U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
x | Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the Quarterly Period Ended June 30, 2008
or
o | Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 |
Commission File Number 000-51364
SINO GAS INTERNATIONAL HOLDINGS, INC.
(Name of small business issuer in its charter)
Utah | 32-0028823 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
No.18 Zhong Guan Cun Dong St. Haidian District Beijing, P. R. China | 100083 |
(Address of principal executive offices) | (Zip Code) |
Issuer’s telephone number: 86-10-82600527
Check whether the issuer (1) has 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 to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer o |
Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o No x
As of August 13, 2008, the Registrant had 25,084,644 shares of common stock outstanding.
Sino Gas International Holdings, Inc.
Table of Contents
Page | ||
PART I - | FINANCIAL INFORMATION | |
Item 1. | Financial Statements | 1 |
Notes to Financial Statements (Unaudited) | 7 | |
Item 2. | Management's Discussion and Analysis or Plan of Operation | 29 |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 43 |
Item 4. | Controls and Procedures | 43 |
PART II - | OTHER INFORMATION | |
Item 1. | Legal Proceedings | 44 |
Item 1A. | Risk Factors | 44 |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 44 |
Item 3. | Defaults Upon Senior Securities | 44 |
Item 4. | Submission of Matters to a Vote of Security Holders. | 44 |
Item 5. | Other Information | 44 |
Item 6. | Exhibits | 45 |
PART I - FINANCIAL INFORMATION
Sino Gas International Holdings, Inc.
Reviewed Financial Statements
June 30, 2008 and December 31, 2007
(Stated in US Dollars)
SINO GAS INTERNATIONAL HOLDINGS, INC.
CONTENTS | PAGES | |||
INDEPENDENT AUDITOR’S REPORT | 1 | |||
CONSOLIDATED BALANCE SHEETS | 2 - 3 | |||
CONSOLIDATED STATEMENTS OF INCOME | 4 | |||
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY | 5 | |||
CONSOLIDATED STATEMENTS OF CASH FLOWS | 6 | |||
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS | 7 - 28 |
Board of Directors and Stockholders
Sino Gas International Holdings, Inc.
Report of Independent Registered Public Accounting Firm
We have reviewed the accompanying consolidated interim balance sheets of Sino Gas International Holdings, Inc. as of June 30, 2008 and December 31, 2007, and the related consolidated statements of income, stockholders’ equity, and cash flows for the three-month and six-month periods ended June 30, 2008 and 2007. These consolidated interim financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial statements consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with U.S. generally accepted accounting principles.
South San Francisco, California | Samuel H. Wong & Co., LLP | |
July 30, 2008 | Certified Public Accountants |
1
Sino Gas International Holdings, Inc. |
Consolidated Balance Sheets |
As of June 30, 2008 and December 31, 2007 |
(Stated in US Dollars) |
ASSETS | June 30, 2008 | December 31, 2007 | ||||||||
Note | Unaudited | Audited | ||||||||
Current Assets | ||||||||||
Cash & cash equivalents | 2(e) | $ | 8,152,907 | $ | 10,915,590 | |||||
Restricted cash | 3 | 739,868 | 478,920 | |||||||
Notes receivable | 283,768 | 825,119 | ||||||||
Accounts receivable | 2(f),4 | 5,933,183 | 7,315,253 | |||||||
Inventory | 276,252 | 207,976 | ||||||||
Advances to suppliers | 2(g) | 2,892,084 | 27,372 | |||||||
Prepayments and others | 474,083 | 320,380 | ||||||||
Other receivables | 5 | 6,486,784 | 3,100,695 | |||||||
Total Current Assets | 25,238,929 | 23,191,305 | ||||||||
Non-Current Assets | ||||||||||
Investment | 2(h) | 4,382,417 | 4,007,310 | |||||||
Property, plant & equipment, net | 2(j),6 | 26,494,692 | 24,572,565 | |||||||
Construction in progress | 2(l) | 14,694,005 | 11,556,820 | |||||||
Intangible assets, net | 2(k),7 | 2,189,172 | 2,028,250 | |||||||
Total non-current assets | 47,760,286 | 42,164,945 | ||||||||
TOTAL ASSETS | $ | 72,999,215 | $ | 65,356,250 | ||||||
LIABILITIES & STOCKHOLDERS' EQUITY | ||||||||||
Current Liabilities | ||||||||||
Bank Loans | 8 | $ | 7,276,114 | $ | 2,734,444 | |||||
Accounts payable | 5,147,415 | 716,707 | ||||||||
Other payables | 9 | 6,597,092 | 10,383,657 | |||||||
Unearned revenue | 2(m) | 757,261 | 312,573 | |||||||
Accrued liabilities | 4,204 | 362,263 | ||||||||
Total current liabilities | 19,782,086 | 14,509,644 | ||||||||
TOTAL LIABILITIES | $ | 19,782,086 | $ | 14,509,644 |
See accompanying notes to financial statements and accountant’s report
2
Sino Gas International Holdings, Inc. |
Consolidated Balance Sheets |
As of June 30, 2008 and December 31, 2007 |
(Stated in US Dollars) |
STOCKHOLDERS' EQUITY | ||||||||||
Preferred Stock A US $0.001 par value; 20,000,000 shares authorized; 275,111 shares issued and outstanding as of June 30, 2008 and December 31, 2007 | 10 | $ | 275 | $ | 275 | |||||
Preferred Stock B US $0.001 par value; 5,000,000 shares authorized; 4,764,486 and 4,971,859 shares issued and outstanding as of June 30, 2008 and December 31, 2007 | 10 | 4,765 | 4,972 | |||||||
Common Stock US $0.001 par value; 250,000,000 shares authorized; 25,489,753 and 25,282,380 shares issued and outstanding as of June 30, 2008 and December 31, 2007 | 10 | 25,490 | 25,283 | |||||||
Additional Paid in Capital | 35,247,303 | 35,247,303 | ||||||||
Statutory Reserve | 3,258,201 | 3,258,201 | ||||||||
Retained Earnings | 10,044,869 | 10,432,430 | ||||||||
Accumulated Other Comprehensive Income | 4,636,225 | 1,878,142 | ||||||||
TOTAL STOCKHOLDERS' EQUITY | 53,217,129 | 50,846,606 | ||||||||
TOTAL LIABILITIES AND | ||||||||||
STOCKHOLDERS' EQUITY | $ | 72,999,215 | $ | 65,356,250 |
See accompanying notes to financial statements and accountant’s report
3
Sino Gas International Holdings, Inc. |
Consolidated Statements of Income |
For the three months and six months periods ended June 30, 2008 and 2007 |
(Stated in US Dollars) |
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Notes | 2008 | 2007 | 2008 | 2007 | ||||||||||||
Revenues | $ | 5,121,521 | $ | 2,796,145 | $ | 9,463,638 | $ | 5,234,372 | ||||||||
Cost of revenues | (3,554,592 | ) | (1,894,203 | ) | (6,530,063 | ) | (3,731,833 | ) | ||||||||
Gross Profit | 1,566,930 | 901,942 | 2,933,575 | 1,502,539 | ||||||||||||
Operating Expenses | ||||||||||||||||
Selling and marketing expenses | (186,193 | ) | (143,296 | ) | (367,896 | ) | (199,494 | ) | ||||||||
General & administrative expenses | (1,163,429 | ) | (247,485 | ) | (1,996,879 | ) | (688,859 | ) | ||||||||
Total operating expenses | (1,349,621 | ) | (390,781 | ) | (2,364,776 | ) | (888,353 | ) | ||||||||
Operating Income/(Loss) | 217,308 | 511,161 | 568,799 | 614,186 | ||||||||||||
Other income | 1,269 | 1,269 | 11,781 | |||||||||||||
Other expenses | (26,330 | ) | (34,789 | ) | (27,176 | ) | (11,977 | ) | ||||||||
Interest income | 12,496 | 38,920 | 45,662 | 33,550 | ||||||||||||
Interest expense | (156,100 | ) | (216,567 | ) | - | |||||||||||
Total other income (expense) | (168,665 | ) | 4,131 | (196,811 | ) | 33,354 | ||||||||||
Earnings before tax | 48,643 | 515,292 | 371,988 | 647,540 | ||||||||||||
Income tax | (128,781 | ) | (10,478 | ) | (302,798 | ) | (27,343 | ) | ||||||||
Income from continuing operation | (80,137 | ) | 504,814 | 69,190 | 620,197 | |||||||||||
Extraordinary loss, net | 12 | (456,751 | ) | - | (456,751 | ) | - | |||||||||
Net Income | $ | (536,888 | ) | $ | 504,814 | $ | (387,561 | ) | $ | 620,197 | ||||||
Earnings per share | ||||||||||||||||
Basic | $ | (0.02 | ) | $ | 0.03 | $ | (0.02 | ) | $ | 0.04 | ||||||
Diluted | (0.02 | ) | 0.03 | (0.01 | ) | 0.03 | ||||||||||
Weighted Average Shares Outstanding | ||||||||||||||||
Basic | 25,312,896 | 15,273,626 | 25,297,638 | 15,216,279 | ||||||||||||
Diluted | 30,529,350 | 19,360,386 | 30,529,350 | 19,486,791 |
See accompanying notes to financial statements and accountant’s report
4
Sino Gas International Holdings, Inc. |
Consolidated Statements of Stockholders’ Equity |
As of June 30, 2008 and December 31, 2007 |
(Stated in US Dollars) |
Preferred Stock A | Preferred Stock B | Common Stock | ||||||||||||||||||||||||||||||||
Shares Outstanding | Amount | Shares Outstanding | Amount | Shares Outstanding | Amount | Common Stock Additional Paid in Capital | Statutory Reserve | Retained Earnings | Accumulated Other Comprehensive Income | Total | ||||||||||||||||||||||||
Balance, January 1, 2007 | - | - | 4,023,268 | 4,023 | 14,693,186 | 14,694 | 18,488,040 | 2,025,022 | 3,958,239 | 824,296 | 25,314,314 | |||||||||||||||||||||||
Net Income | - | - | - | - | - | - | - | - | 7,707,370 | - | 7,707,370 | |||||||||||||||||||||||
Issue of stock and warrant | 275,111 | 275 | 948,591 | 949 | 10,589,194 | 10,589 | 16,759,263 | - | - | - | 16,771,076 | |||||||||||||||||||||||
Appropriations of Retained Earnings | - | - | - | - | - | - | - | 1,233,179 | (1,233,179 | ) | - | - | ||||||||||||||||||||||
Foreign Currency Translation Adjustment | - | - | - | - | - | - | - | - | - | 1,053,846 | 1,053,846 | |||||||||||||||||||||||
Balance, December 31, 2007 | 275,111 | 275 | 4,971,859 | 4,972 | 25,282,380 | 25,283 | 35,247,303 | 3,258,201 | 10,432,430 | 1,878,142 | 50,846,606 | |||||||||||||||||||||||
Balance, January 1, 2008 | 275,111 | 275 | 4,971,859 | 4,972 | 25,282,380 | 25,283 | 35,247,303 | 3,258,201 | 10,432,430 | 1,878,142 | 50,846,606 | |||||||||||||||||||||||
Net Income | - | - | - | - | - | - | - | - | (387,561 | ) | - | (387,561 | ) | |||||||||||||||||||||
Conversion of Stock | - | - | (207,373 | ) | (207 | ) | 207,373 | 207 | - | - | - | - | - | |||||||||||||||||||||
Appropriations of Retained Earnings | - | - | - | - | - | - | - | - | - | - | - | |||||||||||||||||||||||
Foreign Currency Translation Adjustment | - | - | - | - | - | - | - | - | - | 2,758,083 | 2,758,083 | |||||||||||||||||||||||
Balance, June 30, 2008 | 275,111 | 275 | 4,764,486 | 4,765 | 25,489,753 | 25,490 | 35,247,303 | 3,258,201 | 10,044,869 | 4,636,225 | 53,217,129 | |||||||||||||||||||||||
Accumulated Comprehensive Income | ||||||||||||||||||||||||||||||||||
12/31/2007 | 6/30/2008 | Total | ||||||||||||||||||||||||||||||||
Comprehensive Income | ||||||||||||||||||||||||||||||||||
Net Income | 7,707,370 | (387,561 | ) | 7,319,809 | ||||||||||||||||||||||||||||||
Other Comprehensive Income | ||||||||||||||||||||||||||||||||||
Foreign Currency Translation Adjustment | 1,053,846 | 2,758,083 | 3,811,929 | |||||||||||||||||||||||||||||||
8,761,216 | 2,370,522 | 11,131,738 |
