Washington, D.C. 20549
China Daqing M&H Petroleum, Inc.
Jilin Province, P.R. China 138000
Fleurs De Vie Inc.
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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
CHINA DAQING M&H PETROLEUM, INC.
| CHINA DAQING M&H PETROLEUM, INC. AND SUBSIDIARIES | |
| CONSOLIDATED STATEMENTS OF CASH FLOWS | |
| (UNAUDITED) | |
| | | | | | | |
| | | For the Three Months Ended December 31, | |
| | | 2009 | | | 2008 | |
| CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | |
| Net income | | $ | 427,192 | | | $ | 555,353 | |
| Adjustments to reconcile net income to net cash provided by | | | | | | | | |
| operating activities: | | | | | | | | |
| Depreciation, oil and gas properties | | | 180,909 | | | | 129,515 | |
| Depreciation, rental and other property and equipment | | | 26,623 | | | | 27,427 | |
| Minority interest | | | 27,041 | | | | 34,560 | |
| Deferred Income taxes | | | 180,273 | | | | 230,778 | |
| | | | | | | | | |
| Changes in operating assets and liabilities: | | | | | | | | |
| Accounts receivable | | | (294,586 | ) | | | 2,378,776 | |
| Inventories | | | (409,710 | ) | | | (102,842 | ) |
| Prepaid expenses and other current assets | | | 86,344 | | | | (60,832 | ) |
| Accounts payable | | | (725,666 | ) | | | (2,326,490 | ) |
| Other payables and accrued liabilities | | | (46,715 | ) | | | (1,479,403 | ) |
| | | | | | | | | |
| NET CASH USED IN OPERATING ACTIVITIES | | | (548,295 | ) | | | (613,158 | ) |
| | | | | | | | | |
| CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | |
| Acquisition and development of oil and gas properties | | | (58,638 | ) | | | (133,295 | ) |
| Loan (to) payment from related party | | | (17,732 | ) | | | (642,092 | ) |
| Loan (to) payment from others | | | 88,002 | | | | (179,406 | ) |
| | | | | | | | - | |
| NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES | | | 11,632 | | | | (954,793 | ) |
| | | | | | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | |
| Proceeds (repayment) of loan from shareholders | | | 376,069 | | | | (2,007,437 | ) |
| Proceeds of other borrowings | | | 26,987 | | | | 3,584,352 | |
| | | | | | | | | |
| NET CASH PROVIDED BY FINANCING ACTIVITIES | | | 403,056 | | | | 1,576,915 | |
| | | | | | | | | |
| EFFECT OF EXCHANGE RATE CHANGE ON CASH | | | (26 | ) | | | (38,224 | ) |
| | | | | | | | | |
| DECREASE IN CASH | | | (133,633 | ) | | | (29,260 | ) |
| | | | | | | | | |
| CASH - BEGINNING OF PERIOD | | | 160,606 | | | | 43,661 | |
| | | | | | | | | |
| CASH - END OF PERIOD | | $ | 26,973 | | | $ | 14,401 | |
| | | | | | | | | |
| | | | | | | | | |
| See notes to financial statements | | | | | | | | |
CHINA DAQING M&H PETROLEUM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009
(UNAUDITED)
1 ORGANIZATION, DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
China Daqing M&H Petroleum, Inc. (“we”, the “Company” or “China Daqing”) was incorporated in Nevada on April 15, 2005, under the name Fleurs De Vie (“FDVI”). On June 9, 2005, FDVI filed a Certificate of Correction with the State of Nevada to have its registered name corrected to Fleurs De Vie, Inc. On August 31, 2009, FDVI changed its name to China Daqing M&H Petroleum, Inc. in connection with a share exchange transaction as described below.
