
2005
 
2004
 
           
Notes receivable
 
$
9,212,902
 
$
10,815,232
 
Less: Current portion of notes receivable
   
2,724,372
   
3,727,540
 
Totals
 
$
6,488,530
 
$
7,087,692
 
               
The following table represents as of March 31, 2005 the estimated principal collections on notes receivable:

Period Ending March 31,
 
Amount
 
         
2006
 
$
2,724,372
 
2007
   
2,596,939
 
2008
   
2,475,467
 
2009
   
1,232,997
 
2010
   
183,127
 

Note 6 - Inventories

Inventories as of March 31, 2005 and September 30, 2004 consisted of the following:

   
March 31,
 
September 30,
 
   
2005
 
2004
 
           
Raw materials
 
$
2,459,884
 
$
1,013,976
 
Work in progress
   
334,227
   
869,059
 
Finished goods
   
2,492,392
   
2,446,517
 
Totals
 
$
5,286,503
 
$
4,329,552
 
               
Note 7 - Prepaid expenses

Prepaid expenses at March 31, 2005 and September 30, 2004 amounted to $2,962,216 and $1,529,955, respectively. Prepaid expenses represent advances to suppliers on inventory purchases.
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 

Note 8 - Plant and equipment

Plant and equipment as of March 31, 2005 and September 30, 2004 are summarized as follows:

   
March 31,
 
September 30,
 
   
2005
 
2004
 
           
Building
 
$
409,888
 
$
409,888
 
Office equipment
   
83,857
   
80,100
 
Furniture and fixtures
   
41,574
   
41,574
 
Plant, machinery and equipment
   
80,126
   
80,126
 
Vehicle
   
148,586
   
148,586
 
Total     764,031     760,274  
Less: accumulated depreciation
   
265,182
   
231,930
 
Plant and equipment, net
 
$
498,849
 
$
528,344
 
               
Depreciation expense for the six months ending March 31, 2005 and 2004 amounted to $33,252 and $40,906, respectively.

Note 9 - Long-term loan receivable

The long-term loan receivable as of March 31, 2005 amounted to $1,764,376. This amount represents a loan made to third party in China.  The loan bears interest at a monthly interest rate of 0.52%, or an annual rate at 6.24%, and is due on June 30, 2006.  The loan is personally guaranteed by certain board members of SDID.

Note 10 - Notes payable, net

Long-term obligations consisted of the following:

Note payable to finance company, secured by automobile, interest at 5.44% per annum. Monthly payments of $1,067 due through April 2006
$
17,559
Less current maturities
 
12,974
     
Total
$
4,585
 
Principal payments for the next five years are as follows:
 
Year Ending September 30,
   
     
2005
$
12,974
2006
 
4,585
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 11 - Related party transactions

As of March 31, 2005 and September 30, 2004, the due from related party amounted to $1,179,376 and $1,257,130, respectively. A majority of this amount was generated from making cash advances to the shareholders for ordinary business expenses. In addition, certain shareholders had collected payments on receivables on the Company’s behalf from the customers and those payments had not been repaid to the Company by March 31, 2005 and September 30, 2004. These amounts are unsecured, interest free and have no fixed terms of repayment.

Note 12 - Customer deposits

The Company requires their customers to deposit monies with the Company when they place an order for their products. The Company does not pay interest on these amounts in customer deposits amounted to $3,000,705 and $1,752,216 as of March 31, 2005 and September 30, 2004, respectively.
 
Note 13 - Taxes payable

Taxes payable at March 31, 2005 and September 30, 2004 consist of the following:

   
March 31,
 
September 30,
 
   
2005
 
2004
 
 
         
Urban maintenance and construction tax
 
$
34,817
 
$
21,104
 
Education tax
   
896
   
1,058
 
Value added tax
   
3,159,773
   
1,870,514
 
               
Totals
 
$
3,195,486
 
$
1,892,676
 
               
On July 22, 2004, the local Chinese tax authority waived the previously accrued tax accumulated prior to January 1, 2004 in the amount of $4,853,332 which was recorded as a credit during 2004 for previously accrued income taxes. The Company has elected to record the entire credit for Chinese income taxes in 2004.