See accompanying notes to financial statements and accountant’s report
5
Sino Gas International Holdings, Inc. |
Consolidated Statements of Cash Flows |
For the three months and six months periods ended June 30, 2008 and 2007 |
(Stated in US Dollars) |
Three Months Ended | Six Months Ended | ||||||||||||
June 30, | June 30, | ||||||||||||
2008 | 2007 | 2008 | 2007 | ||||||||||
Cash flow from operating activities | |||||||||||||
Net Income | (536,888 | ) | 504,814 | (387,561 | ) | 620,197 | |||||||
Depreciation expense | 218,405 | 657,609 | 858,653 | 696,453 | |||||||||
Amortization expense | 14,463 | 467 | 43,995 | 467 | |||||||||
Invested in restricted time deposits | (75,807 | ) | - | (260,948 | ) | 3,124,541 | |||||||
Decrease/(increase) in accounts and other receivables | 3,894,981 | (940,846 | ) | (1,462,668 | ) | (630,427 | ) | ||||||
Increase in inventory | (29,360 | ) | (57,690 | ) | (68,276 | ) | (57,690 | ) | |||||
Increase in prepaid expenses | (2,186,986 | ) | - | (3,018,416 | ) | - | |||||||
Increase in accounts and other payables | 1,018,505 | (3,903 | ) | 730,773 | 3,019,392 | ||||||||
Cash sourced/(used) in operating activities | 2,317,312 | 160,451 | (3,564,449 | ) | 6,772,933 | ||||||||
Cash flows from investing activities | |||||||||||||
Cash received/paid for investment proceeds | (1,679,262 | ) | 930,801 | (375,108 | ) | - | |||||||
(Purchase)/disposal of property, plant & equipment | 139,869 | (1,412,955 | ) | (2,780,780 | ) | (4,733,643 | ) | ||||||
(Purchase)/disposal of intangible assets | (91,297 | ) | 479,373 | (204,917 | ) | 307,163 | |||||||
Acquisition of subsidiaries | - | (173,167 | ) | - | (173,167 | ) | |||||||
Increase in minority interest | - | 65,575 | - | 65,575 | |||||||||
Increase in construction in progress | (1,863,062 | ) | (1,471,000 | ) | (3,137,183 | ) | (2,816,436 | ) | |||||
Cash sourced/(used) in investing activities | (3,493,752 | ) | (1,581,373 | ) | (6,497,988 | ) | (7,350,508 | ) | |||||
Cash flows from financing activities | |||||||||||||
Proceeds from bank borrowings | 155,838 | 2,623,020 | 4,541,670 | 192,575 | |||||||||
Issue of share capital | - | 2,587,759 | - | 2,587,759 | |||||||||
Cash sourced/(used) in financing activities | 155,838 | 5,210,779 | 4,541,670 | 2,780,334 | |||||||||
Net increase/(decrease) in cash & cash equivalents for the year | (1,020,603 | ) | 3,789,858 | (5,520,767 | ) | 2,202,760 | |||||||
Effect of Currency Translation on cash and cash equivalents | 1,152,297 | 518,617 | 2,758,083 | 812,206 | |||||||||
Cash & Cash Equivalents - Beginning of Year | 8,021,212 | 2,345,164 | 10,915,590 | 3,638,673 | |||||||||
Cash & Cash Equivalents - End of Year | 8,152,907 | 6,653,639 | 8,152,907 | 6,653,639 | |||||||||
Supplementary cash flow information | |||||||||||||
Interest received | $ | 12,496 | $ | 3,931 | $ | 45,662 | $ | 98,584 | |||||
Interest paid | 156,900 | 10,993 | 217,367 | 54,610 | |||||||||
Income tax paid | 123,005 | 10,478 | 123,005 | 27,343 |
See accompanying notes to financial statements and accountant’s report
6
Sino Gas International Holdings, Inc. |
Notes to Consolidated Financial Statements |
For the three months and six months periods ended June 30, 2008 and 2007 |
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
Sino Gas International Holdings, Inc. (“the Company”) was incorporated under the laws of the State of Utah on August 19, 1983 as Evica Resources, Inc. The Company changed its name to American Arms, Inc. on April 5, 1984, and then changed its name to Dolce Ventures, Inc. on May 21, 2002, and ultimate changed its name to Sino Gas International Holdings, Inc. on November 17, 2006.
On September 7, 2006, the Company underwent a reverse-merger with Gas Investment China Ltd. (“GIC”), an International Business Company incorporated in the British Virgin Islands, and its wholly-owned subsidiaries, involving an exchange of shares whereby the Company issued an aggregate of 14,361,646 shares to the shareholders of GIC in exchange for all of the issued and outstanding shares of GIC. For financial reporting purposes, this transaction is classified as a recapitalization of Sino Gas International Holdings, Inc. (Legal acquirer, accounting acquiree) and the historical financial statements of Gas Investment China Co. Ltd. (Legal acquiree, accounting acquirer)
The Company is a natural gas services operator, principally engaging in the investment, operation and management of city gas pipeline infrastructure, in the distribution of natural gas to residential and industrial users, in the construction and operation gas stations, and in the development and application of natural gas related technologies. The Company owns and operates 24 natural gas distribution systems serving approximately 87,500 residential and five commercial and industrial customers. The Company’s facilities include approximately 700 kilometers of pipeline and delivery networks (including delivery trucks) with a designed daily capacity of approximately 70,000 cubic meters of natural gas.
The common stock of the Company is currently quoted on the National Association of Securities Dealers' Over-the-Counter Bulletin Board under the symbol “SGAS”.
Basis of Presentation and Organization
The Company’s consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”).
This basis of accounting differs in certain material respects from that used for the preparation of the books of account of the Company’s principal subsidiaries, which are prepared in accordance with the accounting principles and the relevant financial regulations applicable to enterprises with limited liabilities established in the PRC (“PRC GAAP”) or in the accounting standards used in the places of their domicile. The accompanying consolidated financial statements reflect necessary adjustments not recorded in the books of account of the Company’s subsidiaries to present them in conformity with US GAAP.
7
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) | Method of Accounting |
The Company maintains its general ledger and journals with the accrual method accounting for financial reporting purposes. The financial statements and notes are representations of management. Accounting policies adopted by the Company conform to generally accepted accounting principles in the United States of America and have been consistently applied in the presentation of financial statements, which are compiled on the accrual basis of accounting.
(b) | Use of estimates |
The preparation of the financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made; however actual results could differ materially from those estimates.
(c) | Economic and political risks |
The Company’s operations are conducted in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy.
The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.
(d) | Principles of Consolidation |
The consolidated financial statements include the accounts of the Company and its subsidiaries (“the Group”). Significant inter-company transactions have been eliminated in consolidation. Investments in which the company has a 20 percent to 50 percent voting interest and where the company exercises significant influence over the investor are accounted for using the equity method.
8
The Company owned its subsidiaries soon after its inception and continued to acquire and own the equity interests throughout the reporting periods. The following table depicts the identities of the consolidating subsidiaries as of March 31, 2008 and December 31, 2007 (whichever applicable 2007).
Name of Company | Place of Incorporation | Date of Incorporation | Beneficiary interest % | Equity Interest % | Registered Capital | |||||
GAS Investment China Co., Ltd. | The British Virgin Islands | 6/19/2003 | 100 | 100 | USD 10,000,000 | |||||
Sino Gas Construction Limited | The British Virgin Islands | 1/9/2007 | 100 | 100 | USD 50,000 | |||||
Sino Gas Investment Development Limited | The British Virgin Islands | 1/9/2007 | 100 | 100 | USD 50,000 | |||||
Beijing Zhong Ran Wei Ye Gas Co., Ltd | PRC | 8/29/2001 | 100 | 100 | RMB 150,000,000 | |||||
Peixian Weiye Gas Co., Ltd | PRC | 8/22/2005 | 100 | 90 | RMB 5,000,000 | |||||
Sihong Weiye Gas Co., Ltd | PRC | 12/3/2004 | 100 | 95 | RMB 10,000,000 | |||||
Wuhe Weiye Gas Co., Ltd | PRC | 1/30/2007 | 100 | 100 | RMB 3,000,000 | |||||
Changli Weiye Gas Co., Ltd | PRC | 12/8/2006 | 100 | 100 | RMB 3,000,000 | |||||
Yutian Zhongran Weiye Gas Co., Ltd | PRC | 12/19/2003 | 100 | 90 | RMB 3,000,000 | |||||
Yuxian Jinli Gas Co., Ltd | PRC | 11/8/2005 | 100 | 100 | RMB 9,500,000 | |||||
Zhangjiakou City Xiahuayuan Jinli Gas Co., Ltd. | PRC | 9/30/2005 | 100 | 100 | RMB 2,000,000 | |||||
Wuqiao Gas Co., Ltd | PRC | 6/30/2004 | 100 | 95 | RMB 2,000,000 |
9
Jinzhou Weiye Gas Co., Ltd | PRC | 7/19/2004 | 100 | 95 | RMB 5,000,000 | |||||
Shenzhou Weiye Gas Co., Ltd | PRC | 12/23/2005 | 100 | 95 | RMB 3,000,000 | |||||
Ningjin Weiye Gas Co., Ltd | PRC | 12/3/2003 | 100 | 95 | RMB 3,000,000 | |||||
Linzhang Weiye Gas Co., Ltd | PRC | 7/6/2005 | 100 | 85 | RMB 1,000,000 | |||||
Hengshui Weiye Gas Co., Ltd | PRC | 12/20/2005 | 100 | 100 | RMB 3,000,000 | |||||
Longyao Zhongran Weiye Gas Co., Ltd | PRC | 10/13/2005 | 100 | 95 | RMB 3,000,000 | |||||
9 | ||||||||||
Xingtang Weiye Gas Co., Ltd | PRC | 2/18/2004 | 100 | 95 | RMB 3,000,000 | |||||
Gucheng Weiye Gas Co., Ltd | PRC | 3/21/2007 | 100 | 100 | RMB 3,000,000 | |||||
Langfang Development Region Weiye dangerous Goods Transportation Co., Ltd | PRC | 3/22/2005 | 100 | 95 | RMB 1,000,000 | |||||
Beijing Chenguang Gas Ltd. | PRC | 10/30/2002 | 100 | 100 | RMB 20,000,000 | |||||
Xinji Zhongchen Gas Co., Ltd | PRC | 2/7/2007 | 100 | 100 | RMB 3,000,000 | |||||
Shijiazhuang Chenguang Gas Co., Ltd | PRC | 6/14/2007 | 100 | 100 | RMB 2,000,000 | |||||
Luquan Chenguang Gas Co., Ltd | PRC | 4/27/2007 | 100 | 100 | RMB 2,000,000 | |||||
Chenan Chenguang Gas Co., Ltd | PRC | 1/23/2007 | 100 | 100 | RMB 1,500,000 | |||||
Nangong Weiye Gas Co., Ltd | PRC | 6/25/2007 | 100 | 100 | RMB 3,000,000 | |||||
Sishui Weiye Gas Co., Ltd | PRC | 12/22/2004 | 100 | 95 | RMB 3,000,000 |
10
Guannan Weiye Gas Co., Ltd | PRC | 6/19/2003 | 100 | 100 | RMB 9,510,000 | |||||
Sixian Weiye Gas Co., Ltd | PRC | 9/3/2007 | 100 | 100 | RMB 3,000,000 | |||||
Baishan Weiye Gas Co., Ltd | PRC | 7/13/1007 | 100 | 100 | RMB 15,000,000 |
(e) | Cash and Cash Equivalents |
The Company considers all cash and other highly liquid investments with initial maturities of three months or less to be cash equivalents.