On August 11, 2009, the Company entered into and closed a share exchange agreement with American D&C Investment, Inc. (“ADCI”) whereby the Company issued to the stockholders of ADCI 30,000,000 shares of the Company’s common stock in exchange for all of the issued and outstanding capital stock of ADCI (the “Share Exchange”). Prior to the Share Exchange, China Daqing had 1,857,000 shares of common stock issued and outstanding. After the Share Exchange, China Daqing had 31,857,000 shares of common stock outstanding and the former shareholders of ADCI owned 94.17% of the issued and outstanding shares. The directors and executive officers of ADCI became the directors and officers of China Daqing. This transaction has been accounted for as a reverse acquisition and recapitalization of the Company whereby ADCI is deemed to be the accounting acquirer (legal acquiree) and the Company the accounting acquiree (legal acquirer). The historical financial statements for periods prior to August 11, 2009 are those of ADCI except that the equity section and earnings per share have been retroactively restated to reflect the reverse acquisition.
ADCI was organized under the laws of the State of Delaware on October 29, 2007. ADCI is a holding company that owns 100% of the equity of DaQing YueYu Oilfield Underground Technology Service Co., Ltd (“Daqing Yueyu”). Daqing Yueyu, incorporated on November 9, 2007 under the laws of People’s Republic of China (“China”), is engaged in the sale of steel and steel related products (“Steel”) and through its 95% owned subsidiary Jilin Yifeng Energy Sources Co., Ltd. (“Jilin Yifeng”) is engaged in the business of extraction and sale of crude oil (“Extraction”) and subleasing of oil fields (the “Sublease”), in Jilin Province, China. Jilin Yifeng develops, extracts and sells crude oil pursuant to a twenty year exclusive Cooperative Exploration Contract (the “Oil Lease”) which was entered into on January 3, 2002 with China National Petroleum Corporation (“PetroChina”), a corporation organized and existing under the laws of the Peoples Republic of China. Jilin Yifeng has the right to explore, develop and extract oil in the Jilin Oil Region, China. Pursuant to the Oil Lease, during the first ten years, the Company sells oil to PetroChina at a 20% discount to market price. During the second ten years of this agreement, the Company sells oil to PetroChina at a 40% discount to market price. In addition, the Oil Lease requires that all oil extracted from this location be sold to PetroChina. In addition, Jilin Yifeng subleased 63% of the property under the oil lease pursuant to Daqing Haihang Oil Field Development Company. The lease expires in December 2010 and provides for annual fixed subrental income of RMB 24,000,000 (approximately $3,520,800 based on December 31, 2009 exchange rate).
On September 10, 2009, our Board of Directors approved a change in our fiscal year to September 30.
Basis of presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and pursuant to the requirements for reporting on Form 10-Q. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for annual financial statements. However, the information included in these interim financial statements reflects all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for the fair presentation of the consolidated financial position and the consolidated results of operations. Results shown for interim periods are not necessarily indicative of the results to be obtained for a full year. The consolidated balance sheet as of September 30, 2009 was derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K. These interim financial statements should be read in conjunction with that report.
For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2009 filed on January 13, 2010.
The consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant inter-company accounts and transactions have been eliminated. These financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. The reporting currency of the Company is the US dollar. The functional currency of China Daqing and ADCI is the US dollar. Daqing Yueyu and Jilin Yifeng use their local currency Chinese Renminbi (“RMB”) as their functional currency.
Uses of estimates in the preparation of financial statements
The preparation of financial statements in conformity with generally accepted accounting principles 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 net revenue and expenses during each reporting period. Actual results could differ from those estimates and changes in these estimates are recorded when known. Significant items subject to such estimates and assumptions include the following:
• Estimates of proved reserves and related estimates of the present value of future net revenues;
• The carrying value of oil properties;
• Estimates of the fair value of reporting units and related assessment of goodwill for impairment;
• Asset retirement obligations;
• Income taxes
Oil properties
The Company follows the full cost method of accounting for its oil property. Accordingly, all costs incidental to the acquisition, exploration and development of oil property, including costs of undeveloped leasehold, dry holes and leasehold equipment, are capitalized. Internal costs incurred that are directly identified with acquisition, exploration and development activities undertaken by the Company for its own account, and that are not related to production, general corporate overhead or similar activities, are also capitalized. Major development projects of all oil properties are also capitalized. All costs related to production activities, including workover costs incurred solely to maintain or increase levels of production from an existing completion interval, are charged to expense when incurred.