The credit (provision) for income taxes consisted of the following:
 
   
Six Months Ended
March 31, 
 
   
2005
 
2004
 
 
         
Provision for China income taxes
 
$
 
$
(678,971
Total provision for income taxes
 
$
 
$
(678,971
)
               
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
Note 13 - Taxes payable, (continued)

The following table reconciles the U.S. Statutory rates to the Company’s effective tax rate:
 


   
March 31,
 
   
2005
 
2004
 
               
U.S. Statutory rates
   
34.0
%
 
34.0
%
Foreign income not recognized in USA
   
(34.0
)
 
(34.0
)
China income taxes
   
   
17.0
 
               
 Totals    
%
 
17.0
%
               

The Company located its factories in a special economic region in China. This economic region allows foreign enterprises a two-year income tax exemption and a 50% income tax reduction for the following three years. The Company was approved as a wholly owned foreign enterprise in 2004. The Company has income tax exemption for years ending September 30, 2004 and 2005 and 50% income tax reduction for the years ending September 30, 2006, 2007 and 2008.

The estimated tax savings for the six months ending March 31, 2005 amounted $2,578,472. The net effect on earnings per share if the income tax had been applied would decrease earnings per share from $0.37 to $0.23.

The Company has a net operating loss carry forward of $8,001,000 for US income tax purposes that will expire during the year 2025. The Company has recorded a valuation allowance for the entire amount of the loss carry forward. Since the Company’s main operations are located in the PRC and any income subject to US income taxes will be dependent upon the Company having operations in the US or other US taxable events will have to occur. Since the Company is not sure at this time that the Company will be able utilize the tax benefits of this operating loss management has decided to record a valuation allowance for the entire amount of the operating loss.

Note 14 - Commitments and contingencies

Operating Leases

The Company leases its facilities under long term, non-cancelable operating lease agreements expiring through June 2009. The non-cancelable operating lease agreements provide that the Company pays certain operating expenses applicable to the leased premises.

Total rent expense for the six months ended March 31, 2005 and 2004 amounted to $52,636 and $52,142, respectively.
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 14 - Commitments and contingencies, (continued)

As of March 31, 2005, the future minimum annual lease payments required under the operating leases for the next five years are as follows:

Period Ending March 31,
 
Amount
 
       
2005
 
$
59,270
 
2006
   
58,000
 
2007
   
58,000
 
2008
   
87,000
 
Thereafter
   
 

Note 15 - Equity incentive plan

On September 8, 2004, the Company adopted an Equity Incentive Plan. The purpose of this plan is to attract, retain and motivate eligible persons whose current and potential contributions are important to the success of the Company by offering them an opportunity to participate in the Company’s future performance through awards of Options, the right to purchase common stock and stock bonuses. A total of 1,200,000 shares of common stock have been registered with the Securities and Exchange Commission under this plan.

On September 16, 2004, the Company issued 10,000 shares to non-employee consultants and 620,000 shares of its common stock to certain qualifying employees at US$12.70 per share. The total shares were valued at $8,001,000 ($12.70 per share), the closing price of the stock at the date the shares were issued.

The Company accounts for its employee stock option grants in accordance with the fair value provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation” (SFAS 123). SFAS 123 established a fair-value-based method of accounting for stock-based compensation plans. Pursuant to the transition provisions of SFAS 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" (SFAS 148), the Company has elected the prospective method and will apply the fair value method of accounting to all equity instruments issued to employees. As of September 30, 2004, total stock based compensation expense recorded in the accompanying income statement amounted to $7,874,000.
 
Compensation expense related to stock options granted to non-employees is accounted for under Statement of Financial Accounting Standards No. (SFAS) 123, “Accounting for Stock-Based Compensation” and Emerging Issues Task Force (EITF) 96-18, “Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in conjunction with Selling, Goods, or Services,” which require entities to recognize an expense, based on the fair value of the related awards.  As of September 30, 2004, total stock compensation to non-employees amounted to $127,000.

During October and November 2004, the Company issued 470,000 shares to non-employee consultants of its common stock at US$11.00 and US$13.15 per share. The total shares were valued at $5,256,000, the closing price of the stock at the date the shares were issued.
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 16- Shareholders’ equity

Stock Issuances

On November 17, 2004, the Company completed an acquisition of an additional 15% interest in Starway. Prior to the acquisition, the Company owned 50% of the outstanding shares of capital stock of Starway. After the acquisition, the Company will own a total of 65% of the outstanding shares of Starway capital stock. The Company acquired the additional 15% interest in Starway from Eurofaith. The sole director of Eurofaith is also a director and Corporate Secretary of the Company.