(f) | Accounts and Other Receivable |
Accounts and other receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible accounts, as needed. The Company extends unsecured credit to customers in the normal course of business and does not accrue interest on trade accounts receivable.
(g) | Advances to Suppliers |
Advances to suppliers represent the cash paid in advance for purchasing raw materials. The advances to suppliers are interest free and unsecured.
(h) | Investments in Equity Securities |
The equity method of accounting was used to account for the Company’s investment in equity securities for which the Company did not have controlling equity interest. Non controlling equity interest for the Company is typically a position of less than 50% beneficial ownership.
The consolidated statement of income includes the Company's share of the post-acquisition results of the investment’s performance for the year. In the consolidated balance sheet, investments in equity securities are stated at the Company's share of the net assets of the investments plus any potential premium, or less discounts paid at the time of acquisition, and less any identified impairment loss.
Beijing Zhongran Xiangke Oil Gas Technology Co. Ltd is the Company’s 40% owned investment and is principally engaged in sale of compressed natural gas to domestic households and industrial firms around the suburbs of Beijing as well as the suburban areas of the Hebei Province and Tianjin.
11
Nominal | ||||||||||
Name of | Place | Form of | Value of | |||||||
Associate | of | Business | Registered | Registered | Principal | |||||
Company | Registration | Structure | Capital | Capital | Activities | |||||
Beijing Zhongran Xiangke Oil Gas Technology Co. Ltd | PRC | Sino foreign equity joint venture | RMB 20,000,000 | 40 | Trading of natural gas and gas pipeline construction |
The Company did not record any goodwill when it acquired its equity position in Xiangke. Accordingly, in accordance with SFAS 142, the Company has not taken an amortization expense of goodwill during the time it has carried a 40% stake in Xiangke.
(i) | Accounting for the Impairment of Long-Lived Assets |
The long-lived assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. It is reasonably possible that these assets could become impaired as a result of technology or other industry changes. Determination of recoverability of assets to be held and used is by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the assets.
If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
During the reporting periods, there was no impairment loss.
(j) | Plant and Equipment |
Plant and equipment, other than construction in progress, are stated at cost less depreciation and amortization and accumulated impairment loss.
Plant and equipment are carried at cost less accumulated depreciation. Depreciation is provided over their estimated useful lives, using the straight-line method. Estimated useful lives of the plant and equipment are as follows:
Gas Pipelines (Up to December 31, 2007) | 25 years | |||
Gas Pipelines (Starting from January 1, 2008) | 50 years | |||
Motor Vehicles | 10 years | |||
Machinery & Equipment | 20 years | |||
Buildings | 25 years | |||
Leasehold Improvements | 25 years | |||
Office Equipment | 8 years |
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The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the statement of income. The cost of maintenance and repairs is charged to income as incurred, whereas significant renewals and betterments are capitalized.
(k) | Intangible Assets |
Intangible assets, are stated at cost less amortization and accumulated impairment loss. Amortization is provided over their estimated useful lives, using the straight-line method. Estimated useful lives of the intangibles are as follows:
Land use rights | 40 - 50 years | |||
Franchises | 30 years | |||
Other intangibles | 3 years |
(l) | Construction in Progress |
Construction in progress represents the cost of constructing pipelines and is stated at cost. Costs comprise direct and indirect incremental costs of acquisition or construction. Completed items are transferred from construction in progress to the gas pipelines of fixed assets when they are ready for their intended use. The major cost of construction relates to construction materials, direct labor wages and other overhead. Construction of pipeline, through which to distribute natural gas, is one of the Group’s principal businesses. The Group builds city main pipeline network and branch pipeline network to make gas connection to resident users, industrial, and commercial users, with the objective of generating revenue on gas connection and gas usage fees collected from these customers. As of March 31, 2008, the pipelines under construction include mainly the projects in Beijing. These projects, once completed, will significantly increase the gas supply capacity.
(m) | Unearned Revenue |
Unearned revenue represents prepayments by customers for gas purchases and advance payments on construction and installation of pipeline contracts. The Company records such prepayment as unearned revenue when the payments are received.
(n) | Financial Instruments |
The carrying amounts of all financial instruments approximate fair value. The carrying amounts of cash, accounts receivable, accounts payable and accrued liabilities approximate fair value due to the short-term nature of these items. The carrying amounts of borrowings approximate the fair value based on the Company’s expected borrowing rate for debt with similar remaining maturities and comparable risk.
13
(o) | Foreign Currency Translation |
The accompanying consolidated financial statements are presented in United States dollars. The functional currency of the Company is the Renminbi (RMB). The consolidated financial statements are translated into United States dollars from RMB at March 31, 2008 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 transactions occurred.
6/30/2008 | 3/31/2008 | 12/31/2007 | ||||||||
Years end RMB : US$ exchange rate | 6.8718 | 7.0222 | 7.3141 | |||||||
Average yearly RMB : US$ exchange rate | 7.0726 | 7.1757 | 7.6172 |
The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US$ at the rates used in translation.
(p) | Revenue Recognition |
Revenue is recognized when services are rendered to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as unearned revenue.
Net sales consist of gas and connection fee revenue. Cost of sales include gas and connection cost.
Gas connection revenue is recognized when the outcome of a contract can be estimated reliably and the stage of completion at the balance sheet date can be measured reliably.
Sales of natural gas are recognized when goods are delivered and title has passed.
(q) | Investment Income |
Investment income represents the Group’s share of post-acquisition results of its investment in equity securities for the year.
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(r) | Income Taxes |
Deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. As of December 31, 2007, there was no significant book to tax differences.
Pursuant to the tax laws of PRC, general enterprises are subject to income tax at an effective rate of 33%. Beijing Gas is in the natural gas industry whose development is encouraged by the government. According to the income tax regulation, any company engaged in the natural gas industry enjoys a favorable tax rate. Also, Beijing Gas is exempt from corporate income tax for its first two years and is then entitled to a 50% tax reduction for the succeeding three years. The Company’s first profitable tax year was 2003. Accordingly, the Company’s income is subject to a reduced tax rate of 7.5%. From 2008 onwards, the Company’s income is subject to a reduced tax rate of 9%. Subsidiaries of Beijing Gas are subject to the effective rate of 25%.
(s) | Advertising |
The Group expensed all advertising costs as incurred
(t) | Concentration of Credit Risk |
Concentration of credit risk is limited to accounts receivable and is subject to the financial conditions of major customers. The Company does not require collateral or other security to support accounts receivable. The Company conducts periodic reviews of its clients’ financial condition and customers’ payment practices to minimize collection risk on accounts receivable.
(u) | Retirement Benefits |
Retirement benefits in the form of contributions under defined contribution retirement plans to the relevant authorities are charged to the statements of income as incurred.
(v) | Statutory Reserves |
As stipulated by the Company Law of the People's Republic of China (PRC) as applicable to Chinese companies with foreign ownership, net income after taxation can only be distributed as dividends after appropriation has been made for the following:
15
i. | Making up cumulative prior years' losses, if any; |
ii. | Allocations to the "Statutory surplus reserve" of at least 10% of income after tax, as determined under PRC accounting rules and regulations, until the fund amounts to 50% of the Company's registered capital; |
iii. | Allocations to the discretionary surplus reserve, if approved in the shareholders' general meeting. |
(w) | Statement of Cash Flows |
In accordance with Statement of SFAS 95, “Statement of Cash Flows”, cash flows from the Company’s operations is calculated based upon the local currencies. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.
(x) | Comprehensive Income |
Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, all items that are required to be recognized under current accounting standards as components of comprehensive income are required to be reported in a financial statement that is presented with the same prominence as other consolidated financial statements. The Company’s current component of other comprehensive income is the foreign currency translation adjustment.
(y) | Recent Accounting Pronouncements |
In December 2007, the Financial Accounting Standards Board issued FASB Statement No. 141 (Revised 2007), Business Combinations (“SFAS 141R”). SFAS 141R provides additional guidance on improving the relevance, representational faithfulness, and comparability of the financial information that a reporting entity provides in its financial reports about a business combination and its effects. This Statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company believes there will be no material impact on its financial statements upon adoption of this standard.
In December 2007, the Financial Accounting Standards Board issued FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (“SFAS 160”). SFAS 160 amends ARB No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This Statement is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company believes there will be no material impact on its financial statements upon adoption of this standard.
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In December 2007, the FASB issued SFAS 141 (revised 2007), Business Combinations, (‘‘SFAS 141(R)’’). SFAS 141(R) retains the fundamental requirements of the original pronouncement requiring that the purchase method be used for all business combinations, but also provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired and liabilities assumed arising from contingencies, the capitalization of in-process research and development at fair value, and the expensing of acquisition-related costs as incurred. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008. In the event that the Company completes acquisitions subsequent to its adoption of SFAS 141 (R), the application of its provisions will likely have a material impact on the Company’s results of operations, although the Company is not currently able to estimate that impact.