Under the full cost method of accounting, the net book value of oil properties, less related deferred income taxes, may not exceed a calculated “ceiling”. The ceiling limitation is the estimated after-tax future net revenues, discounted at 10% per annum, from proved oil reserves plus the cost of properties not subject to amortization. Estimated future net revenues exclude future cash outflows associated with settling asset retirement obligations included in the net book value of oil properties. In calculating future net revenues, prices and costs used are those as of the end of the appropriate period. These prices are not changed except when different prices are fixed and determinable from applicable contracts for the remaining term of those contracts.
Any excess of the net book value, less related deferred tax benefits, over the ceiling is written off as expenses. Expenses recorded in one period may not be reversed in a subsequent period even though higher oil and gas prices may have increased the ceiling applicable to the subsequent period.
Capitalized costs are depleted by an equivalent unit-of-production method. Depletion is calculated using the capitalized costs, including estimated asset retirement costs, plus the estimated future expenditures (based on current costs) to be incurred in developing proved reserves, net of estimated salvage values.
Sales of a portion of development rights and other proved and unproved properties are accounted for as adjustments to capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas, in which case the gain or loss is recognized as income.
Abandonment of oil and gas properties other than the development rights are accounted for as adjustments of capitalized costs with no loss recognized.
Other property and equipment
Property and equipment are recorded at cost. Depreciation is provided in amounts sufficient to amortize the cost of the related assets over their useful lives using the straight line method for financial reporting purposes.
| | Maintenance, repairs and minor renewals are charged to expense when incurred. Replacements and major renewals are capitalized. |
Oil sales are recognized when production has been delivered to the Company’s sole customer, PetroChina, the sales price is fixed and collectability of the revenue is probable.
Revenue from the sale of steel and steel related products is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, and 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 advances from customers.
Subrental income is recognized on the straight-line basis over the life of the sublease.
Impairment of long lived assets
| | The Company accounts for the impairment of long-live assets in accordance with FASB issued accounting standards regarding impairment or disposal of long-lived assets. Long-lived assets are reviewed for impairment when circumstances indicate the carrying value of an asset may not be recoverable. For assets that are to be held and used, impairment is recognized when the estimated undiscounted cash flows associated with the asset or group of assets is less than their carrying value. If impairment exists, an adjustment is made to write the asset down to its fair value, and a loss is recorded as the difference between the carrying value and fair value. Fair values are determined based on quoted market values, discounted cash flows or internal and external appraisals, as applicable. Assets to be disposed of are carried at the lower of carrying value or estimated net realizable value. Based on its review, the Company believes that, as of December 31, 2009, there were no significant impairments of its long-lived assets used in operations. |
Recent accounting pronouncements
In June 2009, the FASB issued an accounting standard amending the accounting and disclosure requirements for transfers of financial assets. This accounting standard requires greater transparency and additional disclosures for transfers of financial assets and the entity’s continuing involvement with them and changes the requirements for derecognizing financial assets. In addition, it eliminates the concept of a qualifying special-purpose entity (“QSPE”). This accounting standard is effective for financial statements issued for fiscal years beginning after November 15, 2009. The Company has not completed their assessment of the impact that this pronouncement will have on the Company’s financial condition, results of operations or cash flows.
In October 2009, the FASB issued new standards that revised the guidance for revenue recognition with multiple deliverables. These new standards impact the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting. Additionally, these new standards modify the manner in which the transaction consideration is allocated across the separately identified deliverables by no longer permitting the residual method of allocating arrangement consideration. The guidance is effective for revenue arrangements entered into for fiscal years beginning on or after June 15, 2010. The Company does not expect the adoption will have a material impact on its consolidated financial statements.
2 ACQUISITION OF JILIN YIFENG
Between November 28, 2007 and October 28, 2008, DaQing Yueyu acquired 95% of the capital of Jilin Yifeng. The purchase price for the acquisition was $3,864,600. $1,580,756 was paid in 2008 with the remaining payable upon demand (see Note 7).