The Company acquired the 15% interest in Starway by issuing a total of 3,346,100 shares of common stock of the Company. The amount of consideration given by the Company for the acquisition was determined with reference to the acquisition of shares of Starway capital stock as reported in the Company's Current Report on Form 8-K filed on June 30, 2004. The closing of the Acquisition (the "Closing") occurred on November 17, 2004 (the "Closing Date"). The sole consideration for the Acquisition is common stock of the Company.

In accordance with SFAS 141, the Company is required to record the acquisition of the minority interest in accordance with purchase accounting. However entities that are under common control are required to record the acquisition of the assets and liabilities transferred at their carrying amounts. Due to the common majority ownership in the Company and Eurofaith, the Company and Eurofaith are deemed in common control in accordance with SAB No. 47. Due to the common control element in accordance with SFAS 141 the Company has recorded the 15% acquisition from Eurofaith at historical costs value of $6,095,901.

During November and December 2004, the Company issued 7,683 shares of common stock for legal services and director fees. The total shares were valued at $71,740.

The Company acquired the remaining 35% interest (the "Acquisition") in Starway Management Limited ("Starway) from Sky Beyond Investments Limited ("Sky Beyond") on February 1, 2005 by issuing a total of 7,807,569 shares of common stock of the Company. Sky Beyond had acquired the 35% interest in Starway from Golden Resorts Group Limited (formerly known as "Meditech Group Company Limited"). The amount of consideration given by the Company for the Acquisition was determined with reference to the acquisitions of the 50% and subsequently the 15% interest in Starway as reported in the Company's Form 8-K filed on June, 30, 2004 and November 18, 2004, respectively. The closing of the Acquisition (the "closing") occurred on February 1, 2005 and the Company owns 100% of Starway after the Acquisition.

However management of the Company has learned that the stock sale between Sky Beyond and Golden Resorts Group Limited was subject to approval by the shareholders of Golden Resorts. As of May 18, 2005, the shareholder meeting to approve the sale has not been held. The Company and Sky Beyond believe that the Company’s acquisition of the 35% in Starway has been legally completed. However the Company is in the process of investigating this matter and is taking a conservative approach in reflecting this acquisition in the financial statements of the Company.
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 16- Shareholders’ equity, (continued)

As of March 31, 2005, the Company has decided not to reflect the additional earnings and additional paid in capital of the acquisition of the remaining 35% interest in Starway. However since the 7,807,569 shares have been issued in this transaction the par value of the stock has been reflected in the shareholders’ equity statement and the shares has been reflected in the earnings per share calculation as issued. If 100% of the income was to be reflected in the income statement at the date of acquisition, the Company net income would increase by $1,534,770 to $5,396,914 for the three months ended March 31, 2005 and earnings per share would increase by $0.07 to $0.25 for the three months ended March 31, 2005. Year to date net income would increase to $8,255,192 and year to date earnings per share would increase to $0.45.

If the Acquisition had been reflected in the financial statements, the net income and earning per share for the periods presented would have been adjusted to the amounts indicated below:


   
Three months ended
March 31, 2005
 
Three months ended
March 31, 2004
 
Six months ended
March 31, 2005
 
Six months ended
March 31, 2004
 
                   
Net Income
                 
Net income as reported
 
$
3,862,144
 
$
2,531,516
 
$
6,720,422
 
$
4,176,947
 
Add income attributed to minority interest
   
1,534,770
   
   
1,534,770
   
 
Adjusted net income after recognizing 100% subsidiary income
 
$
5,396,914
 
$
2,531,516
 
$
8,255,192
 
$
4,176,947
 
                           
Basic and Diluted EPS
                         
Net income per share - as reported
 
$
0.18
 
$
0.22
 
$
0.37
 
$
0.36
 
Add earnings per share attributed to minority interest
   
0.07
   
   
0.08
   
 
Adjusted earnings per share
 
$
0.25
 
$
0.22
 
$
0.45
 
$
0.36
 
                           
Statutory Reserves and Restricted Retained earnings

The Company is required to make appropriations to reserve funds, comprising the statutory surplus reserve, statutory public welfare fund and discretionary surplus reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the People’s Republic of China (the “PRC GAAP”). Appropriation to the statutory surplus reserve should be at least 10% of the after tax net income determined in accordance with the PRC GAAP until the reserve is equal to 50% of the entities’ registered capital. Appropriations to the statutory public welfare fund are at 5% to 10% of the after tax net income determined in accordance with the PRC GAAP.

