UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
| FORM 10-Q |
x Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscalquarter ended August 31, 2008
¨ Transition report under Section 13 or 15(d) of the SecuritiesExchange Act of 1934 for the transition period from __ ___ to______.
Commission file number: 000-52409
CHINA ENERGY CORPORATION
(Name of small business issuer in its charter)
Nevada | 98-0522950 | |
| (State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |
6130 Elton Avenue, Las Vegas, NV | 89107 | |
| (Address of principal executive offices) | (Zip Code) | |
1-888-597-8899 | ||
| (Issuer’s telephone number) |
Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx No¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or 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. (Check one):
| Large accelerated filer¨ | Accelerated filer ¨ | Non-accelerated | Smaller reporting |
| filer¨ | companyx | ||
| (Do not check if a smaller | |||
| reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.¨Yes xNo
State issuer’s revenue for its most recent fiscal year: $ 20,251,033 for the fiscal year ended November 30, 2007.
State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date:
| Class | October 20, 2008 | ||
| Common Stock, $ 0.001 par value | 45,000,000 shares | ||
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| FORWARD |
This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends affecting the financial condition of our business. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including, among other things:
| · | general economic and business conditions, both nationally and in our markets, |
| · | our expectations and estimates concerning future financial performance, financing plans and the impact of competition, |
| · | our ability to implement our growth strategy, |
| · | anticipated trends in our business, |
| · | advances in technologies, and |
| · | other risk factors set forth herein. |
In addition, in this report, we use words such as "anticipates," "believes," "plans," "expects," "future," "intends," and similar expressions to identify forward-looking statements.
China Energy Corporation and its subsidiaries (“CEC”, the “Company”, “Coal Group” and “Heat Power”) undertakes no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this prospectus. In light of these risks and uncertainties, the forward-looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements.
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ITEM 1 . FINANCIAL STATEMENTS
CHINA ENERGY CORPORATION
| Consolidated Financial Statements August 31, 2008 (Prepared Without Audit) |
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| CHINA ENERGY CORORATION | ||
| CONSOLIDATED BALANCE SHEETS | ||
| ASSETS | ||
| Current Assets: | August 31, 2008 | November 30, 2007 |
| (Unaudited) | (Audited) | |
| Cash | $1,916,319 | $1,478,264 |
| Accounts receivables | 3,435,595 | 3,683,819 |
| Other receivables | 1,298,796 | 914,451 |
| Advances to suppliers | 2,527,039 | 1,180,386 |
| Inventory | 257,808 | 152,133 |
| Total current assets | 9,435,557 | 7,409,053 |
| Fixed Assets: | ||
| Property, plant and equipment | 26,497,448 | 26,251,940 |
| Construction in Progress | 9,546,388 | 7,297,380 |
| 36,043,836 | 33,549,320 | |
| Less accumulated depreciation and depletion | 3,972,245 | 2,600,080 |
| Net fixed assets | 32,071,591 | 30,949,240 |
| Other Assets: | ||
| Investment property, net of depreciation of $ 93,139 and $ 62,850 | 1,694,794 | 1,725,083 |
| Intangible asset, net of amortization of $ 768,240 and $ 544,155 | 2,888,491 | 3,112,576 |
| Long term investment | 210,394 | 3,863,041 |
| Notes receivable | 557,254 | 4,790,483 |
| Deferred charges | - | 487 |
| Total other assets | 5,350,933 | 13,491,670 |
| Total Assets | $46,858,081 | $51,849,963 |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||
| Current Liabilities: | ||
| Notes payable | 5,257,839 | 10,552,091 |
| Accounts payable | 5,976,305 | 6,745,522 |
| Advances from customers | 5,019,393 | 2,721,869 |
| Accrued liabilities | 1,466,734 | 1,754,284 |
| Other accounts payable | 5,842,413 | 5,011,660 |
| Shareholder loans | 6,689,139 | 6,602,727 |
| Total current liabilities | 30,251,823 | 33,388,153 |
| Long Term Obligations | 1,752,613 | 1,623,399 |
| Deferred Income | 2,181,417 | 1,664,841 |
| Total liabilities | 34,185,853 | 36,676,393 |
| Stockholders’ Equity: | ||
| Common stock : authorized 75,000,000 shares of $0.001 par | ||
| value; issued and outstanding 45,000,000 | 45,000 | 45,000 |
| Additional paid - in capital | 8,655,805 | 8,655,805 |
| Paid in capital – options | 315,000 | - |
| Retained earnings | 6,562,827 | 6,820,157 |
| Statutory reserves | 1,203,557 | 1,203,557 |
| Accumulated comprehensive loss | (4,109,961) | (1,550,949) |
| Total Stockholders’ equity | 12,672,228 | 15,173,570 |
| Total Liabilities and Stockholders’ Equity | $46,858,081 | $51,849,963 |
| The accompanying notes are an integral part of these financial statements. |
| -F1- |