In accordance with the purchase method of accounting as prescribed by FASB accounting standards on business combinations, the Company allocated the consideration to the net tangible and identifiable intangible assets, based on their estimated fair values. Goodwill represents the excess of the purchase price over the fair value of the underlying net tangible and identifiable intangible assets.
The purchase price was allocated as follows:
| Allocation: | | | |
| Current assets | | $ | 1,533,286 | |
| Oil and gas properties | | | 8,047,107 | |
| Less liabilities assumed | | | (5,755,084) | |
| | | $ | 3,825,309 | |
3 PROPERTY AND EQUIPMENT
Oil and gas properties
A summary of oil and gas properties at December 31 and September 30, 2009 is as follows:
| | | Dec. 31, Sept. 30, | |
| | | 2009 | | | 2009 | |
Oil and gas properties, proven reserves | | $ | | | | $ | | |
Less: accumulated depletion | | | | | | | | |
Oil and gas properties, net | | | | | | | | |
Rental properties
A summary of oil and gas properties at December 31 and September 30, 2009 is as follows:
| | | Dec. 31 Sept. 30, | |
| | | 2009 | | | 2009 | |
| Rental properties - drill rights | | $ | 245,058 | | | $ | 245,057 | |
| Less: accumulated depreciation | | | 163,372 | | | | 142,950 | |
| Rental properties, net | | $ | 81,686 | | | $ | 102,107 | |
Other property and equipment
Other property and equipment and the estimated lives used in the computation of depreciation is as follows:
| | | | | Dec. 31, Sept. 30, | |
| | Life | | | 2009 | | | 2009 | |
| Transportation equipment | 5 years | | | $ | 115,173 | | | $ | 115,173 | |
| Furniture, fixtures and equipment | 5 years | | | | 7,190 | | | | 7,190 | |
| Subtotal | | | | | 122,363 | | | | 122,363 | |
| Less: accumulated depreciation | | | | | 52,238 | | | | 46,032 | |
| Other property and equipment, net | | | | $ | 70,125 | | | $ | 76,331 | |
4 LOAN RECEIVABLE – RELATED PARTY
Loan receivable – related party consists of a loan to a 5% owner of Jilin Yifeng, bearing no interest and due on August 11, 2011.
5 LOAN RECEIVABLE – OTHER
Loan receivable consists of a loan to an unrelated company bearing no interest and due on September 9, 2010. The loan was paid off this quarter.
6 OTHER LOANS PAYABLE
As of December 31 and September 30, 2009, the outstanding balance on other loans payable were $1,861,131 and $1,834,138, respectively, and these loans consisted of the following:
| | | December 31, | | | September 30, | |
| | | 2009 | | | 2009 | |
| Due to former shareholders (see Note 2), non-interest bearing and payable on demand. | | $ | 1,758,933 | | | $ | 1,758,933 | |
| Loan from unrelated company, with no interest, due upon demand. | | | 102,198 | | | | 75,205 | |
| | | | | | | | | |
| Total other loans payable | | $ | 1,861,131 | | | $ | 1,834,138 | |
7 DUE TO SHAREHOLDERS
As of December 31 and September 30, 2009, we had total borrowings from shareholders in the amount of $944,087 and $567,941, respectively, and these loans consisted of the following:
| | | December 31, | | | September 30, | |
| | | 2009 | | | 2009 | |
| Due to shareholders, bear interest at Bank of China 1-year rate (5.4% at Dec. 31 and Sept. 30, 2009), due no later than December 10, 2010 | | $ | 888,789 | | | $ | 512,643 | |
| Outstanding borrowing on $60,000 unsecured line of credit with a shareholder, with no interest and due by December 10, 2010 | | | 55,298 | | | | 55,298 | |
| | | | | | | | | |
| Total due to shareholders | | $ | 944,087 | | | $ | 567,941 | |
8 LONG-TERM DEBT
Long-term debts consist of the following:
| | | December 31, | | | September 30, | |
| | | 2009 | | | 2009 | |
| Loan from Bank of Jilin, bears interest at 5.85‰ per month, due on March 16, 2011 | | $ | 5,134,500 | | | 5,134,500 | |
| Note payable to a supplier, bears interest at 10% per annum, due in November, 2011 | | | 44,010 | | | | 44,010 | |
| | | | | | | | | |
| Total long-term debt | | $ | 5,178,510 | | | $ | 5,178,510 | |
9 BUSINESS SEGMENT INFORMATION
All of the Company’s sales are to companies located in China. All sales of crude oil are to one company, China National Petroleum Corporation.