The statutory public welfare fund is established for the purpose of providing employee facilities and other collective benefits to the employees and is non-distributable other than in liquidation. Appropriations to the discretionary surplus reserve are made at the discretion of the Board of Directors.
 

AND SUBSIDIARIES
 
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 17 - Minority Interest

Minority interest represents the outside shareholder’s 35% ownership of the common stock of Starway Management Limited. Due to common control over the entities the financial statements of the Company have been restated to reflect the minority’s shareholder’s interest as if the transaction was effective January 1, 2003.

As described in note 16 the Company has decided not to reflect the additional earnings and additional paid in capital of the acquisition of the remaining 35% interest in Starway.

 

 
The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto. The following discussion contains forward-looking statements. China Energy Savings Technology, Inc. is referred to herein as the “Company”, "we" or "our." The words or phrases "would be," "will allow," "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," or similar expressions are intended to identify "forward-looking statements." Such statements include those concerning expected financial performance, corporate strategy, and operational plans. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including: (a) general economic conditions in China; (b) regulatory factors in China that may lead to additional costs or otherwise negatively affect our business; (c) whether we are able to manage our planned growth efficiently, including whether our management will be able to: (i) identify, hire, train, retain, motivate and manage required personnel or (ii) successfully manage and exploit existing and potential market opportunities; (d) whether we are able to generate sufficient revenues or obtain financing to sustain and grow our operations; and (e) whether we are able to successfully fulfill our primary cash requirements which are explained below under "Liquidity and Capital Resources.” Statements made herein are as of the date of the filing of this Form 10-QSB with the Securities and Exchange Commission and should not be relied upon as of any subsequent date. Unless otherwise required by applicable law, we do not undertake, and we specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.

OVERVIEW
 
We are a Nevada corporation headquartered in Hong Kong, China that invests in, develops, markets, distributes and manufactures energy saving products for use in commercial and industrial settings. As of December 31, 2004, we owned a 65% interest in Starway Management Limited, a British Virgin Islands corporation ("Starway") which owns all of the equity interests in Shenzhen Dicken Industrial Development Limited ("SDID"), a company incorporated in the People's Republic of China on November 20, 1996 which in turn owns all of the equity interest in Shenzhen Dicken Technology Development Limited ("SDTD"), a company incorporated in the People’s Republic of China on November 9, 1999. Subsequently, in February 2005, we acquired all of the remaining 35% interest in Starway from Sky Beyond Investments Limited (“Sky Beyond”) bringing our total ownership of Starway to 100%. Starway's subsidiaries, SDID and SDTD, develop, market, distribute and manufacture energy saving products for use in commercial and industrial settings in China.

As discussed more fully in Part II, Item 5 below and in Notes 2 and 16 in the Condensed Notes to the Consolidated Financial Statements, the Company is aware of a dispute regarding the Company’s February 2005 acquisition of the remaining 35% interest in Starway. The Company is in the process of resolving this matter and has decided to take a conservative approach in reflecting this acquisition in the financial statements of the Company. Thus, our financial statements are consolidated with those of Starway and its subsidiaries with an adjustment so as not to reflect the additional earnings and additional paid in capital of the acquisition of the remaining 35% interest in Starway until the Company receives confirmation that the matter has been fully resolved.
 