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| CHINA ENERGY CORPORATION | ||||
| CONSOLIDATED STATEMENTS OF INCOME | ||||
| For the Three and Nine Months Periods Ended August 31, 2008 and 2007 | ||||
| (Prepared Without Audit) | ||||
| Nine Months Ended August 31, | Three Months Ended August 31, | |||
| 2008 | 2007 | 2008 | 2007 | |
| Revenue | $14,367,294 | $13,286,400 | 2,173,319 | 4,104,862 |
| Cost of Sales | 10,604,383 | 9,158,026 | 2,453,152 | 3,608,947 |
| Gross Profit | 3,762,911 | 4,128,374 | (279,833) | 495,915 |
| Expenses: | ||||
| Selling | 234,315 | 199,619 | 22,738 | 47,680 |
| General and Administrative | 1,895,166 | 1,413,366 | 423,078 | 477,130 |
| Options issued for services | 315,000 | - | - | - |
| Total expenses | 2,444,481 | 1,612,985 | 445,816 | 524,810 |
| Operating income (loss) | 1,318,430 | 2,515,389 | (725,649) | (28,895) |
| Other Income and Expense: | ||||
| Other Income | 216,885 | 175,889 | 63,838 | 94,546 |
| Finance expense, net | (768,142) | (507,890) | (277,399) | (104,808) |
| Non operating expense | (199,221) | (86,168) | (31,403) | (45,822) |
| Income (loss) Before Income Taxes | (567,952) | 2,097,220 | (970,613) | (84,979) |
| Provision for Income Taxes: | ||||
| Current provision | 825,282 | 660,898 | 65,007 | 164,546 |
| Net income (loss) | (257,330) | 1,436,322 | (1,035,620) | (249,525) |
| Other Comprehensive Income | ||||
| Loss on foreign currency conversion | (2,559,012) | (322,742) | (576,887) | (176,227) |
| Total Comprehensive Income | ($2,816,342) | $1,113,580 | ($1,612,507) | ($425,752) |
| Income Per Share - | ||||
| Basic and Diluted | ($0.01) | $0.03 | ($0.02) | ($0.01) |
| Weighted average number of shares outstanding | 45,000,000 | 45,000,000 | 45,000,000 | 45,000,000 |
| The accompanying notes are an integral part of these financial statements. | ||||
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| CHINA ENERGY CORPORATION | ||
| CONSOLIDATED STATEMENTS OF CHANGES | ||
| For the Three and Nine Months Periods Ended August 31, 2008 and 2007 | ||
| (Prepared Without Audit) | ||
| 2008 | 2007 | |
| CASH FLOWS FROM OPERATIONS: | ||
| Net income (loss) | (257,330) | 1,436,322 |
| Adjustments to reconcile net income to net cash provided | ||
| (consumed) by operating activities: | ||
| Charges not requiring the outlay of cash: | ||
| Depreciation and amortization | 1,626,538 | 1,424,991 |
| Options issued for services | 315,000 | - |
| Company share of loss on equity investment | - | 13,203 |
| Changes in assets and liabilities: | ||
| Decrease in accounts receivable | 248,224 | 2,482,437 |
| Increase in other receivables | (384,345) | (1,540,590) |
| Increase in advances to suppliers | (1,346,653) | (3,091,849) |
| Receipt of deferred income | 516,575 | - |
| Decrease (Increase) in inventory | (105,675) | 206,828 |
| Increase (Decrease) in accounts payable | (769,217) | 784,548 |
| Increase in advance from customers | 2,297,524 | 2,447,874 |
| Decrease in accrued liabilities | (287,550) | (128,693) |
| Increase (Decrease) in other accounts payable | 830,753 | (683,493) |
| Net Cash Provided By Operating Activities | 2,683,844 | 3,351,578 |
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||
| Advances under notes receivable | - | (2,588,620) |
| Repayments of notes receivable | 4,233,229 | - |
| Purchase of fixed assets | (245,508) | (1,361,513) |
| Increase in construction in progress | (2,249,008) | (1,723,991) |
| Decrease in deferred charges | 487 | 35,715 |
| Return on long term investments | 3,652,647 | - |
| Net Cash Provided (Consumed) By Investing Activities | 5,391,847 | (5,638,409) |
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||
| Borrowing under notes payable | 129,216 | 2,640,276 |
| Repayments of notes payable | (5,294,252) | - |
| Proceeds from capital contributions | - | 1,940,603 |
| Advances from (Repayments to) shareholder | 86,412 | (1,159,477) |
| Decrease in long term liabilities | - | (508,702) |
| Net Cash Provided (Consumed) By Financing Activities | (5,078,624) | 2,912,700 |
| Exchange rate effect on cash | (2,559,012) | (322,742) |
| Net change in cash | 438,055 | 303,127 |
| Cash balance, beginning of period | 1,478,264 | 899,689 |
| Cash balance, end of period | $1,916,319 | $1,202,816 |
| The accompanying notes are an integral part of these financial statements. | ||
| -F3- | ||
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CHINA ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2008
(Prepared Without Audit)
| 1. | BASIS OF PRESENTATION |
| The unaudited interim financial statements of China Energy Corporation. (“the Company”) as of August 31, 2008 and for the three and nine month periods ended August 31, 2008, and 2007, have been prepared in accordance with generally accepted accounting principles. In the opinion of management, such information contains all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for such periods. The results of operations for the quarter ended August 31, 2008 are not necessarily indicative of the results to be expected for the full fiscal year ending November 30, 2008. | |