In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements − an amendment of ARB No. 51. SFAS 160 requires that ownership interests in subsidiaries held by parties other than the parent (previously referred to as minority interests), and the amount of consolidated net income, be clearly identified, labeled and presented in the consolidated financial statements. It also requires once a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value. Sufficient disclosures are required to clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners as components of equity. It is effective for fiscal years beginning after December 15, 2008, and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements are applied prospectively. The Company does not expect the adoption of SFAS 160 to have a material impact on its financial condition or results of operations.
The Company does not anticipate that the adoption of the above standards will have a material impact on these consolidated financial statements.
(Z) | Earnings Per Share |
Basic earnings per share is computed on the basis of the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method for warrants and the as-if method for convertible securities. Dilutive potential common shares include outstanding warrants, and convertible preferred stock.
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3. | RESTRICTED CASH |
Restricted Cash represents compensating balances held at banks to partially secure banking facilities in the form of loans and notes payable. The imposed restrictions dictate that funds cannot be withdrawn when there are outstanding loans and notes payable, and the funds are only allowed to be used to settle bank indebtedness. The funds deposited as compensating balances are interest bearing. The amount of cash restricted varies based on the Bank’s credit policy at the time that the Company requests for increase or extension of credit facilities.
4. | ACCOUNTS RECEIVABLE |
For natural gas sales, it is due when the gas is sold. Normally, most of them are settled by prepayments from the customers.
In general for construction projects, deposits of 30% of total contract sum are received from client when the project commences. Second payment of 30% is received after the construction is completed for around 6 months. The final sum of the remaining portion normally acts as retention money for quality warranty to the developer. The retention money would be received by the company after the 1 year warranty period.
The phrase "receivables are due within one year of aging" means the receivable that are within one year of aging.
The "amounts are not due within one year" are mostly retention money from construction sales that are based on contracts. The continued demand from the natural gas sales from them also help assure the amount could be collected. No experience of wholly-unsettled accounts receivable in the year June 30, 2008 and December 31, 2007
Trade accounts receivable are recorded at the invoiced amount, net of allowances for doubtful accounts and sales returns. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company determines the allowance based on historical write-off experience, customer specific facts and economic conditions. Bad debt expense is included in the general and administrative expenses.
Outstanding account balances are reviewed individually for collectibles. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. To date, the Company has not charged off any balances as it has yet to exhaust all means of collection. The Company does not have any off-balance-sheet credit exposure to its customers, except for outstanding notes receivable discounted with banks that are subject to recourse for non-payment.
The credit and billing policy is that, for the residential customer, we collect prepayment from customers; for the industrial customers, we settle the payment based on the contract terms signed, from 10 days to one month; for the construction business, we collect the payment from customer based on the percentage of the construction progress. The risk that business faces from inability to collect account is Operation risk in industrial customers.
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Accounts Receivable | |||||||
6/30/2008 | 12/31/2007 | ||||||
Gross accounts receivable | $ | 5,961,402 | $ | 7,352,013 | |||
Allowance for bad debt | (28,219 | ) | (36,760 | ) | |||
Net accounts receivable | $ | 5,933,183 | $ | 7,315,253 |
Allowance for Bad Debt | |||||||
6/30/2008 | 12/31/2007 | ||||||
Beginning balance | $ | 36,760 | $ | 32,838 | |||
Addition | 17,191 | 26,909 | |||||
Less - write off | (25,732 | ) | (22,987 | ) | |||
Ending balance | $ | 28,219 | $ | 36,760 |
Accounts Receivable Aging Report | |||||||
6/30/2008 | 12/31/2007 | ||||||
30 Days | $ | 5,102,537 | $ | 5,557,172 | |||
30-60 Days | 237,327 | 1,212,413 | |||||
60-90 Days | 474,655 | 8,747 | |||||
90-180 Days | 23,733 | - | |||||
180-360 Days | - | 27,489 | |||||
>360 Days | 94,931 | 509,433 | |||||
Total | $ | 5,933,183 | $ | 7,315,254 |
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The followings are the largest ten accounts receivable as of June 30, 2008
Accounts Receivable | ||||
6/30/2008 | ||||
Hebei zhonggang Steel, Ltd. | $ | 209,407 | ||
Peixuan Jiannan Development, Co., | 275,925 | |||
Beijing Xianjin Construction, Ltd. | 276,267 | |||
Hebei Oil Management Machine, Ltd. | 280,852 | |||
Xuzhou Shenyuan Real Estate, Co., | 317,564 | |||
Baishang Jiehe Construction Development, Co., | 336,611 | |||
Jianshu Hongzhe Farm | 359,716 | |||
Sihong Jinwan Development, Ltd. | 372,533 | |||
Guannan Construction & Development, Co., | 439,866 | |||
Lianyun Port Development, Ltd. | 675,141 | |||
Total | $ | 3,543,882 |
5. OTHER RECEIVABLES
The followings are the ten largest other receivables as of June 30, 2008
Other receivables | ||||
6/30/2008 | ||||
Qujin Development & Investment, Ltd. | $ | 58,882 | ||
Langfang Transportation, Ltd. | 20,373 | |||
West House, Co., | 21,731 | |||
Shenzhen Chengtong Investment, Co., | 24,251 | |||
Peixuan Construction Department | 29,104 | |||
Tongshang Jieye, Ltd. | 37,189 | |||
Beijing Natural Gas Investment, Ltd. | 43,657 | |||
Tianjin Feite Consultant, Co., | 436,567 | |||
Shanghou Debt Corp. | 1,901,929 | |||
Baoding City Management Department | 2,910,446 | |||
Total | $ | 5,484,129 |
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6. PROPERTY, PLANT AND EQUIPMENT
Property, Plant and Equipment consist of the following as of June 30, 2008 and December 31, 2007
6/30/08 | 12/31/07 | ||||||
At Cost | |||||||
Gas Pipelines | $ | 21,283,153 | $ | 18,885,734 | |||
Motor Vehicles | 5,262,742 | 4,874,685 | |||||
Machinery & Equipment | 798,610 | 885,997 | |||||
Buildings | 1,405,640 | 1,405,638 | |||||
Leasehold Improvements | 70,970 | 68,942 | |||||
Office Equipment | 186,000 | 105,336 | |||||
Total | $ | 29,007,115 | $ | 26,226,336 | |||
Less: Accumulated Depreciation | (2,512,423 | ) | (1,653,771 | ) | |||
Property, Plant and Equipment, net | $ | 26,494,692 | $ | 24,572,565 |
03/31/08 | 12/31/07 | ||||||
Accumulated Depreciation | |||||||
Gas Pipelines | $ | 1,194,117 | $ | 591,419 | |||
Motor Vehicles | 884,844 | 687,354 | |||||
Machinery & Equipment | 169,335 | 161,703 | |||||
Buildings | 167,586 | 128,514 | |||||
Leasehold Improvements | 39,861 | 34,070 | |||||
Office Equipment | 56,680 | 50,711 | |||||
Total | $ | 2,512,423 | $ | 1,653,771 |
Depreciation expense included in the consolidated statements of income for the period ended June 30, 2008 was $858,653.
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7. INTANGIBLE ASSETS
Intangible assets consist of the following as of June 30, 2008 and December 31, 2007
6/30/08 | 12/31/07 | ||||||
At Cost | |||||||
Land use rights | $ | 510,328 | $ | 452,345 | |||
Franchises | 400,186 | 359,464 | |||||
Goodwill | 1,662,752 | 1,562,202 | |||||
Other | 15,225 | 9,563 | |||||
Total | $ | 2,588,491 | $ | 2,383,574 | |||
Less: Accumulated Amortization | (399,319 | ) | (355,324 | ) | |||
Intangible Assets, net | $ | 2,189,172 | $ | 2,028,250 |
The Group operates as a local natural gas distributor in a city or county, known as an operation location, under an exclusive franchise agreement between the Group and the local government or entities in charge of gas utility. Franchises are the rights to develop sites in Anping and Jinzhou in China. They are stated at cost less accumulated amortization.
8. SHORT-TERM BANK LOANS
Short-term bank loans are as follows:
3/31/2008 | 12/31/2007 | ||||||
Loans from China Renmin Bank Co.,Ltd. | |||||||
Interest rate at 7.22% per annual plus 10% fluctuation market rate | $ | 2,910,446 | $ | 2,734,444 | |||
Loans from Huashang Bank Co., Ltd. | 4,365,668 | - | |||||
Total | $ | 7,276,114 | $ | 2,734,444 |
Interest expenses for the short-term bank loans were $216,567 and $55,405 for the six months ended June 30, 2008, and the twelve months ended December 31, 2007.
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9. OTHER PAYABLES
Other payables at June 30, 2008 and December 31, 2007 consist of the following:
6/30/2008 | 12/31/2007 | ||||||
Employees’ welfare payables | $ | 194,199 | $ | 176,236 | |||
Amount due to employees | 23,140 | 150,711 | |||||
Tax payable | 179,792 | 922,620 | |||||
Other Payable | 6,199,961 | 9,134,091 | |||||
Total | $ | 6,597,092 | $ | 10,383,657 |
All the amounts due to employees are unsecured, interest free, and have no fixed repayment terms.
The followings are the ten largest other payables as of June 30, 2008
6/30/2008 | ||||
Caiyou Haoche Rental, Co., | $ | 26,236 | ||
Education Associate | 44,498 | |||
Work Union Associate | 66,261 | |||
He Shunchun | 72,761 | |||
Social Insurance Associate | 137,016 | |||
Shenzhen Polian Shiye, Ltd. | 203,731 | |||
Beijing Qianshi Development, Co., | 241,852 | |||
Liu Yuchuan | 291,045 | |||
Chenguang Consulatant, Ltd. | 436,567 | |||
Baishang Gas, Ltd. | 3,986,675 | |||
$ | 5,506,642 |
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10. CAPITAL STOCK
The authorized capital stock consists of (i) 250,000,000 shares of common stock, par value $0.001 per share, of which there are 25,489,753 shares issued and outstanding, and (ii) 100,000,000 shares of preferred stock, par value $0.001 per share. The preferred stock consists of (i) series A convertible preferred stock, of which 20,000,000 shares have been authorized and 275,111 shares are issued and outstanding; and (ii) series B convertible preferred stock, of which 5,000,000 shares have been authorized and 4,764,486 shares are issued and outstanding.
The following is a summary of the material terms of its capital stock. This summary is subject to and qualified in its entirety by its Articles of Incorporation, as amended and corrected, certificates of designations for its series A and series B convertible preferred stock, its by-laws and by the applicable provisions of Utah law.
Common Stock
The Company is authorized to issue 250,000,000 shares of common stock, with a par value of $0.001. There are 25,489,753 shares of common stock issued and outstanding as of June 30, 2008. All shares of common stock have one vote per share on all matters including election of directors, without provision for cumulative voting. The common stock is not redeemable and has no conversion or preemptive rights. The common stock currently outstanding is validly issued, fully paid and non-assessable. In the event of liquidation of the company, the holders of common stock will share equally in any balance of the company's assets available for distribution to them after satisfaction of creditors and preferred shareholders, if any. The holders of common stock are entitled to equal dividends and distributions per share with respect to the common stock when, as and if, declared by the board of directors from funds legally available.