RESULTS OF OPERATIONS

General results of operations for the three months ended March 31, 2004 and March 31, 2005 and for the six months ended March 31, 2004 and March 31, 2005 are summarized as follows:


Three Months Ended March 31    
2005
   
2004
   
Change
 
                     
Revenues    11,175,617   8,818,742     27.00 %
Cost of goods sold      4,254,122     3,234,882     32.00 %
Gross profit     6,921,495     5,583,860     24.00 %
Operating expenses      1,203,613     517,150     133.00 %
Operating profit      5,717,882     5,066,710     13.00 %
Other income/(expense)      396,363     (3,677 )   N/A
                     
Income before income taxes and minority interest      6,114,245     5,063,033     21.00 %
                     
Net income (after minority interest)     3,862,144     2,531,516     52.50 %
                     
 
Six Months Ended March 31    
2005
   
2004
   
Change
 
                     
Revenues    22,884,307   20,320,207     13.00 %
Cost of goods sold      9,145,530     10,682,628     –14.00 %
Gross profit     13,738,777     9,637,579     43.00 %
Operating expenses      2,788,152     1,384,097     101.00 %
Operating profit      10,950,625     8,253,482     33.00 %
Other income     741,751     779,383     5.00 %
                     
Income before income taxes and minority interest      11,692,376     9,032,865     29.00 %
                     
Net income (after minority interest and taxes)     6,720,422     4,176,947     60.80
                     
 
The key financial ratios for the three months ended March 31, 2004 and March 31, 2005 and six months ended March 31, 2004 and March 31, 2005 are as follows:

Three Months Ended March 31
 
2005
 
2004
         
Gross profit margin
 
62%
 
63%
Income before taxes and minority interest margin
 
55%
 
57%
Current ratio
 
5.9 times
 
1.8 times
Quick ratio
 
5.3 times
 
1.6 times

Six Months Ended March 31
 
2005
 
2004
         
Gross profit margin
 
60%
 
47%
Income before taxes and minority interest margin
 
51%
 
44%
Current ratio
 
5.9 times
 
1.8 times
Quick ratio
 
5.3 times
 
1.6 times


(1)
REVENUES
 
Consolidated revenues increased by $2,356,875, or approximately 27%, from $8,818,742 for the three months ended March 31, 2004 to $11,175,617 for the three months ended March 31, 2005. The 27% increase was a result of increased unit sales in our energy savings products.
 
 
Consolidated revenues increased by $2,564,100, or approximately 13%, from $20,320,207 for the six months ended March 31, 2004 to $22,884,307 for the six months ended March 31, 2005. The increase in revenues reflects sales growth in SDID's energy savings products, and was the result of increased unit sales. Our management expects that revenue will continue to grow in 2005 because of our marketing and sales efforts and growing demand for our products due to electricity shortages in many parts of China. Further, our management believes that we will be able to maintain our price levels due to the growing demand and a lack of strong competitive products. While our products may be used internationally, we currently have focused our sales efforts in China, targeting large businesses and local governments. Management hopes to continue to increase our sales in China. 
 
(2)
COST OF GOODS SOLD
 
Consolidated costs of goods sold increased by $1,019,240, or approximately 32%, from $3,234,882 for the three months ended March 31, 2004 to $4,254,122 for the three months ended March 31, 2005. The 32% increase was a result of an increase in sales as discussed previously and a slight increase in raw material costs of energy savings products in the period.
 
Consolidated costs of goods sold decreased by $1,537,098, or approximately 14%, from $10,682,628 for the six months ended March 31, 2004 to $9,145,530 for the six months ended March 31, 2005. The decrease in cost of goods sold is a result of better control over production costs. Because of our increase in sales volume, we are able to buy our production materials in mass quantities so we are able to leverage more buying power to get better prices for supplies and materials used for the production of our products. Additionally, we have seen an increase in suppliers for the supplies and materials used for the production of our products, which results in more competitive pricing for such supplies and materials. As a result, the cost of materials such as chipsets and other hardware used in the production of our products has decreased substantially,  which in turn produces better profit margins for us. Such a decrease is expected to continue in the short term but we expect it to be minimized in the future.

(3)
GROSS PROFIT

Consolidated gross profit increased by $1,337,635, or approximately 24%, from $5,583,860 for the three months ended March 31, 2004 to $6,921,495 for the three months ended March 31, 2005. Gross profit as a percentage of sales decreased from approximately 63% for the three months ended March 31, 2004 to 62% for the three months ended March 31, 2005. The increase in gross profit was a result of an increase of sales units. The decrease in gross profit as a percentage of sales was mainly attributable to variations in the type of products purchased in the period by the Company’s customers and variations in profit margins associated with different types of products.