| Certain information and disclosures normally included in the notes to financial statements have been condensed or omitted as permitted by the rules and regulations of the Securities and Exchange Commission, although the Company believes the disclosure is adequate to make the information presented not misleading. The accompanying unaudited financial statements should be read in conjunction with the financial statements of the Company for the year ended November 30, 2007. | |
| 2. | SUPPLEMENTAL CASH FLOWS INFORMATION |
| Cash paid for income taxes during the nine month periods ended August 31, 2008 and 2007 was $800,000 and $500,000, respectively. Cash paid for interest during those nine month periods was $943,000 and $712,000, respectively. | |
| There were no non cash investing activities during the reported periods. | |
| Options to purchase common stock, valued at $315,000, were issued for services during the 2008 nine month period. There were no other non cash financing activities during the reported periods. | |
| 3. | SEGMENT REPORTING |
| The Company is made up of two segments of business, Coal Group which derives its revenue from the mining and purchase and sale of coal, and Heat Power which derives its revenue by providing heating and electricity to residents and businesses of a local community. Each of these segments is conducted in a separate corporation and each functions independently of the other. | |
| During the periods reported there were no transactions between the two segments. There also were no differences between the measurements used to report operations of the segments and those used to report the consolidated operations of the Company. In addition, there were no differences between the measurements of the assets of the reported segments and the assets reported on the consolidated balance sheet. | |
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| CHINA ENERGY CORPORATION | ||||||
| NOTES TO CONSOLIDATED FINANCIAL STATEMENTS | ||||||
| AUGUST 31, 2008 | ||||||
| (Prepared Without Audit) | ||||||
| Nine Months Period Ended August 31, 2008 | Nine Months Period Ended August 31, 2007 | |||||
| Heat | Coal | Total | Heat | Coal | Total | |
| Power | Group | Power | Group | |||
| Sales to external customers | 4,894,540 | 9,472,754 | 14,367,294 | 4,001,900 | 9,284,500 | 13,286,400 |
| Intersegment revenues | - | - | - | - | - | - |
| Interest expense (income), net | 988,229 | (220,087) | 768,142 | 874,958 | (367,068) | 507,890 |
| Depreciation & depletion | 1,265,757 | 360,781 | 1,626,538 | 1,091,588 | 333,403 | 1,424,991 |
| Segment profit | (1,354,223) | 2,987,653 | 1,633,430 * | (529,203) | 3,044,592 | 2,515,389 |
| Corporate items | - | - | 315,000 * | - | - | - |
| August 31, 2008 | August 31, 2007 | |||||
| Heat | Coal | Total | Heat | Coal | Total | |
| Power | Group | Power | Group | |||
| Segment assets | 31,350,933 | 13,792,354 | 45,143,287 | 27,805,365 | 14,962,837 | 42,768,202 |
| Assets not allowable to segments | - | - | 1,694,794 | - | - | 1,733,334 |
| Expenditures for | ||||||
| segment assets: | ||||||
| Construction in progress | 3,811,758 | 5,734,630 | 9,546,388 | 1,596,489 | 1,644,751 | 3,241,240 |
| Other assets | 547,224 | 4,803,709 | 5,350,933 | - | 5,095,356 | 5,095,356 |
| * For the nine month period ended August 31, 2008, expenses not allocable to segments consist of stock options expensed during the quarter totaling $ 315,000 not included in segment profit of $ 1,633,430. For the nine month period ended August 31, 2008, total operating income was $ 1,318,430 including stock options expensed. | ||||||
| Three Months Period Ended August 31, 2008 | Three Months Period Ended August 31, 2007 | |||||
| Heat | Coal | Total | Heat | Coal | Total | |
| Power | Group | Power | Group | |||
| Sales to external customers | 114,441 | 2,058,878 | 2,173,319 | 749,763 | 3,355,099 | 4,104,862 |
| Intersegment revenues | - | - | - | - | - | - |
| Interest expense (income), net | 352,708 | (75,309) | 277,399 | 194,160 | (89,352) | 104,808 |
| Depreciation & | ||||||
| depletion | (103,820) | 121,531 | 17,711 | 377,608 | 104,925 | 482,533 |
| Segment profit (loss) | (1,117,119) | 391,470 | (725,649) | (633,397) | 604,502 | (28,895) |
| -F5- |
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
| History |
We, China Energy Corporation (“CEC”), produce coal through our subsidiary Inner Mongolia Tehong Coal Group Co, Ltd. (“Coal Group”) and supply heating and electricity requirements throughout the XueJiaWan district through our subsidiary Inner Mongolia Zhunger Heat Power Co., Ltd. (“Heat Power”).
CEC was incorporated in the state of Nevada on October 11, 2002 for the purpose of producing coal to meet the increasing demand in power and heating industries and also to expand thermoelectric plants and networks in rural developments. CEC acquired Coal Group and Heat Power on November 30, 2004.