The Company operates in three reportable segments which are the extraction and sale of crude oil, the purchase and sale of drilling materials and subleasing.
The following table presents financial information about the Company’s reportable segments as of and for the three months ended December 31, 2009 and 2008:
| | | | Three Months Ended December 31, | |
| | | | 2009 | | | | 2008 | |
| | | | Extraction and | | | | | | | | Sale of steel & | | | | Extraction and | | | | | | | | Sale of steel & | |
| | | | sale of crude oil | | | | Subrental | | | | related products | | | | sale of crude oil | | | | Subrental | | | | related products | |
| Net revenues | | | $ | 565,736 | | | | $ | 831,619 | | | | $ | - | | | | $ | 501,476 | | | | $ | 830,428 | | | | $ | 793,728 | |
| Operating income (loss) | | | | 1,195 | | | | | 808,702 | | | | | (18,131 | ) | | | | 103,691 | | | | | 807,540 | | | | | (11,352 | ) |
| Identifiable assets | | | | 25,652,549 | | | | | 81,686 | | | | | 287 | | | | | 22,493,521 | | | | | 163,372 | | | | | 665,453 | |
Forward-Looking Statements
The following discussion may contain certain forward-looking statements. Such statements are not covered by the safe harbor provisions. These statements include the plans and objectives of management for future growth of the Company, including plans and objectives related to the consummation of acquisitions and future private and public issuances of the Company's equity and debt securities. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved.
The words “we,” “us” and “our” refer to the Company. The words or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions are intended to identify “forward-looking statements.” Actual results could differ materially from those projected in the forward looking statements as a result of a number of risks and uncertainties, including but not limited to: (a) limited amount of resources devoted to achieving our business plan; (b) our failure to implement our business plan within the time period we originally planned to accomplish; (c) our strategies for dealing with negative cash flow; and (d) other risks that are discussed in this report or included in our previous filings with the Securities and Exchange Commission.
For the purposes of this report, we have calculated there to be 7.315 barrels in 1 ton.
Overview
Through our subsidiaries, we are engaged in the sale of steel and steel related products (“Steel”), the business of extraction and sale of crude oil (“Extraction”) and subleasing of oil fields (the “Subrental”).
Our 100% owned subsidiary DaQing YueYu Oilfield Underground Technology Service Co., Ltd (“Daqing Yueyu”) is engaged in the sale of steel and steel related products, and through its 95% owned subsidiary Jilin Yifeng Energy Sources Co., Ltd. (“Jilin Yifeng”) acquired on November 28, 2007, is engaged in the business of extraction and sale of crude oil and subleasing of oil fields (the “Subrental”). Since 2003, Jilin Yifeng has been engaged in the development of oil wells and extracting oil from the Miao 14 oilfield blocks (“Miao 14”). Miao 14 covers 19.8 square kilometers, of which 15.6 square kilometers are oil-bearing areas. The geological reserve is 6.07 million tons in this area, which include proven oil reserves of 5.35 million tons. The thickness of the crust increases from 300 meters to 360 meters, inclining from the west to the east. Oil is found from 1,500 meters to 1,700 meters below sea level. Miao 14 is located in Song Yuan City of Jilin Province, China, at the intersection of Nenjiang River and Songhua River. The Chang Bai Railway and highway south of the oilfield provides the Company with convenient access to transportation for the delivery of crude oil.