Consolidated gross profit increased by $4,101,198, or approximately 43%, from $9,637,579 for the six months ended March 31, 2004 to $13,738,777 for the six months ended March 31, 2005. Gross profit as a percentage of sales increased from approximately 48% for the six months ended March 31, 2004 to approximately 60% for the six months ended March 31, 2005. The increase in gross profit was a result of an increase unit sales and a decrease in cost of goods sold. The increase in gross profit as a percentage of sales was mainly attributable to increased sales of the Company’s products that are mass produced which have a higher profit margin.  
 
(4)
OPERATING EXPENSES
 
Consolidated operating expenses increased by $686,463, or approximately 133%, from $517,150 for the three months ended March 31, 2004 to $1,203,613 for the three months ended March 31, 2005. The operating expenses as a percentage of sales increased to 11% for the three months ended March 31, 2005 from 6% for the three months ended March 31, 2004. The increase in operating expenses is primarily due to the significant increase in our unit sales of energy savings products, the cost of increased employee turnover, and costs associated with increases in our staff’s salary by approximately 10% and the number of employees increased from approximately 90 to about 110. In addition our operating expenses have increased due to the increase in consulting fees for stock issued in October and November 2004, which is discussed below.
 
 
Consolidated operating expenses increased by $1,404,055, or approximately 101%, from $1,384,097 for the six months ended March 31, 2004 to $2,788,152 for the six months ended March 31, 2005. The operating expenses as a percentage of sales increased to 12% for the six months ended March 31, 2005 from 7% for the six months ended March 31, 2004. In general, there were significant increases in sales, marketing and administrative and operating expenses. A large part of the increase is attributable to the fact that during October and November 2004, we signed agreements with various consultants for consulting services. The agreements range between three to five years. As compensation for the consulting services we issued 470,000 shares of our common stock at US$11.00 and US$13.15 per share. The total shares were valued at $5,256,000, the closing price of the stock at the date the shares were issued. This amount is being amortized over the life of the agreements on a straight-line basis and consulting expense amounted to $1,093,128 for the six months ended March 31, 2005. We believe expenses related to the marketing and selling of our products will continue to increase substantially to handle our growing sales volume. During November and December 2004, we also issued 7,683 shares of common stock for legal services and director fees. The total shares were valued at $71,740. We expect that professional fees and expenses to ensure compliance with U.S. Securities laws, the Sarbanes-Oxley Act and marketplace rules for the NASDAQ National Market will increase substantially.
 
(5)
OTHER INCOME

Consolidated “other income” increased by $400,040 from ($3,677) for the three months ended March 31, 2004 to $396,363 for the three months ended March 31, 2005. The increase mainly represents the interest income received by the Company in excess of the original estimated cost savings for cost savings contracts for the period.

Consolidated “other income” decreased by $37,632, or approximately 5%, from $779,383 for the six months ended March 31, 2004 to $741,751 for the six months ended March 31, 2005. The decrease was mainly due to the decrease in interest income received by the Company in excess of the original estimated cost savings for cost savings contracts for the period.
 
(6)
NET INCOME

Consolidated net income increased by $1,330,628, or approximately 53%, from $2,531,516 for the three months ended March 31, 2004 to $3,862,144 for the three months ended March 31, 2005. The increase was mainly due to the increase of revenue by 27% and the additional interest income received by the Company in excess of the original estimated cost savings for cost savings contracts for the period.

Consolidated net income increased by $2,543,475, or approximately 61%, from $4,176,947 for the six months ended March 31, 2004 to $6,720,422 for the six months ended March 31, 2005. The increase was mainly due to the increase of revenue by 13%, the decrease in cost of goods sold by 14% which was offset by an increase in operating expenses of 5%.

LIQUIDITY AND CAPITAL RESOURCES
 
Six Months Ended March 31
 
2005
 
2004
 
Change
 
               
Net cash provided by operating activities
   
4,906,060
   
6,352,304
   
 22.77
%
Net cash used in investing activities
   
(3,758
)
 
   
 
 
Net cash used in financing activities
   
(1,767,511
)
 
(238,060
)
 
642.46
%
 
The decrease of $1,446,244, or approximately 22.8% in net cash provided by operating activities primarily reflects an increase in revenues for the six months ended March 31, 2005 offset by the effect of a significant increase of accounts receivable during the period.
 