Inner Mongolia Tehong Coal Group Co., Ltd. (“Coal Group”)
Coal Group produces coal from the LaiYeGou coal mine located in Erdos City, Inner Mongolia, People’s Republic of China. Its trade consists of production and processing of raw coal for domestic heating, electrical generation and coking purposes for subsequent steel production. The principal sources of revenue are generated from local heating power industry.
Coal Group produces approximately 500,000 tons of coal per year based on current levels of input and has the capacity of producing approximately up to 1,200,000 tons subject to enhancement of productions lines in the next 2 years. Coal Group is in the process of increasing its capacity.
The raw coal produced is noncaking coal and has a high ash melting point with high thermal value used almost exclusively as fuel for steam-electric power generation. It has low sulphur and low chemical emission which satisfies government environmental protection standards with heating capability of 6,800 -7,000 Kilocalories (“Kcal”).
Inner Mongolia Zhunger Heat Power Co., Ltd. (“Heat Power”)
Heat Power currently supplies heating requirements throughout 120 hectares of the XueJiaWan district in XueJiaWan Town, Zhunger County with its newly constructed thermoelectric plant (“XueJiaWan Expansion”) and 2 heating plants previously used exclusively for heating supply operations. These plants are operated by Heat Power employees. The Autonomous Region Planning & Reform Committee appointed Heat Power in 2003 to establish a thermoelectric plant providing heating and electricity capable of expanding coverage in the area serving a larger population base.
Heat Power supplies heating to users directly and supplies electricity through a government controlled intermediary, Inner Mongolia Electric Power Group Co., Ltd. (“Electric Power Group”). Heat Power will, therefore, be operating two processes, one for heating and one for co-generation of electricity supply.
Heat Power supplies heating to private dwellings and factories, as well as municipal facilities.
| Granting of Stock Options |
On February 11, 2008, the Board of Directors approved the granting of options to purchase a total of 4,500,000 shares of common stock as described in the 2008 Stock Option Plan (the “2008 Plan”) to directors, officers, employees and consultants of the Company. The following is intended as a brief description of the 2008 Plan and is qualified in its entirety by the full text of the 2008 Plan which is attached as Exhibit 99.1.
| Administration |
The 2008 Plan will be administered by the Board of Directors. The Board of Directors may appoint a committee of the Board of Directors (the “Committee”) comprised of two or more of directors, each of whom will be a “Non-Employee Director” within the meaning of Rule 16b-3 under theSecurities Exchange Act of 1934, as amended, and an “Outside Director” within the meaning of Section 162(m) of the Code, to administer the 2008 Plan. Subject to the terms of the 2008 Plan, the Board of Directors or the Committee may determine and
| - 10 - |
designate those employees, directors and consultants to whom options should be granted and the nature and terms of the options to be granted.
| Eligibility |
All of our employees, including our executive officers and directors who are also employees, are eligible to participate in the 2008 Plan. Directors who are not employees, as well as our consultants and advisers, are eligible to receive options under the 2008 Plan, except that such persons may only receive non-qualified options. Additionally, options granted to non U.S. residents may also only receive non-qualified options.
| Exercise of Stock Options |
The exercise price per share for each option granted under the 2008 Plan shall be determined by the Board of Directors or the Committee. The price is payable in cash.
Subject to earlier termination upon termination of employment and the incentive stock option limitations as provided in the 2008 Plan, each option shall expire on the date specified by the Board of Directors or the Committee.
The options will either be fully exercisable on the date of grant or shall be exercisable thereafter in such installments as the Board of Directors or Committee may specify. Upon termination of employment or other service of an option holder, an option may only be exercised for a period of three months or, in the case of termination due to disability or death, a period of 12 months.
| Transferability |
Options granted under the 2008 Plan may not be transferred except by will or the laws of the descent and distribution and, during his or her lifetime, options may be exercised only by the optionee.
| Certain Adjustments |
In the event of any change in the number or kind of our outstanding common shares by reason of a stock dividend, stock split, recapitalization, combination, subdivision, rights issuance or other similar corporate change, the Board of the Committee shall make such adjustment in the number of common shares that may be issued under the 2008 Plan, and the number of common shares subject to, and the exercise price of, each then-outstanding option, as it, in its sole discretion, deems appropriate.
| Amendment or Discontinuance |
The Board may amend or discontinue the 2008 Plan, provided that no amendment may, without an optionee’s consent, materially and adversely affect any rights under any option previously granted to the optionee under the 2008 Plan. Additionally, the approval of our shareholders is required for any amendment that would:
| · | increase or decrease the number of common shares that may be issued under the 2008 Plan; or |
| · | materially modify the requirements as to eligibility for participation in the 2008 Plan. |
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| Results of operations |
The following is an analysis of our revenues and gross profit, details and analysis of components of expenses, and variance; for the nine month periods ended August 31, 2008 compared to August 31, 2007.
| Nine Month Periods Ended August 31, | ||||
| 2008 | 2007 | |||
| Revenue | $ 14,367,294 | 100% | $ 13,286,400 | 100% |
| Cost of Sales | 10,604,383 | 74% | 9,158,026 | 69% |
| Gross Profit | $3,762,911 | 26% | $4,128,374 | 31% |
| Coal Group |
For the nine month periods ended August 31, 2008, revenues for Coal Group were $ 9,472,754 in 2008 compared to $ 9,284,500 in the comparable nine months of 2007. The $ 188,254 increase is a result of the escalating demand in the market for coal which, in turn, causes the increase in price per ton of coal. Although Coal Group’s revenues increased during the nine month period, the level of the increase in revenues projected given the increase price per ton of coal was hindered as a result of transportation constraints as mentioned below.