Preferred Stock
In addition to the 250,000,000 shares of common stock, The Company is authorized to issue 100,000,000 shares of preferred stock, with a par value of $0.001 per share. Shares of the preferred stock may be issued from time to time in one or more classes or series, each of which class or series shall have such distinctive designation or title as shall be fixed by the board of directors prior to the issuance.
On August 30, 2006, the Company’s board of directors designated 20,000,000 shares of its authorized $0.001 par value per share preferred stock as series A convertible preferred stock and 5,000,000 shares of its preferred stock as series B convertible preferred stock. On August 31, 2006, the Company filed certificates of designations for the series A and series B convertible preferred stock with the Office of the Secretary of State of Utah. On September 6, 2006, the board of directors amended the designations of the Series B convertible preferred stock and the Company filed an amended certificate of designations for the Series B convertible preferred stock with the Office of the Secretary of State of Utah. The board of directors created the series A convertible preferred stock to allow the Company to consummate the share exchange transaction with the Gas (BVI) Shareholders and the series B convertible preferred stock in connection with its private financing transactions, although the Company does not have sufficient unissued authorized common stock to allow for a complete conversion. Each of the shares of series A convertible preferred stock was automatically converted into one share of its common stock upon the effectiveness of its reverse stock-split on November 17, 2006. Therefore, as of December 31, 2006, the Company has no shares of series A convertible preferred stock issued and outstanding.
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Conversion
The Company issued 14,361,646 of its common shares upon the automatic conversion of its series A convertible preferred shares after the 304.44-for-1 reverse stock-split on November 17, 2006. The Company no longer has any series A convertible preferred shares outstanding.
Each share of the series B convertible preferred stock will become convertible into common stock, at the option of its holder after the 304.44-for-1 reverse stock-split, based on the then applicable conversion rate, which is initially one share of series B convertible preferred stock for one share of common stock.
Total Capitalization
The Following table depicts an analysis of total capitalization for the issuance of Preferred Stock A, Preferred Stock B, Common Stock, and the related additional Paid in Capital as of June 30, 2008:
Preferred Stock A | Preferred Stock B | Common Stock | |||||||||||||||||||||||
Name of Shareholder | Number of Shares Outstanding | Capital | Number of Shares Outstanding | Capital | Number of Shares Outstanding | Capital | Additional Paid in Capital | % of Equity Holdings | |||||||||||||||||
Private Investor | 275,111 | 275 | - | - | - | - | 1,210,213 | 0.90 | % | ||||||||||||||||
Investor Relations firm | - | - | 4,764,486 | 4,765 | 207,373 | 207 | 6,994,270 | 16.29 | % | ||||||||||||||||
Management / Insider | - | - | - | - | 12,653,661 | 12,654 | 4,252,959 | 41.45 | % | ||||||||||||||||
Investor - 1st Round Raising | - | - | - | - | 5,628,722 | 5,629 | 2,997,371 | 18.44 | % | ||||||||||||||||
Less: Cost of Stock Issurance | - | - | - | - | - | - | (412,241 | ) | - | ||||||||||||||||
Investor - 2nd Round Raising | - | - | - | - | 6,999,997 | 7,000 | 15,743,000 | 22.93 | % | ||||||||||||||||
Less: Cost of Stock Issurance | - | - | - | - | - | - | (1,957,133 | ) | - | ||||||||||||||||
Beneficial Conversion Feature | - | - | - | - | - | - | 6,418,864 | - | |||||||||||||||||
275,111 | 275 | 4,764,486 | 4,765 | 25,489,753 | 25,490 | 35,247,303 | 100.00 | % |
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11. SEGMENT INFORMATION
The Company has contracted with customers usually in two revenue segments altogether, one is for the construction and installation of gas facilities and another one is the subsequent sales of gas to that customers through the gas facilities the Company constructs. However, the respective gas facilities contracts and gas supply contracts have separately provided for the basis of revenue recognition and distinctive from each other for the relevant cost-and-revenue to be incurred and hence separate calculation and subsequent payment of fees for respective business without any interdependence on each other in this respect.
For management purposes, the company is currently organized into two major operating divisions - gas pipeline construction (installation of gas facilities) and sales of piped gas. These principal operating activities are the basis on which the Company reports its primary segment information.
6/30/2008 Balance Sheet Segment Report | |||||||||||||
As of June 30, 2008 | |||||||||||||
Gas Distribution | Gas pipeline Installation | Others | Total | ||||||||||
Assets | |||||||||||||
Current Assets | $ | 15,883,136 | $ | 5,264,012 | $ | 4,091,781 | $ | 25,238,929 | |||||
Non-Current Assets | 12,014,339 | 35,745,947 | - | 47,760,286 | |||||||||
Total Assets | $ | 27,897,475 | $ | 41,009,959 | $ | 4,091,781 | $ | 72,999,215 | |||||
Liabilities | |||||||||||||
Current Liabilities | 1,690,577 | 18,091,509 | - | 19,782,086 | |||||||||
Total Liabilities | $ | 1,690,577 | $ | 18,091,509 | $ | - | $ | 19,782,086 | |||||
Net Assets | $ | 26,206,898 | $ | 22,918,450 | $ | 4,091,781 | $ | 53,217,129 |
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6/30/2008 Income Statement Segment Report | |||||||||||||
Gas Distribution | Gas pipeline Installation | Others | Total | ||||||||||
Sales Revenue | $ | 6,553,899 | $ | 2,909,739 | $ | - | $ | 9,463,638 | |||||
Cost of Revenue | (5,709,186 | ) | (820,877 | ) | - | (6,530,063 | ) | ||||||
Gross Profit | 844,713 | 2,088,862 | - | 2,933,575 | |||||||||
Operating Expense | (494,742 | ) | (1,223,431 | ) | (646,603 | ) | (2,364,776 | ) | |||||
Other Income | (67,795 | ) | (167,648 | ) | 38,633 | (196,811 | ) | ||||||
Earnings before tax | 282,176 | 697,783 | (607,971 | ) | 371,988 | ||||||||
Income tax | (87,190 | ) | (215,608 | ) | - | (302,798 | ) | ||||||
Income from continuing operation | 194,986 | 482,174 | (607,971 | ) | 69,190 | ||||||||
Extraordinary Loss, net | - | - | (456,751 | ) | (456,751 | ) | |||||||
Net Income | $ | 194,986 | $ | 482,174 | $ | (1,064,722 | ) | $ | (387,561 | ) |
Balance Sheet Segment Report | |||||||||||||
As of December 31, 2007 | |||||||||||||
Gas Distribution | Gas pipeline Installation | Others | Total | ||||||||||
Assets | |||||||||||||
Current Assets | 11,509,765 | 3,814,583 | 7,866,957 | 23,191,305 | |||||||||
Non-Current Assets | 10,606,803 | 31,558,142 | - | 42,164,945 | |||||||||
Total Assets | 22,116,568 | 35,372,725 | 7,866,957 | 65,356,250 | |||||||||
Liabilities | |||||||||||||
Current Liabilities | 1,228,727 | 13,149,074 | 131,843 | 14,509,644 | |||||||||
Total Liabilities | 1,228,727 | 13,149,074 | 131,843 | 14,509,644 | |||||||||
Net Assets | 20,887,841 | 22,223,651 | 7,735,114 | 50,846,606 |
27
Income Statement Segment Report | |||||||||||||
For the six months ended June 30, 2007 | |||||||||||||
Gas Distribution | Gas pipeline Installation | Others | Total | ||||||||||
Sales Revenue | $ | 3,245,311 | $ | 1,989,061 | $ | - | $ | 5,234,372 | |||||
Cost of Revenue | (2,313,736 | ) | (1,418,097 | ) | - | (3,731,833 | ) | ||||||
Gross Profit | 931,574 | 570,965 | - | 1,502,539 | |||||||||
Operating Expense | (550,779 | ) | (337,574 | ) | - | (888,353 | ) | ||||||
Other Income | 27,350 | 6,004 | - | 33,354 | |||||||||
Earnings before tax | 408,146 | 239,394 | - | 647,540 | |||||||||
Income tax | (4,922 | ) | (22,421 | ) | - | (27,343 | ) | ||||||
Net Income | $ | 403,224 | $ | 216,973 | $ | - | $ | 620,197 |
The Company's operations are located in the PRC. All revenue is from customers in the PRC. All of the Company’s assets are located in the PRC. Sales of piped gas and gas pipeline construction are carried out in the PRC. Accordingly, no analysis of the Company's sales and assets by geographical market is presented.
No other measures of segment profit or loss and assets have been provided or reviewed by the company's chief operating decision maker.
12. EXTRAORDINARY EVENT
The Company entered into a registration rights agreement related to a private placement financing transaction with accredited investors on September 13, 2007. Pursuant to the agreement, the Company had to (1) file the registration statement within 45 days of the execution, and (2) declare the effectiveness within 150 days of filing the registration statement. However, the Company did not meet the aforementioned requirements under the registration rights agreement, and was subjected to liquidated damages. The Company, which has paid $456,751 in liquidated damages to investors in May 2008, was reported as extraordinary loss net in the statements of income.
28
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes to those financial statements appearing elsewhere in this Form 10-Q. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, such as those set forth elsewhere in this Form 10-Q, our actual results may differ materially from those anticipated in these forward-looking statements.
Economic & Industrial Trend
We generate revenue from two sources: connection fees for constructing connections to our natural gas distribution network, and sales of natural gas. Our connection activities are closely related to the development of real estate industry in our targeting cities in China, given the fact that almost all of our connection fees are from new residential apartments. Natural gas facilities in new apartments are often required by local governments, who aim to promote the use of natural gas to improve local residents’ life quality.
We have experienced high growth of our connection activities since inception of our business, thanks to Chinese real estate boom in the past five years. We see no major factors that will change the trend of real estate industry in the coming year. Therefore we expect to continue to see growth of household connections, especially in small-to-medium sized cities where the real estate market is at an early developing stage.
If Chinese real estate market does slow down in the future, our connection business would be negatively affected as a result of fewer new household connections.
Our gas users are composed of industrial and residential users. Gas sales from residential users are much less affected by economic and industrial factors and would maintain stable growth in the future, due to the increasing pool of our residential customers. Gas sales from industrial users is subject to the operating performance of the end industrial user and development of new users. Gas sales to our industrial users have increased 89% during the first half of 2008, as our existing users have expanded their production capacity. As we develop into more cities, we expect to add one to two industrial users in the coming year.
Material Opportunities
The gas distribution market is quite fragmented in the small (population less than 100,000)-to-medium (population between 100,000 to 300,000) sized cities. We have been in active talks with potential project targets. The size of the projects varies from small cities, like the ones we have, to medium-sized cities. For small city markets, many of them are still untapped or undeveloped. The development of these markets is generally considered major growth components of the company.
Regarding medium-sized or large cities, most of them have already been developed by large distributors or are still operated by state-owned companies. Acquisition opportunities exist for those still run by state-owned companies, as the central government encourages suppliers to turn them into privately-owned companies. The acquisition of these markets would have material impact on the company, increasing the company’s assets and revenues significantly. The company has finalized one acquisition, and needs to raise money to fund another acquisition.