Pursuant to a 20-year Exclusive Business Cooperation Agreement entered into between PetroChina and our 95% owned subsidiary Jilin Yifeng in February 2002, we have the right to explore, develop and produce oil at Miao 14 Oilfield and take responsibility for well logging, drill-stem testing and core sampling. Pursuant to the agreement with PetroChina, during the first ten years of this agreement, the Company sells oil to PetroChina at a 20% discount to market price. During the second ten years of this agreement, the Company sells oil to PetroChina at a 40% discount to market price.
Since January 2006 Jilin Yifeng has entered into a few oilfield sublease agreements (“the Agreement?? with Daqing Haihang Oilfield Technology Development Co., Ltd. (“Daqing Haihang”). According to the Agreement, Jilin Yifeng subleases 63% out of its overall oilfield of 19.8 square kilometers to Daqing Haihang for the period from January 2007 to December 31, 2010. As prescribed in the Agreement, Daqing Haihang, a limited liability company founded and registered in China, owns the necessary knowledge and construction equipments of both exploring and extracting crude oil. During the effective term of the Agreement, Daqing Haihang needs to carry out and be responsible for the obligations to PetroChina from Jilin Yifeng, and all production of Daqing Haihang could only be distributed to PetroChina, in compliance with the description of the Agreement.
The oilfield property the Company subleased to Daqing Haihang, accounts for about 63% of the overall area of Miao 14 oilfield, or 12.5 square kilometers, whereas the Company, Jilin Yifeng operates on the other 7.3 square kilometers during the effective term of the Agreement. The geological reserve for the area is 6.07 million tons of oil, which include proven oil reserves of 5.35 million tons. As of February 2002, the company’s operating ratio out of total reserve is about 1.97 million tons. The following table sets forth the information of the oilfield reserves and our output for the periods indicated.
| Remaining Oil reserves we acquired (in tons) as of | | Our Production (in tons) |
| September 30 2008 | September 30, 2009 | December 31, 2009 | | From November 28, 2007 to September 30, 2008 | | | From October 1, 2008 to September 30, 2009 | | | From October 1, 2009 to December 31, 2009 | |
| 1.92 million | 1.91 million | 1.91 million | | | 9,863 | | | | 14,544 | | | | 3,201 | |
As of the end of 2005, Jilin Yifeng had 57 working oil wells, and produced approximately 44,000 tons or 314,160 barrels of crude oil from 2002 to 2005.
From 2006 to 2007, Jilin Yifeng was not able to explore for new oil wells due to a lack of capital resources. In addition, due to limited working capital, during these two years, output of oil was at a lower level compared to previous years.
As of September 30, 2008 and 2009, Jilin Yifeng had 91 producing oil wells. Of these oil wells, 34 wells were developed in 2008.
As of December 31, 2009, our number of producing oil wells remained unchanged compared to September 30, 2009. There were no newly developed oil wells from October 1, 2009 to December 31, 2009. The primary reason is the dramatic decrease in the price of crude oil. Consequently, the lower price of oil has limited the demand for new oil well exploration. We are unable to predict when this trend will reverse itself.
Results of Operations – For the Three Months Ended December 31, 2009 and 2008
All of the Company’s sales were generated within China. PetroChina is the only and exclusive customer for our crude oil products. Substantially, all accounts receivable are due from PetroChina. We operate three reportable segments: extraction and sale of crude oil (“Extraction”), subleasing of oil fields (“Subrental”) and sale of steel and steel related products (“Steel”).
Our Subrental business segment is limited to the subleasing of Miao 14 and our drilling equipment and materials to Daqing Haihang Oil Field Development Company (“Daqing Haihang”). Current term of the sublease expires in December 2010 and provides for annual fixed income of RMB 24 million or approximately $3.5 million dollars. The subrental to Daqing Haihang includes 63% of our total property including 12.5 square kilometers of oilfield. All oil wells operated by the Company are located at the remaining 7.3 square kilometers oilfield. Under the agreement between the Company and its oilfield leasee, the leasee is able to drill new oil wells, explore, extract oil from the oilfield subleased, and the leasee is also authorized to sell crude oil to a third Party. The agreement was executed from January 1, 2008, and will expire on December 31, 2010.