Coal Group revenues are determined by Government regulation as a minimum price per ton is enforced. Coal Group’s selling price per ton has consistently been above this minimum set standard. A significant amount of revenues were generated from the coal mine. In addition Coal Group met the demands of customers by supplementing coal mine production with outside purchases.
Coal Group does not typically sign contracts to fix its prices per ton. This allows Coal Group to sell its products at the going market rate which, to the best of management’s knowledge, will continue its upward trend in price. Locking in a fixed price does not allow Coal Group to capitalize on the increase in demand for its products.
For the three month period ended August 31, 2008, revenues for Coal Group were $ 2,058,878 in 2008 compared to $ 3,355,099 in the comparable three months of 2007. The decrease of $ 1,296,221 is as a result of reduced capacity of railway transportation. Coal Group also experienced this decrease during the second quarter of the 2008 year. Transportation has always been a challenge and with new routes being constructed, some routes previously used were not operational. The decrease was also as a result of the decreased capacity of the Laiyegou coal mine as a result of expansion efforts.
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| Heat Power |
For the nine month periods ended August 31, 2008, revenues generated by Heat Power were $ 4,894,540 compared to $ 4,001,900 in the comparable nine months of 2007. The $ 892,640 increase was as a result of the increase in the number of users as a result of expansion in the XueJiaWan area. It is expected that this area will expand further in the next 2 fiscal years. Although Heat Power experienced an increase in revenues during this period, the projected level of revenues based on number of users was not met. This was as a result of the temporary shut down of the thermoelectric plant during the current quarter for the 2008 Summer Olympics as instructed by the PRC Government as mentioned below.
For the three month period ended August 31, 2008, revenues generated by Heat Power were $ 114,441 compared to $ 749,763 in the comparable three months of 2007. The $ 635,322 decrease was directly as a result of the temporary shut down of operations for the purpose of complying with PRC Government regulations to improve the air quality during the 2008 Summer Olympics. Heat Power was instructed to temporarily shut down operations from June 9th until September 20th. We do not expect to encounter further interruptions to our operations in the foreseeable future.
We expect our revenues to increase during the next two fiscal years as a result of retaining additional users while the XueJiaWan area is being further developed. The increase in revenues will also be attributed to the increase in the prices of heat supply in response to increased cost of raw materials. Revenues generated are a function of Government regulation as the prices charged are approved by the Government. The Government reviews the pricing of heating from time to time as market conditions change. Also, the cost of raw materials, coal, are also regulated by the Government as the price point which we obtain from suppliers is controlled as the Government ensures that such prices are affordable for utility companies. The incentive for the supplier to supply at such prices is that transportation routes are guaranteed and arranged by the Government, thereby saving transportation costs on part of the supplier. Such savings outweigh the reduction in the selling price fo r the supplier.
| Cost of Sales |
For the nine month periods ended August 31, 2008, cost of sales increased by $ 1,446,357 from the comparable nine month period of 2007, a result of change in the following expenses:
| Nine Months Periods Ended August 31 | |||
2008 | 2007 | Variance | |
| Coal & freight | 7,653,074 | 6,967,425 | 685,649 |
| Utilities | 580,490 | 260,013 | 320,477 |
| Salaries | 443,374 | 456,118 | (12,744) |
| Operating supplies | 238,057 | 236,724 | 1,333 |
| Repairs | 73,016 | 31,531 | 41,485 |
| Other | 385,360 | 144,982 | 240,378 |
| Depreciation & depletion | 1,231,012 | 1,061,233 | 169,779 |
| Total | $10,604,383 | $9,158,026 | $1,446,357 |
For the nine month periods ended August 31, 2008 our gross margin was 26% compared with and 31% in the 2007 nine month period. The decrease resulted from the increase in the cost of coal, utilities and freight prices incurred by Heat Power. The price of coal is expected to continue on an upward trend. Our gross margin also decreased this quarter as a result of a decrease in revenues of Coal Group and Heat Power as mentioned above.
For the three month periods ended August 31, 2008, cost of sales decreased by $ 1,155,695 from the comparable three month period of 2007, a result of change in the following expenses:
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| Three Months Periods Ended August 31 | |||
| 2008 | 2007 | Variance | |
| Coal & freight | 1,494,178 | 2,815,533 | (1,321,355) |
| Utilities | 165,672 | 103,065 | 62,607 |
| Salaries | 144,647 | 173,085 | (28,438) |
| Operating supplies | 72,355 | 102,382 | (30,027) |
| Repairs | 39,371 | 6,807 | 32,564 |
| Other | 7,717 | 2,588 | 5,129 |
| Depreciation & depletion | 529,212 | 405,487 | 123,725 |
| Total | $2,453,152 | $3,608,947 | ($1,155,795) |
The decrease was primarily as a result of the decrease of the use of coal and freight by Heat Power as a result of the temporary shut down of operations as discussed above. As a result of the temporary shut down, salaries and operating supplies also decreased.