Material Challenges
There are vast number of small-to-medium sized cities left undeveloped, but the competition is intense, as there are many small new players in the market attracted by the profitability and growth potential of the business. Meanwhile, from time to time, we are also facing competitions from stronger competitors, as large city markets are getting saturated and our competitors are beginning to expand into smaller cities.
29
We are facing limited opportunities in developing into first-tier cities in China, as most of them have already been taken by other large gas distributors, such as Xin’ao Gas Co. Ltd (largest in China) in the past decade.
Still, potential users in small and medium-sized cities need to be educated by the benefits of natural gas. It takes some time for them to get to know how natural gas can improve the quality of life. This is especially true for new markets, where there is no use of natural gas. Small cities tend to be more reluctant for use of new energies than large cities where residents depend more on coal, rather than natural gas.
China’s energy market is highly regulated by the government, with regard to purchase price and sale price of natural gas. Whenever there is an adjustment to purchase price by the government, gas distributors would increase the sale price correspondingly, subject to a public hearing and government approval. The increase of natural gas price in China is lagging behind that in the international markets, which has soared in the past year. The Chinese government has seldom adjusted natural gas and we can not rule out the possibilities of increase of natural gas price by the government in the future. Even though we can adjust the sale price accordingly after the increase of purchase price, passing the increase to end users. However, it would make natural gas more expensive, as compared to other alternative energies. Thus this increase of price will deter our business development.
Risks in Short-Term and Long-Term
In each of the cities we are developing and aiming to develop, the real estate market is the major factor that impacts us. Most of our residential customers are the new home buyers. If the real estate market turns downward, the demands for new homes would decrease, resulting in fewer natural gas connections, and thus negatively impacting our business.
To reduce the company’s heavy dependence on connection fees, the company is looking at opportunities to diversify its business by expanding into related areas, such as pipeline and gas station business. However, we do not expect to develop into those areas in large scale any time soon and it may take some time for those business to become our major business.
Liquidity and Capital Resources
Natural gas distribution is a typical capital-intensive industry, which requires a large amount of capital for the construction of pipelines and gas stations, purchase of transportation vehicles etc. while the investment would be paid back in the following year with increasing new household connections. Under the organic growth model (growth by the Company without outside funding), the Company can develop new city projects by using the money generated from existing cities. The Company would be constrained by inadequate capital when developing into bigger cities or making Merger &Acquisition activities, under which situation the company needs to raise money to finance its business expansion.
Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007
During the three months ended June 30, 2008, our company achieved strong increases in financial and operational results. Our net revenues and gross profit were $ 5,121,521 and $ 1,566,930, respectively, representing an increase of 83.16% and 73.73%, respectively, from those of the same period in the previous year. Our operating income in 2008 was $217,308, representing a decrease of 57.49% from 2007.
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For the 3 months ended June 30, | ||||||||||
2008 | 2007 | Change | ||||||||
US$ | US$ | % | ||||||||
Net Revenues | 5,121,521 | 2,796,145 | 83.16 | % | ||||||
Gross Profit | 1,566,930 | 901,942 | 73.73 | % | ||||||
Operating Income | 217,308 | 511,161 | -57.49 | % | ||||||
Net Income | -536,888 | 504,814 | -206.35 | % | ||||||
Gross Margin | 30.60 | % | 32.26 | % | ||||||
Net Margin | -10.48 | % | 18.05 | % |
Net Revenues
We generate revenues from two sources: connection fees for constructing connections to our natural gas distribution network, and sales of natural gas.
Total net revenues for the three months ended June 30, 2008 were $5,121,521, compared to $2,796,145 for the same period in 2007, representing an increase of 83.16%. The increase was due to new customers’ connecting to our gas distribution network and new customers’ purchasing our natural gas. During this period, we connected 7,096 new residential households to our gas distribution network, resulting in total connection fees of $1,555,041. Gas sales during the same period amounted to 10.55 million cubic meters, or $3,566,480. In comparison, we connected 4,326 new residential households to our gas distribution network in 2007, resulting in total connection fees of $1,370,536. Gas sales during the period amounted to 5.41 million cubic meters, or $1,425,609.
For the 3 months ended June 30, | ||||||||||||||||
2008 | 2007 | Change | ||||||||||||||
(In $ million) | US$ | % | US$ | % | % | |||||||||||
Net Revenues | 5.12 | 100 | % | 2.80 | 100 | % | 83.16 | % | ||||||||
Connection Fees | 1.56 | 30 | % | 1.37 | 49 | % | 13.46 | % | ||||||||
Gas Sales | 3.57 | 70 | % | 1.43 | 51 | % | 150.17 | % |
Connection Fees
Connection fees during the three months ended June 30, 2008 were $1.56 million, representing an increase of 13.46% over the same period of 2007, accounting for 30% of the total net revenue compared with approximately 49% for the same period in 2007. With regard to the source of connection fees, 100% of total connection fees came from the development of new residential users. We connected 7,096 residential users during the three months ended June 30, 2008, an increase of approximately 64.03% from 2007.
For the 3 months ended June 30, | ||||||||||||||||
2008 | 2007 | Change | ||||||||||||||
(in US$ millions) | US$ | % | US$ | % | % | |||||||||||
Connection Fees | 1.56 | 100 | % | 1.37 | 100 | % | 13.46 | % | ||||||||
Residential Users | 1.56 | 100 | % | 1.37 | 100 | % | 13.46 | % | ||||||||
Industrial Users | 0.00 | 0 | % | 0.00 | 0 | % | 0 | % |
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Such increase was primarily attributable to the following aspects.
We tried our best to develop more residential customers in those cities of which we have obtained franchise of natural gas distribution systems. Our invested projects in the three months ended June 30, 2008 connected 7,096 new residential households in the three months ended June 30, 2008, resulting in approximately $1, 555,041 to our total connection fees. In comparison, during the same period of 2007, we connected 4,326 new residential households to our gas distribution network, resulting in total connection fees of $1,370,536.
The table below is a breakdown of our top five customers by connection fees:
Customers | Connection Fees: ($ million) | |||
Oriental Sun City Real Estate Development Co. Ltd | 0.2453 | |||
Shanghai Datun Energy Co. Ltd | 0.1396 | |||
Peixian Wuzhou Real Estate Development Co. | 0.1156 | |||
Beijing Huiyou Real Estate Development Co. | 0.0901 | |||
Xuzhou Shenyuan Real Estate Development Co., Ltd. | 0.0882 |
Due to seasonality effects, the second quarter is usually a weak season for gas distribution companies in China in terms of recognition of revenue from connection fees. New construction projects are not finished in this quarter, and only a small portion of connection fees are achieved in this quarter.
Gas Sales
In terms of volume, we sold 10.55 million cubic meters of natural gas during the three months ended June 30, 2008, compared with 5.41 million cubic meters in 2007. In terms of value, gas sales were $3.57 million during the three months ended June 30, 2008, accounting for 70% of total net revenue in 2008, representing an increase of 150.17% over the year 2007. Gas sales to residential increased 423.61% from $0.26 million in 2007 to $1.34 million in 2008. Gas sales to industrial users increased 82.74%, from $0.71 million in 2007 to $1.29 million in 2008. Gas sales to commercial users increased 101.79%, from $0.46 million in 2007 to $0.93 million in 2008.
For the 3 months ended June 30, | ||||||||||||||||
2008 | 2007 | Change | ||||||||||||||
($ million) | US$ | % | US$ | % | % | |||||||||||
Gas Sales | 3.57 | 100 | % | 1.43 | 100 | % | 150.17 | % | ||||||||
Residential Users | 1.34 | 36 | % | 0.26 | 18 | % | 423.61 | % | ||||||||
Industrial Users | 1.29 | 37 | % | 0.71 | 50 | % | 82.74 | % | ||||||||
Commercial Users | 0.93 | 26 | % | 0.46 | 32 | % | 101.79 | % |
Such substantial increase was primarily attributable to the following aspect.
Our invested projects maintained steady and rapid development. During the three months ended June 30, 2008, 20.00 million cubic meters of gas were sold, resulting in approximately $3.57 million. In comparison, during the same period of last year, 10.94 million cubic meters of gas were sold, resulting in approximately $1.43 million.
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The table below is a breakdown of our major industrial customers for gas consumption in the second quarter of 2008.
Industrial Customers | Gas Usage (million cubic meters) | Gas Usage ($ million) | |||||
Hebei Zhonggang Steel Co., Ltd. | 2.6577 | 0.9311 | |||||
The First Machine Factory of Huabei Petrol Bureau | 0.4231 | 0.1430 | |||||
Tangshan Changsheng Ceramic Factory | 0.2837 | 0.0958 | |||||
Hebei Jihengyuan Group Ltd. | 0.1965 | 0.0885 | |||||
Elite (Langfang) Textile Corporation | 0.0747 | 0.0228 |
Gas sales of $0.9311 million were contributed by a single industrial user, Hebei Zhonggang Steel Co., Ltd. (“Hebei Zhonggang”), which started to use gas at the beginning of 2006. The gas consumption of Hebei Zhonggang has increased to 2.6577 million cubic meters during the three months ended June 30, 2008 from 1.3 million cubic meters in 2007.
As mentioned above, due to seasonality factors of our business, gas sales accounted for a relatively higher percentage of our total sales, though gas sales in absolute value remained relative stable throughout the year. Sales from industrial users are lower than that from residential users, due to our customer base grows.
Cost of Revenues
Cost of revenues for the three months ended June 30, 2008, which includes cost of connection and cost of gas sales was $3.55 million, an increase of 87.66%, from $1.66 million in the same period of 2007.
For the 3 months ended June 30, | ||||||||||||||||
2008 | 2007 | Change | ||||||||||||||
($ million) | US$ | % | US$ | % | % | |||||||||||
Cost of Revenues | 3.55 | 100 | % | 1.66 | 100 | % | 87.66 | % | ||||||||
Connection Cost | 0.39 | 11 | % | 0.52 | 27 | % | -24.27 | % | ||||||||
Gas Cost | 3.16 | 89 | % | 1.38 | 73 | % | 129.60 | % |
Cost of Connection
Our cost of connection during the three months ended June 30, 2008 was $0.39 million, or 11% of total cost of revenues. By comparison, the cost of connection during the same period of 2007 was $0.52 million, or 27% of total cost of revenue.
Cost of connection decreased around 24.27% from the same period in 2007, mainly due to the decreased cost of gas station maintenance resulting from the development of our gas stations. Increase of revenues from connection fees increased nearly 13% from the same period in 2007.
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Cost of connection includes depreciation of major pipelines, the cost of courtyard pipelines, valves, gas meters, and installation and maintenance fees.
Considering the city's overall planning and the long-term interests of our company, the capacity of the gas pipeline network we designed to distribute gas for a city usually greatly exceeded the number of households we served at the very beginning, which makes the cost of connection, specifically the depreciation of fixed assets and maintenance cost greatly increase. However, with connection of more households to the gas pipeline, the average cost to each household will be gradually reduced.