The following table presents financial information about the Company’s reportable segments for the three months ended December 31, 2009 and 2008 (unaudited):
| | | | For the Three Months Ended December 31, | |
| | | | 2009 | | | | | | | | 2008 | | | | | |
| | | | Extraction | | | | Subrental | | | | Steel | | | | Total | | | | Extraction | | | | Subrental | | | | Steel | | | | Total | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Revenue | | | $ | 565,736 | | | | $ | 831,619 | | | | $ | - | | | | $ | 1,397,355 | | | | $ | 501,476 | | | | $ | 830,428 | | | | $ | 793,728 | | | | $ | 2,125,632 | |
| Gross profit | | | $ | 129,211 | | | | $ | 811,202 | | | | $ | - | | | | $ | 940,413 | | | | $ | 213,355 | | | | $ | 810,040 | | | | $ | 9,685 | | | | $ | 1,033,080 | |
| Gross margin | | | | 23 | % | | | | 98 | % | | | | - | | | | | 67 | % | | | | 43 | % | | | | 98 | % | | | | 1 | % | | | | 49 | % |
| | | Percentage Change between the Three Months ended | |
| | | December 31, 2009 and 2008 | |
| | | Extraction | | | | Subrental | | | | Steel | | | | Total | |
| Revenue | | | 13 | % | | | | 0.14 | % | | | | -100 | % | | | | -34 | % |
| Gross profit | | | -39 | % | | | | 0.14 | % | | | | -100 | % | | | | -9 | % |
Revenues.
Revenues for the three months ended December 31, 2009 totaled $1,397,355 as compared to $2,125,632 for the same period in 2008, a decrease of $728,277 or 34%. The decrease was due to the fact that we didn’t have any steel trading activities in our Steel segment this period.
For the three months ended December 31, 2009, the sale of crude oil generated net sales of $565,736, an increase of 13% as compared to the same period in 2008. The increase was due to more oil was sold during current period, partially offset by lower selling price as compared to the same period last year.
We produced 3,201 tons (or 23,415 barrels) of oil for the three months ended December 31, 2009 as compared to 4,489 tons (or 32,837 barrels) of oil during the same period in 2008. We do not recognize sales until PetroChina has accepted delivery of the oil.
As a result, during the three months ended December 31, 2009, the Company sold approximately 1,433 tons or 10,482 barrels to PetroChina, and for the three months December 31, 2008, approximately 1,006 tons or 7,359 barrels were sold to PetroChina. However, the average selling price to PetroChina per barrel was $58.39 for the period ended December 31, 2009, as compared to $76.51 per barrel for the period ended December 31, 2008. According to the agreement between the Company and PetroChina, PetroChina is entitled for a 20% discount of the Company’s output during the first 10 years of the agreement term.
Our subrental income is fixed in RMB by contract with Daqing Haihang and the slight change in USD term was due to currency exchange rate effect.
For the three months ended December 31, 2009, prices of steel and related products remained stable in the Chinese market thus we didn’t engage in any trading activities in our Steel segment during current period. For the three months ended December 31, 2008, our steel trading activities generated $793,728 in revenue.
Cost of Sales.
Cost of sales totaled $456,942 for the three months ended December 31, 2009, a decrease of $635,610 or 58% as compared to the same period in 2008. Cost of sales for our three business segments amounted to $436,525 for Extraction segment, $20,417 for Subrental segment, and $0 for Steel segment. The decrease was due to no activities in our Steel segment this period.