The decrease in net cash used in investing activities was due to the acquisition of equipment during the period.
 

The decrease of $1,529,451, or approximately 642% in net cash used in financing activities was due to the increase of long-term loan receivable and the repayment of notes payable during the period.

We believe that we have adequate capital resources to continue our operations and will not need to raise capital in the near future. We believe that our current cash balance and the revenues that will be generated will cover anticipated operating expenses for a period of at least one year without supplementing our cash reserves. We may, however, raise additional capital to further develop our other products.
 
MANAGEMENT ASSUMPTIONS

Management anticipates, based on internal forecasts and assumptions relating to our current operations that existing cash and funds generated from operations will be sufficient to meet working capital for at least the next 12 months. In the event that plans change, our assumptions change or prove inaccurate or if other capital resources and projected cash flow otherwise prove to be insufficient to fund operations (due to unanticipated expense, technical difficulties, or otherwise), we could be required to seek additional financing. There can be no assurance that we will be able to obtain additional financing on terms acceptable to it, or at all.

EFFECTS OF INFLATION

We are subject to commodity price risks arising from price fluctuations in the market prices of the various raw materials that comprise our products. Price risks are managed by each business unit through productivity improvements and cost-containment measures. For the time being, the management does not believe that inflation risk is material to our business or our consolidated financial position, results of operations or cash flows.

EFFECT OF FLUCTUATION IN FOREIGN EXCHANGE RATES

Our operating subsidiaries are located in China, and our Company buys all raw materials in China and sells all our products in China using Chinese Renminbi as the functional currency. Based on China government regulation, all foreign currencies under the category of current accounts are allowed to be freely exchanged with hard currencies. During the past two years of operation, there were no significant changes in exchange rates; however, unforeseen developments may cause a significant change in exchange rates.

SHAREHOLDING OF STARWAY MANAGEMENT LIMITED

As of June 30, 2004, the Company held a 50% stake in Starway Management Limited (“Starway”) and subsequently increased its share in Starway to 65% by acquiring an additional 15% stake in Starway on November 16, 2004. Finally, the Company, pursuant to an Agreement and Plan of Share Exchange with Sky Beyond dated February 1, 2005 (the “Agreement”), purchased the remaining 35 shares of Starway stock from Sky Beyond representing the final 35% stake in Starway. As discussed more fully in Part II, Item 5 below and in Notes 2 and 16 in the Condensed Notes to the Consolidated Financial Statements, the Company is aware of a dispute regarding the Company’s February 2005 acquisition of the final 35% interest in Starway.
 
Starway owns all of the equity interests in Shenzhen Dicken Industrial Development Limited, a company incorporated in the People's Republic of China (“SDID”) which in turns owns all of the equity interest in Shenzhen Dicken Technology Development Limited, a company incorporated in the People's Republic of China ("SDTD"). SDID and SDTD are the Company’s operating subsidiaries which develops, markets, distributes and manufactures the Company’s energy saving products.
ITEM 3.
CONTROLS AND PROCEDURES

(a)
Evaluation of Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us required to be included in our periodic SEC filings.

(b)
Changes in Internal Controls Over Financial Reporting. There was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 

 
ITEM 1.
LEGAL PROCEEDINGS
 
None.
 
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
In February, 2004, the Registrant issued 7,807,569 shares of common stock to Sky Beyond, which represented that it is an accredited investors as part of the acquisition of a 35% interest in Starway. This transaction was effected under an exemption to registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. The recipients of the securities in the above-described transaction represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificate and other instruments issued in such transaction.

ITEM 3.
DEFAULTS UPON SENIOR SECURITIES

Not Applicable.

ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not Applicable.

ITEM 5.
OTHER INFORMATION

The management of the Company became aware of a dispute between Golden Resorts Group Limited, a Bermuda company listed on the Hong Kong Stock Exchange (“Golden Resorts”) under the stock code 1031, and Sky Beyond Investments Limited, a British Virgin Islands corporation (“Sky Beyond”) with respect to the sale of 35 shares of Starway Management Limited, a British Virgin Islands corporation (“Starway”), representing 35% of the outstanding shares of Starway, by Win Matching Limited (“Win Matching”), the wholly-owned subsidiary of Golden Resort, to Sky Beyond pursuant to a Sale and Purchase Agreement dated January 10, 2005 between Win Matching and Sky Beyond (the “Starway Stock Sale”) from an announcement made on May 9, 2005. Golden Resorts announced in a public filing that it is taking the position that the Starway Stock Sale is not completed because such sale was subject to Golden Resorts shareholder approval and such approval has not been obtained. Sky Beyond, however, contends that the Starway Stock Sale was complete because the consideration for the sale has been delivered to Golden Resorts and that the stock certificate representing the 35 Starway shares has been delivered.