Cost of Gas Sales
The cost of gas sales increased 129.60% to $3.16 million during the three months ended June 30, 2008 from the same period in 2007, when it was $1.38 million. This increase is largely due to the increase of gas sales which increased 150.17%.
The cost of natural gas sales includes the purchase and transportation of natural gas and depreciation of delivery trucks.
The purchase price that gas distributors pay for natural gas, which is set by the PRC government, is approximately CNY 1.6 to 1.9 ($0.22 to $0.26) per cubic meter. We signed a ten-year gas supply agreement in 2003. It is tentatively prescribed that every year Petro China supplied a total of 10 million cubic meters of natural gas at CNY 1.55 ($0.212) per cubic meter between April 1 and October 31 and CNY 1.65 ($0.226) per cubic meter during the rest of the year. At the beginning of each year in the ten-year contract period, we negotiate with Petro China on the price and supply amount according to market conditions.
The table below details our major gas suppliers in three months ended June 30, 2008:
Gas Supplier | Gas Purchase (million cubic meters) | Gas Purchase ($ million) | |||||
Beijing Natural Gas Co. | 2.83 | 0.64 | |||||
North China Oil Field Fourth Oil Extraction Plant of Petro China | 2.19 | 0.45 | |||||
Tianjin Dagang Oilfield Transportation Co., Ltd. | 0.71 | 0.23 | |||||
Suqian Petro China Piped Gas Co. | 0.63 | 0.19 | |||||
Hebei Natural Gas Co. Ltd | 0.34 | 0.08 |
Gross Profit
Gross income increased from $0.9 million in 2007 to $1.57 million for 2008.
For the 3 months ended June 30, | ||||||||||||||||
2008 | 2007 | Change | ||||||||||||||
($ million) | US$ | % | US$ | % | % | |||||||||||
Gross Profit | 1.57 | 100 | % | 0.90 | 100 | % | 73.73 | % | ||||||||
Connection | 1.16 | 74 | % | 0.85 | 95 | % | 36.27 | % | ||||||||
Gas | 0.40 | 26 | % | 0.05 | 5 | % | 743.27 | % |
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During the three months ended June 30, 2008, gross profit was $1.57 million, an increase of approximately 73.73% from the same period of 2007. Gross profit from connection fees is $1.16 million for the three months ended on June 30, 2008, accounting for 74% of total gross profit. In comparison, gross profit from connection fees was $0.85 million for the same period of 2007, accounting for 95% of total gross profit. Gross profit from gas sales was $0.40 million, accounting for 26% of total gross profit, compared to $0.05 million, 5% of total gross profit in the same period of 2007.
Decrease of gross margin for connection is attributable to the increase of cost for connection fees. We believe that the gross margin for connection will greatly increase if the number of households we developed meets the capacity of pipeline network. Increase of gross margin for gas sales is attributable to the fact that the growth rate of gas sales is larger than the growth rate of cost of gas sales. We believe that the gross margin for gas sales will increase with a more considerable amount of gas consumption.
Selling and Marketing Expenses
Our selling and marketing expenses in the three months ended June 30, 2008 were $186,193 and approximately 3.64% of our net revenues, compared with $143,296, or 5.12% of net revenues in the same period of 2007.
In 2008, we acquired Tongshan Hengxin Jiaye Natural Gas Co., Ltd., and we incorporated one new subsidiary. The expansion of our company led to some increased staff salary, social insurance cost, travel and communications cost, and depreciation of fixed assets, which are attributable to increase of selling and marketing expenses.
General and Administrative Expenses
General and administrative expenses were $1.16 million for the three months ended June 30, 2008, which was 370% higher than $0.25 million for the same period last year.
The increase was largely due to our new 6 subsidiaries incorporated in the second half of 2007 and 2 in the first half of 2007, which led to increases in salary, social insurance, traveling expenses and other expenses. The new subsidiaries will definitely bring income of long-term. Nevertheless, the expenses from business operation occur simultaneously. Therefore, a good expense to revenue ration was unable to be achieved currently. The increase was also due in part to largely increased depreciation relating to new assets described above. We believe an upward trend in general and administrative expenses is inevitable in 2008.
And the increase was also resulted from the contingent payment of Gas Investment China Co., Ltd., and a joint signatory account in US.
Operating Income
The operating income for the three months ended Mar31, 2008 was $0.22 million, representing a decrease of 57.49%, compared to the operating income of $0.51 million in 2007.
Our company endured a unsatisfactory performance due to a prominent increase in contingent payments and a faster general and administrative expenses growth than revenues growth.
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Income tax
Income tax was $0.13 million for the three months ended June 30, 2008, compared to $0.01 million in 2007. The reason of increased income tax expense is due to the increase of tax rate from 7.5% to 25% as prepayment.
Beijing Gas is classified as a foreign high-tech enterprise by the tax regulatory authority, and therefore has enjoyed a favorable tax rate for the past five years, with an income tax rate of zero in 2004 and 7.5% from 2005 to 2007. The income tax rate is expected to be 15% in 2008, the standard rate for foreign high-tech enterprises.
The income tax rate of our subsidiaries is 20-25%, except for Beijing Chenguang and Beijing Gas. Beijing Chenguang has also been classified as a foreign high-tech enterprise and is subject to the favorable income tax rate of 7.5% from 2006 to 2008.
Net Income
Net income in the three months ended June 30, 2008 was -$0.54 million, representing a decrease of 206.35% from $0.50 million in the same period in 2007. The decrease was caused by the liquidated damages paid to the investors.
Six Months Ended June 30, 2008 Compared to Six Months Ended June 30, 2007
During the six months ended June 30, 2008, our company achieved strong increases in financial and operational results. Our net revenues and gross profit were $9,463,638 and $2,933,575, respectively, representing an increase of 80.80% and 95.24%, respectively, from those of the same period in the previous year. Our operating income in 2008 was $568,799, representing a decrease of 7.39% from 2007.
For the 6 months ended June 30, | ||||||||||
2008 | 2007 | Change | ||||||||
US$ | US$ | % | ||||||||
Net Revenues | 9,463,638 | 5,234,372 | 80.80 | % | ||||||
Gross Profit | 2,933,575 | 1,502,539 | 95.24 | % | ||||||
Operating Income | 568,799 | 511,161 | -7.39 | % | ||||||
Net Income | -387,561 | 620,197 | -162.49 | % | ||||||
Gross Margin | 31.00 | % | 28.71 | % | ||||||
Net Margin | -4.10 | % | 11.85 | % |
Net Revenues
We generate revenues from two sources: connection fees for constructing connections to our natural gas distribution network, and sales of natural gas.
Total net revenues for the six months ended June 30, 2008 were $9,463,638, compared to $5,234,372 for the same period in 2007, representing an increase of 80.80%. The increase was due to new customers’ connecting to our gas distribution network and new customers’ purchasing our natural gas. During this period, we connected 11,686 new residential households to our gas distribution network, resulting in total connection fees of $2,909,739. Gas sales during the same period amounted to 20.00 million cubic meters, or $6,553,899. In comparison, we connected 6,586 new residential households to our gas distribution network in 2007, resulting in total connection fees of $1,985,872. Gas sales during the period amounted to 11.73 million cubic meters, or $3,248,500.
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For the 6 months ended June 30, | ||||||||||||||||
2008 | 2007 | Change | ||||||||||||||
(In $ million) | US$ | % | US$ | % | % | |||||||||||
Net Revenues | 9.46 | 100 | % | 5.23 | 100 | % | 80.80 | % | ||||||||
Connection Fees | 2.91 | 31 | % | 1.99 | 38 | % | 46.52 | % | ||||||||
Gas Sales | 6.55 | 69 | % | 3.25 | 62 | % | 101.75 | % |
Connection Fees
Connection fees during the six months ended June 30, 2008 were $2.91 million, representing an increase of 46.52% over the same period of 2007, accounting for 31% of the total net revenue compared with approximately 38% for the same period in 2007. With regard to the source of connection fees, 100% of total connection fees came from the development of new residential users. We connected 11,686 residential users during the six months ended June 30, 2008, an increase of approximately 77.43% from 2007.
For the 6 months ended June 30, | ||||||||||||||||
(in US$ millions) | 2008 | 2007 | Change | |||||||||||||
US$ | % | US$ | % | % | ||||||||||||
Connection Fees | 2.91 | 100 | % | 1.99 | 100 | % | 46.52 | % | ||||||||
Residential Users | 2.91 | 100 | % | 1.99 | 100 | % | 46.52 | % | ||||||||
Industrial Users | 0.00 | 0 | % | 0.00 | 0 | % | 0 | % |
Such increase was primarily attributable to the following aspects.
We tried our best to develop more residential customers in those cities of which we have obtained franchise of natural gas distribution systems. Our invested projects in the six months ended June 30, 2008 connected 11,686 new residential households in the six months ended June 30, 2008, resulting in approximately $2,909,739 to our total connection fees. In comparison, during the same period of 2007, we connected 6,586 new residential households to our gas distribution network, resulting in total connection fees of $1,985,872.
Gas Sales
In terms of volume, we sold 20.00 million cubic meters of natural gas during the six months ended June 30, 2008, compared with 11.73 million cubic meters in 2007. In terms of value, gas sales were $6.55 million during the six months ended June 30, 2008, accounting for 69% of total net revenue in 2008, representing an increase of 101.75% over the year 2007. Gas sales to residential increased 16.51% from $0.55 million in 2007 to $0.64 million in 2008. Gas sales to industrial users increased 100.25%, from $0.44 million in 2007 to $0.89 million in 2008. Gas sales to commercial users increased 75.70%, from $0.83 million in 2007 to $1.47 million in 2008.
For the 6 months ended June 30, | ||||||||||||||||
2008 | 2007 | Change | ||||||||||||||
($ million) | US$ | % | US$ | % | % | |||||||||||
Gas Sales | 6.55 | 100 | % | 3.25 | 100 | % | 101.75 | % | ||||||||
Residential Users | 2.03 | 31 | % | 0.80 | 25 | % | 152.55 | % | ||||||||
Industrial Users | 2.18 | 33 | % | 1.15 | 35 | % | 89.46 | % | ||||||||
Commercial Users | 2.35 | 36 | % | 1.30 | 40 | % | 81.16 | % |
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Such substantial increase was primarily attributable to the following aspect.
Our invested projects maintained steady and rapid development. During the six months ended June 30, 2008, 20.00 million cubic meters of gas were sold, resulting in approximately $6.55 million. In comparison, during the same period of last year, 10.94 million cubic meters of gas were sold, resulting in approximately $3.25 million.
Cost of Revenues
Cost of revenues for the six months ended June 30, 2008, which includes cost of connection and cost of gas sales was $6.53 million, an increase of 74.98%, from $3.73 million in the same period of 2007.