Salaries are expected to vary as a result of bonus structures set for employees. Operating supplies and utilities expenses are a direct function of revenues. The increase in utilities is also attributed to the increase in usage fees, substantially incurred by Coal Group.
| Selling Expenses |
For the three month period ended August 31, 2008, selling expenses decreased by $ 24,942 compared to the same period in 2007. For the nine month period ended August 31, 2008, selling expenses increased by $ 34,696 compared with the same period in 2007.
Salaries and wages increased as a result of retaining additional sales and marketing staff and also because of bonuses granted. Our sales tax expense will increase as a direct function of the variance in revenues.
| Nine Months Periods Ended August 31 | |||
| 2008 | 2007 | Variance | |
| Salaries and wages | 23,328 | 10,254 | 13,074 |
| Office | 1,120 | - | 1,120 |
| Sales tax and other expenses | 209,867 | 189,365 | 20,502 |
| Total Expenses | $234,315 | $199,619 | $34,696 |
| Three Month Periods Ended August 31, | |||
| 2008 | 2007 | Variance | |
| Salaries and wages | 4,255 | 3,792 | 463 |
| Office | 185 | - | 185 |
| Sales tax and other expenses | 18,298 | 43,888 | (25,590) |
| Total Expenses | $22,738 | $47,680 | ($24,942) |
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| General and Administrative Expenses |
For the nine month periods ended August 31, 2008, general and administrative expenses increased by $ 481,800 and for the three month period ended August 31, 2008, general and administrative expenses decreased by $54,052 from the comparable periods of 2007, a result of change in the following expenses:
| Nine Months Periods Ended August 31 | |||
| 2008 | 2007 | Variance | |
| Office | 452,412 | 274,487 | 177,925 |
| Salaries and wages | 380,263 | 267,629 | 112,634 |
| Professional and other fees | 282,252 | 124,193 | 158,059 |
| Travel | 274,061 | 246,272 | 27,789 |
| Repairs | 32,447 | 77,264 | (44,817) |
| Exploration | 1,338 | 58,453 | (57,115) |
| Other expenses | 76,867 | 1,310 | 75,557 |
| Depreciation | 395,526 | 363,758 | 31,768 |
| Total Expenses | $1,895,166 | $1,413,366 | $481,800 |
| Three Months Periods Ended August 31 | |||
| 2008 | 2007 | Variance | |
| Salaries and wages | 129,443 | 100,810 | 28,633 |
| Travel | 59,663 | 108,502 | (48,839) |
| Office | 38,674 | 91,270 | (52,596) |
| Professional and other fees | 27,033 | 47,885 | (20,852) |
| Repairs | 2,513 | 11,994 | (9,481) |
| Exploration | 1,338 | 395 | 943 |
| Other expenses | 30,867 | 1,310 | 29,557 |
| Depreciation | 133,547 | 114,964 | 18,583 |
| Total Expenses | $423,078 | $477,130 | ($54,052) |
Salaries and Wages.During the nine months periods ended, salaries and wages increased as a result of retaining additional staff in our thermoelectric plant operations and also as a result of granting bonuses. We expect salaries and wages to vary. The increase during the three month period ended was not as substantial as a result of the temporary shut down of Heat Power’s operations as mentioned above.
Office.During the nine months periods ended, the increase was primarily a result of distributing promotional materials to potential customers of Coal Group and Heat Power, advertising in trade magazines and on billboards. We expect such expenses to increase for the foreseeable future as such efforts have been effective in increasing our revenues. Heat Power’s promotion efforts were scaled back as a result of the temporary shut down of operations which resulted in the decrease during the three month period ended.
Travel.During the nine months periods ended, travel expense increased as a result of travel by engineering consultants to the thermoelectric plant and also travel incurred by sales staff in their marketing initiatives. We expect such expenses to recur on an ongoing basis. For the three month period ended, Heat Power’s travel costs were reduced substantially as a result of the temporary shut down of operations.
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Repairs.In the 2007 period, repairs were made mostly to Coal Group’s office building as the facilities required repairs after flooding that occurred during the last quarter in 2006. All repairs to our office building have been made. Additional repair expenses were incurred for minor repairs to equipment.
Professional and other Fees.For the nine months periods ended professional fees increased as result of fees paid to engineer professionals to evaluate the overall efficiencies of the LaiYeGou coal mine. Fees were also incurred to retain environmental professionals which assisted in the implementation of environmental protection policies and procedures for the LaiYeGou Coal mine and also for our thermoelectric plant operations. Fees paid to environmental professionals are expected to be an ongoing expense. For the three month period ended, such fees paid by Heat Power were reduced as a result of the temporary shut down of operations.
| Finance Expense |
For the nine month periods ended August 31, 2008 and 2007, finance expenses amounted to $ 768,142 and $ 507,890, respectively. The interest expense incurred was a result of loans obtained by Coal Group. Please refer to “Sources of Capital” below.
| Current trends in the Industry |
Given the increase in demand for coal production for electricity and heating production, the Central Government is encouraging sectors to build more power stations, coking factories, calcium carbide factories and silicon iron factories across the country. The coal industry is expected to grow at a rate of 9.5% per year. A challenge in meeting this demand is transporting coal to nearby regions, such as Shanxi and Hebei Provinces, as transportation routes are currently inefficient or non existent. These routes are expected to be completed in the next 5 years. As a result, sales to these regions during this period may not be at levels we desire.