The Company, pursuant to an Agreement and Plan of Share Exchange with Sky Beyond dated February 1, 2005 (the “Agreement”), purchased 35 shares of Starway stock from Sky Beyond. Sky Beyond represented to the Company in the Agreement that it owned such shares of Starway and stock certificates representing such shares were delivered to the Company upon closing.

On May 17, 2005, the management of the Company, upon learning the claims made by Golden Resort and upon receiving correspondences from Sky Beyond and Golden Resorts contacted representatives of Sky Beyond and Golden Resorts regarding the dispute and together with Starway, the four parties have executed a Memorandum of Understanding in which Win Matching and its parent company, Golden Resorts, claimed to undertake to resolve the dispute in an expedited manner.

There were no changes to the procedures by which security holders may recommend nominees to our board of directors.
 

ITEM 6.
EXHIBITS  AND REPORTS ON FORM 8-K

(a)
Exhibits

Exhibit
Number
 
 
Description
     
3.1
 
Certificate of Incorporation (2)
3.2
 
Bylaws (2)
10.1
 
Agreement and Plan of Share Exchange dated November 16, 2004 by and between Eurofaith Holdings, Inc. and China Energy Savings Technology, Inc. (1)
10.2
 
Agreement and Plan of Share Exchange dated February 1, 2005 by and between Sky Beyond Investments Limited and China Energy Savings Technology, Inc. (3)
31.1
 
Certification of Chief Executive Officer Pursuant to 302 of the Sarbanes-Oxley Act of 2002 (4)
31.2
 
Certification of Chief Financial Officer Pursuant to 302 of the Sarbanes-Oxley Act of 2002 (4)
32.1
 
Certification of Chief Executive Officer Pursuant to 906 of the Sarbanes-Oxley Act of 2002 (4)
32.2
 
Certification of Chief Financial Officer Pursuant to 906 of the Sarbanes-Oxley Act of 2002 (4)
___________
(1)
Previously filed with the Securities and Exchange Commission as Exhibit 10.1 to the Company's Current Report on Form 8K filed on November 18, 2004 and incorporated herein by reference.
(2)
Previously filed with the Securities and Exchange Commission as an exhibit to the Registration Statement on Form 10 filed on July 11, 2000 and incorporated herein by reference.
(3)
Previously filed with the Securities and Exchange Commission as Exhibit 10.1 to the Company's Current Report on Form 8K filed on February 4, 2005 and incorporated herein by reference.
(4)
Filed herewith.
 
 
(b)
Reports on Form 8-K

1.
 
8-K
 
January 27, 2005, Press Release re Corporate plans and objectives for 2005
2.
 
8-K
 
February 4, 2005, Acquisition of 35% of Starway from Sky Beyond Investments Limited
3.
 
8-K
 
April 19, 2005, Press Release re listing of Company’s common stock on NASDAQ National Market System
4.
 
8-K/A
 
April 21, 2005, Press Release re payment of fee for listing of Company’s Common Stock on NASDAQ National Market System, and Research Works, Inc. ("RW"), an independent equity research company initiating coverage of China Energy Savings Technology, Inc.
5.
 
8-K
 
April 21, 2005, Press Release re Company’s common stock trading on NASDAQ National Market System as of April 21, 2005 under symbol “CESV”


In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
     
 
CHINA ENERGY SAVINGS TECHNOLOGY, INC.
(Registrant)
 
 
 
 
 
 
Date:  May 23, 2005 By:   /s/  Sun Li
 
 
Sun Li
Chief Executive Officer
 
     
 
 
 
 
 
 
Date:  May 23, 2005 By:   /s/  Kam Wah Poon
 
 
Kam Wah Poon
Chief Financial Officer
 
31