For the 6 months ended June 30, | ||||||||||||||||
2008 | 2007 | Change | ||||||||||||||
($ million) | US$ | % | US$ | % | % | |||||||||||
Cost of Revenues | 6.53 | 100 | % | 3.73 | 100 | % | 74.98 | % | ||||||||
Connection Cost | 0.82 | 13 | % | 0.64 | 17 | % | 28.14 | % | ||||||||
Gas Cost | 5.71 | 87 | % | 3.09 | 83 | % | 84.69 | % |
Cost of Connection
Our cost of connection during the six months ended June 30, 2008 was $0.82 million, or 13% of total cost of revenues. By comparison, the cost of connection during the same period of 2007 was $0.64 million, or 17% of total cost of revenue.
Cost of connection increased around 28.14% from the same period in 2007, mainly due to the increased cost of gas station maintenance resulting from the development of our gas stations and increase of revenues from connection fees. Increase of revenues from connection fees raised nearly 47% from the same period in 2007.
Cost of connection includes depreciation of major pipelines, the cost of courtyard pipelines, valves, gas meters, and installation and maintenance fees.
Considering the city's overall planning and the long-term interests of our company, the capacity of the gas pipeline network we designed to distribute gas for a city usually greatly exceeded the number of households we served at the very beginning, which makes the cost of connection, specifically the depreciation of fixed assets and maintenance cost greatly increase. However, with connection of more households to the gas pipeline, the average cost to each household will be gradually reduced.
Cost of Gas Sales
The cost of gas sales increased 84.69% to $5.71 million during the six months ended June 30, 2008 from the same period in 2007, when it was $3.09 million. This increase is largely due to the increase of gas sales which increased 101.75%.
The cost of natural gas sales includes the purchase and transportation of natural gas and depreciation of delivery trucks.
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Gross Profit
Gross income increased from $1.50 million in 2007 to $2.93 million for 2008.
For the 6 months ended June 30, | ||||||||||||||||
2008 | 2007 | Change | ||||||||||||||
($ million) | US$ | % | US$ | % | % | |||||||||||
Gross Profit | 2.93 | 100 | % | 1.50 | 100 | % | 95.24 | % | ||||||||
Connection | 2.09 | 71 | % | 1.35 | 90 | % | 55.27 | % | ||||||||
Gas | 0.84 | 29 | % | 0.16 | 10 | % | 437.14 | % |
During the six months ended June 30, 2008, gross profit was $2.93 million, an increase of approximately 95.24% from the same period of 2007. Gross profit from connection fees is $2.09 million for the second six months of 2008, accounting for 71% of total gross profit. In comparison, gross profit from connection fees was $1.35 million for the six months of 2007, accounting for 90% of total gross profit. Gross profit from gas sales was $0.84 million, accounting for 29% of total gross profit, compared to $0.16 million, 10% of total gross profit in the same period of 2007.
Increase of gross margin for connection is attributable to the number of households we developed is under the capacity of pipeline network. Increase of gross margin for gas sales is attributable to the fact that the growth rate of gas sales is larger than the growth rate of cost of gas sales. We believe that the gross margin for gas sales will increase with a more considerable amount of gas consumption.
Selling and Marketing Expenses
Our selling and marketing expenses in the six months ended June 30, 2008 were $367,896 and approximately 3.89% of our net revenues, compared with $199,494, or 3.81% of net revenues in the same period of 2007.
In 2008, we acquired Tongshan Hengxin Jiaye Natural Gas Co., Ltd., and we incorporated one new subsidiary. The expansion of our company led to some increased staff salary, social insurance cost, travel and communications cost, and depreciation of fixed assets, which are attributable to increase of selling and marketing expenses.
General and Administrative Expenses
General and administrative expenses were $2.00 million for the six months ended June 30, 2008, which was 190% higher than $0.69 million for the same period last year.
Operating Income
The operating income for the six months ended Mar31, 2008 was $0.57 million, representing a decrease of 7.39%, compared to the operating income of $0.61 million in 2007.
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Income tax
Income tax was $0.30 million for the six months ended June 30, 2008, compared to $0.03 million in 2007. The reason of increased income tax expense is due to the increase of tax rate from 7.5% to 25% as prepayment.
Beijing Gas is classified as a foreign high-tech enterprise by the tax regulatory authority, and therefore has enjoyed a favorable tax rate for the past five years, with an income tax rate of zero in 2004 and 7.5% from 2005 to 2007. The income tax rate is expected to be 15% in 2008, the standard rate for foreign high-tech enterprises.
The income tax rate of our subsidiaries is 20-25%, except for Beijing Chenguang and Beijing Gas. Beijing Chenguang has also been classified as a foreign high-tech enterprise and is subject to the favorable income tax rate of 7.5% from 2006 to 2008.
Net Income
Net income in the six months ended June 30, 2008 was -$0.39 million, representing a decrease of 162.49% from $0.62 million in the same period in 2007.
Cash and cash equivalents
Cash sourced in financing activities during the six months ended June 30, 2008 is $8.15 million.
In January of 2008, Beijing Gas, the main subsidiary of Sino Gas in China, took out a loan in the amount of CNY 30 million (approximately $4.18 million), accruing interest at an adjustable rate (currently at 20% per year), with interest payable quarterly, from Chinese Mercantile Bank.
Cash sourced in operating activities during the six months ended June 30, 2008 is $2.32 million, which is due to our effective management of accounts receivable.
Cash used in investing activities during the six months ended June 30, 2008 is $3.49 million. We used the funds raised for project developments.
Accounts Receivable
Accounts receivable during the three months as of March 31, 2008 were $5.93 million, representing a decrease of $0.23 million from $6.16 million in 2007. The decrease was due to the fact that we attach great importance to the management and control of accounts receivable.
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Our account receivable is expected to gradually decrease during the first six months of 2008 due to our seasonal business cycle, in which many accounts receivable are recorded upon completion of construction projects in the fourth quarter, and are collected in the second quarter of the following year. The term of most of our accounts receivable is one year. As of the end of March in 2008, accounts receivable dated from 2006 had been mostly collected, and the remainder were primarily warranty payments of 2007. A warranty payment is the final payment that a customer makes for a construction project. It consists of the final 10% of the total project cost, and it becomes payable one year after construction has been completed, provided that no significant problems with the construction have arisen during the year.
Notes Receivable
Notes receivable of $0.28 million as of June 30, 2008 is the Note issued by Hebei Zhonggang for its use of gas. The Note is risk-free and will be duly honored by bank at the due date.
Inventory
Inventory of $0.28 million as of June 30, 2008 was comprised of the spare parts of Maintenance equipment stored for Langfang Development Zone Wei Ye Hazardous Goods Transportation Co. Ltd., steel gas storage tanks, and natural gas.
Prepayments
Prepayments of $0.47 million as of June 30, 2008 were consisting entirely of the prepayments for gas purchasing in accordance with the purchase and sale contract we signed with the gas suppliers.
Deferred and Prepaid Expense
The amount of $0.47 million of car insurance, parking fee and prepaid rent will be amortized in one year.
Other Receivable
Other receivable of $6.49 million includes the payment to Chenguang, expenses due to the internal business activities, employees’ borrowing, the funds for business turnover, project deposit and payments of other business activities.
Long-term Assets
Long term investment: we invested Beijing Zhongran Xiangke Co. Ltd with $2.70 million for 40% equity in the long term run.
Fixed Assets: our fixed assets were $26.49 million in the first quarter of 2008, causing an increase of $1.92 in comparison with the same period of 2007.
Construction in process: $14.69 million was fully utilized for constructing the gas stations and gas distribution network where our major investment was put.
Intangible assets: $2.19 million was used for land using rights of all gas stations, franchise and goodwill etc.
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Liabilities
$7.28 million Short term borrowings consists of the one year liquidity loan of RMB 20 million from Industrial Bank Beijing Shangdi Sub-branch and RMB 30 million from China Mercantile Bank.
Accounts Payable and other payables were mainly for the construction cost of gas distribution network and material purchase.
Income tax paid was the income tax for the second quarter of 2008 and operating tax for the month of June, 2008.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not required.
Item 4. Controls and Procedures
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act and have designed internal control over financial reporting or caused internal control over financial reporting to be designed under its supervision in order to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, as applicable. Due to its inherent limitations, internal control over financial reporting may not prevent or detect material misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision of and with the participation of our Chief Executive Officer and our Chief Financial Officer, our management conducted its evaluation of the effectiveness of our Company’s internal control over financial reporting as of June 30, 2008, using the criteria in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, our management concluded that, as of June 30, 2008, our Company’s internal control over financial reporting was not effective due to the material weaknesses described below.
(1) The Company has not yet established a comprehensive Code of Conduct and Ethics (the “Code”) which is applicable to all Company directors, officers and employees.
(2) Our Internal Audit Department has not taken an active role in the conduct of its activities due to insufficient resources. The annual plan, budget, and specific procedures to perform the internal audit function has not been developed, and the anti-fraud audit plan has not been developed either.
(3) Our Audit Committee was not comprised of sufficient independent directors who are "independent" as the term is used in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act. Our Audit Committee did not appoint a member who qualifies as an "audit committee financial expert" as defined in Item 401(e) of Regulation S-B. Our written Audit Committee Charter was not submitted to the Boards for approval.
(4) Our Company did not formulate a Related Party Transactions Policy and develop a master list of all Related Parties.
Management’s Plan for Remediation of Material Weaknesses
In light of the conclusion that our Company’s internal control over financial reporting was not effective, our management has worked, and will continue to work, to address these weaknesses in our internal control over financial reporting. Implementations of certain remedial measures include the following:
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(1) We are going to issue the Code, and arrange respective training to all the employees in the near future. Training which includes the content of the Code will be provided to new employees at the time of hiring. All the employees will be required to sign an affidavit acknowledging that the employee has read and will intend to comply with the Code;
(2) The management is committed to develop a comprehensive and risk-based internal audit function within the Company. With the limited human capital supplies in the market, we have engaged a third party professional to assist the management in establishing the internal control system. At the same time, we have enhanced our efforts of recruitment and interviews are undergoing. We expect that an internal audit department will be set up in the near future. With the continuous assistance from the third party professional, the roles and responsibilities of the internal audit department will be formulated and a risk-based internal audit plan will be developed and approved by the Audit Committee within a month after the set up.
(3) The Board of Directors has appointed Mr. Zhang Xin Min on March 10, 2008, Mr. Zhang serves as a financial expert of Audit Committee and will provide oversight/monitoring over our financial reporting mechanism.
Changes in Internal Control over Financial Reporting
Other than the remediation measures described above, during the period ended June 30, 2008, there was no change in our internal controls over financial reporting that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 1A. Risk Factors
Not required.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders.
None
Item 5. Other Information
None
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Item 6. Exhibits
The following exhibits are hereby filed as part of this Quarterly Report on Form 10-Q.
Exhibit Number: | Description | |
31.1 | Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Principal Accounting Officer under Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 |
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant certifies that it has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized, in Beijing.
SINO GAS INTERNATIONAL HOLDINGS, INC. | ||
| | |
Date: August 14, 2008 | By: | /s/ Yuchuan Liu |
Yuchuan Liu | ||
Chairman and Chief Executive Officer |
SINO GAS INTERNATIONAL HOLDINGS, INC. | ||
| | |
Date: August 14, 2008 | By: | /s/ Yong Zhang |
Yong Zhang | ||
Chief Financial Officer |
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