For Coal Group, methods of circumventing transportation challenges are to receive contracts granted by the Government where transportation is guaranteed from LaiYeGou coal mine to the final destination. Where contracts are privately arranged, transportation is arranged through the hiring of 3rd party transporters or by customers. In some instances, coal is purchased by 3rd parties in close proximity to train stations where transportation to customer destinations is more efficiently arranged. However, transportation to destinations is limited to those for which routes are in place.
For Heat Power, transportation of coal to our facility is provided by its supplier, Guanbanwusu.
Coal Group does not have competition in the usual sense of the term that most other businesses experience. There are approximately 30,000 coal mining companies throughout China; however, since demand currently exceeds supply, competition is not a variable which warrants concern in the operations of our business.
China’s coal industry remains large and growing. Its customer base is chronically under-supplied. There are pressures from the Government to use nuclear power instead of coal due to environmental concerns; however, coal reserves in China are abundant and less expensive and a switch to other forms of resources to generate energy is unlikely.
The electricity and heating supply industry is also growing; however, the government is taking steps to monitor and control economic growth in the rural areas to ensure that the economy is developing at a stable rate.
| Liquidity and Capital Resources |
As of August 31, 2008 we had a working capital deficit of $ 20,816,266.
Not including funds required for expansion of our facilities, we have estimated our cash requirements for the next 12 months. Coal Group will require approximately $ 4,200,000 and Heat Power will require approximately $4,300,000 a total of $ 8,500,000 in order to cover our working capital needs.
We currently are able to sustain our working capital needs through profits we generate and bank and shareholder loans.
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We anticipate sales will generate the cash flow from collection of accounts receivables, customer deposits and proceeds from bank and shareholder loans to be sufficient to sustain our working capital needs. However we may require other sources of capital.
We do not know of any trends, events or uncertainties that are likely to have a material impact on our short-term or long-term liquidity other than those factors discussed below.
| Sources of Capital |
If additional capital is needed, we will explore financing options such as shareholder loans. Shareholder loans are payable on demand and interest is calculated at 6.31% per annum.
Coal Group obtained loans from the Agriculture Commercial Bank amounting to 32 million RMB or $ 4,673,634 to assist in funding working capital needs.
The remaining balance in our Notes Payable account consists of $ 584,204 for obligations for mining rights due in annual installments.
Shareholders loans are granted from time to time as required to meet current working capital needs. We have no formal agreement that ensures that we will receive such loans. We may exhaust this source of funding at any time.
We may also receive capital contributions from our shareholders.
| Cash Flows Operating Activities: |
Our cash flows provided by operating activities were $ 2,683,844 and $ $ 3,351,580 for the nine month periods ended in 2008 and 2007, respectively. The following summarizes the inflow and outflow of cash for these periods:
| 2008 | 2007 | |
| Net income (loss) | $ (257,330) | $1,436,322 |
| Depreciation and amortization | 1,626,538 | 1,424,991 |
| Options issued for services | 315,000 | - |
| Decrease in accounts receivable | 248,224 | 2,482,437 |
| Increase in other receivables | (384,345) | (1,540,590) |
| Increase in advances to suppliers | (1,346,653) | (3,091,849) |
| Increase in advances from customers | 2,297,524 | 2,447,876 |
| Decrease (increase) in inventory | (105,675) | 206,828 |
| Increase (decrease) in accounts payable | (769,217) | 784,548 |
| Other | 1,059,778 | (798,985) |
| Net Cash Provided By Operating Activities | $2,683,844 | $3,351,578 |
The Company issued 4,500,000 options to purchase common stock to directors, officers, consultants, and employees and the value of such options was $ 315,000 based on a Black Scholes valuation model.
Accounts Receivable.The increase in accounts receivables are mainly attributed to Heat Power’s user fees made on account. The age of such accounts was less than 3 months. Coal Group’s sales on account were also outstanding for less than 6 months.
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Advances to Suppliers.Advances were made to suppliers of materials required for the completion of Heat Power’s expansion and Coal Group’s Laiyegou coal mine expansion. Advances were also made to procure raw materials. Prepayment is also a common business practice in China as it allows for a determined price and in some instances will grant us discounts on purchases.
Advances from customers.Deposits on sales of coal are a normal business practice that ensures that the customer obtains Coal Group’s Product at the market price determined on the date of purchase. The decrease compared to 2007 was a result of the increase in sales made on account.
Inventory.Inventory mainly consists of operating supplies used by Heat Power for heat generation such as raw coal and boiler fittings.
Accounts Payable.These amounts consist of accruals made for freight, repairs and maintenance of heating plants, labor union fees, social insurance, and technical training for our employees.
| Investing Activities: |
Our cash provide by investing activities were $ 5,391,847 for the nine month period ended August 31, 2007 and cash consumed by investing activities were $ 5,638,409 for the nine month periods ended August 31, 2007.
Construction in progress charges incurred were as a result of funding for the Coal Group Laiyegou coal mine expansion and also the Heat Power construction of additional boilers and conversion of existing heating plants previously used in exclusive heat supply operations. Heat Power also purchased additional production equipment for the thermoelectric plant operations. Various production equipment which became obsolete were disposed of in Heat Power’s operations.
The Company granted notes to two vendors previously of which $ 4,233,229 were repaid. The full balance is expected to be repaid by the fiscal year end. The Company had previously made investments in two other companies of which such investments were converted to promissory notes during the quarter of which $3,652,647 were repaid
The Company has a $ 210,394 investment in Litai Coking Co. Ltd Litai Coking Co. Ltd. is a customer of the Company owned coal mine. This investment is a 20% equity interest which has been accounted for by the equity method of accounting. LiTai Coking Co. Ltd was not operating in 2008 and did not generate an income or loss.
| Financing Activities: |
Our cash flows consumed by financing activities were $ 5,078,624 for the nine month period ended 2008. Cash flows provided by financing activities for the same period in 2007 were $ 2,912,700.
We added $86,412 during the quarter to the loans from shareholders. All shareholder loans bear interest at 6.31% and are due on demand. The outstanding balances of such loans, at August 31, 2008, were as follows:
| Ordos City YiYuan Investment Co., Ltd. | $810,583 |
| Hangzhou Dayovan Group Co., Ltd. | 4,476,465 |
| Xinghe County Haifu Coal Transportation & Sales Co., Ltd. | 1,402,091 |
| Total | $6,689,139 |
Coal Group had previously obtained loans from the Agriculture Commercial Bank amounting to 70 million RMB or $10,552,091 to assist in funding working capital needs. This balance was reduced to $5,257,839 at August 31, 2008.
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| Material Commitments |
We committed to payment of bank loans, shareholder loans and payment of mining rights as mentioned above. Our expansion plans for the LaiYeGou mine will require approximately $ 10,500,000. We have title to all our capital assets consisting of production equipment, automobiles, and office equipment.
Heat Power’s offices are currently leased on a month to month basis and Coal Group occupies space purchased in 1998. Coal Group holds title to this property in the form of a 50 year lease from the Government. There are no amounts owing.
| Seasonal Aspects |
Coal Group’s business is seasonal in that sales are particularly low in February up to mid March, due to the Chinese New Year holiday. During this time our business is closed for 2 weeks. As a result, sales in March are usually higher.
Heat Power sales level relating to heat generation decreases from April through October as the climate in the region is high, reducing heating requirements.
| Off Balance Sheet Arrangements We have no off balance sheet arrangements. |
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash. The Company does not believe that it is significantly exposed to interest rate risk, foreign currency exchange rate risk, commodity price risk, or equity price risk.
| ITEM 4T. CONTROLS AND PROCEDURES |
(A) Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer/Chief Accounting Officer of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. The Company’s disclosure controls and procedures are designed to provide a reasonable level of assurance of achieving the Company’s disclosure control objectives. The Company’s Chief Executive Officer/Chief Accounting Officer has concluded that the Company’s disclosure controls and procedures are, in fact, effective at this reasonable assurance level as of the period covered. In addition, the Company reviewed its internal controls, and there have been no significant changes in its internal controls or in other factors that could significantly affect those controls subsequent to the date of their last evaluation or from the end of the repor ting period to the date of this Form 10-Q.
(B) Changes in Internal Controls Over Financial Reporting
In connection with the evaluation of the Company’s internal controls during the Company’s 3rd fiscal quarter ended August 31, 2008, the Company’s Chief Executive Officer/Chief Accounting Officer has determined that there are no changes to the Company’s internal controls over financial reporting that has materially affected, or is reasonably likely to materially effect, the Company’s internal controls over financial reporting.
| PART II. |
| OTHER INFORMATION |
| ITEM 1. Legal Proceedings-None. Item 1A. Risk Factors |
A description of the risks associated with our business, financial condition, and results of operations is set forth in our annual report on Form 10-KSB for the year ended November 30, 2007 filed simultaneously with this Quarterly Report on Form 10-Q.
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 AND REPORTS ON FORM 8-K |
| Exhibit Number | Description |
| 31.1 | CEO Section 302 Certification |
| 31.2 | CAO Section 302 Certification |
| 32.1 | CEO Section 906 Certification |
| 32.2 | CAO Section 906 Certification |
| 99.1 | 2008 Stock Option Plan* |
·Incorporated by reference from Form 8K originally filed on February 13, 2008.
REPORTS ON FORM 8-K
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| SIGNATURES |
In accordance with the Securities Exchange Act of 1934, this Quarterly Report on Form 10-Q has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| CHINA ENERGY CORPORATION | ||||
| Date: October 20, 2008 | ||||
| /s/ WenXiang Ding | ||||
| By: | ||||
| WenXiang Ding | ||||
| President, Chief Executive Officer,Director& | ||||
| Secretary | ||||
| /s/ Fu Xu | ||||
| By: | ||||
| Fu Xu | ||||
| Chief Accounting Officer | ||||
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