The breakdown of cost of sales from the Extraction segment of $436,525 or 96% of our total cost of sales is as follows:
| | Three Months Ended December 31, | | | |
| Cost of sales of crude oil | | | 2009 | | | | 2008 | | | | % Change | |
| Oil production costs | | | $ | 184,676 | | | | $ | 66,986 | | | | | 176 | % |
| Government oil surcharge | | | | 70,940 | | | | | 91,620 | | | | | -23 | % |
| Depletion | | | | 180,909 | | | | | 129,515 | | | | | 40 | % |
| Subtotal | | | $ | 436,525 | | | | $ | 288,121 | | | | | 52 | % |
As compared to the period earlier, the oil surcharge paid to the Chinese government decreased because of much lower oil prices during the period. Particularly, under a regulation introduced in June 2006, a surcharge of 20% is imposed on the portion of the selling price of crude oil which exceeds $40 per barrel and a surcharge of 40% is imposed on the portion of the selling price of crude oil which exceeds $60 per barrel. Our oil production and depletion costs increased in correlation with the increase of the amount of oil we extracted and sold this period.
Gross Profit.
Gross profit totaled $940,413 for the period, as compared to $1,033,080 for the same period last year, of which $129,211 were contributed by Extraction, $811,202 by Subrental and $0 by Steel. Gross profit decreased by $92,667 or 9% as compared to last period, primarily because of lower gross profit on Extraction segment despite increased sales in the segment. Gross margin of the Extraction segment decreased from 43% in last period to 23% this period primarily because of lower price for sale of crude oil, coupled with higher oil production costs. The average selling price to PetroChina per barrel was $58.39 this period, as compared to $76.51 per barrel for the period ended December 31, 2008.
Gross margin on Subrental segment remained stable from last period. Gross margin for all three segments as a whole stood at 67% this period as compared to 49% last year. The increase was because we didn’t have any activities in the low-margin Steel segment this period.
General & Administrative Expenses.
Operating expenses for the three months ended December 31, 2009 was $148,647, an increase of $15,445 or 12% compared with the three months ended December 31, 2008. For the three months ended December 31, 2009, our general and administrative expenses include salary expense of $40,656, office expense of $16,784, entertainment expense of $15,511, supplies $5,579, travel expense of $11,906, repair and maintenance $19,872, insurance $4,161, governmental mineral resource fee $5,657, totaling more than 80% of our overall operating expenses for the three months ended December 31, 2009. The following is a comparison breakdown of operating expenses for the three months ended December 31, 2009 and 2008, respectively.
| | | | | For the Three Months Ended December 31, | | | | | |
| General & Administrative Expenses | | | 2009 | | | | % Total | | | | 2008 | | | | % Total | | | | % Change | |
| Salary | | | | $ | 40,656 | | | | | 27 | % | | | $ | 41,518 | | | | | 31 | % | | | | -2 | % |
| Office Expense | | | | | 16,784 | | | | | 11 | % | | | | 17,090 | | | | | 13 | % | | | | -2 | % |
| Entertainment Expense | | | | | 15,511 | | | | | 10 | % | | | | 11,669 | | | | | 9 | % | | | | 33 | % |
| Supplies | | | | | 5,579 | | | | | 4 | % | | | | 19,706 | | | | | 15 | % | | | | -72 | % |
| Travel Expense | | | | | 11,906 | | | | | 8 | % | | | | 6,803 | | | | | 5 | % | | | | 75 | % |
| Repair and Maintenance | | | | | 19,872 | | | | | 13 | % | | | | 1,033 | | | | | 1 | % | | | | 1824 | % |
| Insurance | | | | | 4,161 | | | | | 3 | % | | | | 4,274 | | | | | 3 | % | | | | -3 | % |
| Mineral Resource Expense | | | | | 5,657 | | | | | 4 | % | | | | 518 | | | | | 0 | % | | | | 993 | % |
| Other Expenses | | | | | 28,521 | | | | | 19 | % | | | | 30,591 | | | | | 23 | % | | | | -7 | % |
| Total | | | | $ | 148,647 | | | | | 100 | % | | | $ | 133,202 | | | | | 100 | % | | | | 12 | % |
Income from operations.
Income from operations for three months ended December 31, 2009 totaled $791,766 and consisted of operating income generated by three segments. It represents a decrease of $108,112 or 12% as compared to the three months ended December 31, 2008. The decrease is primarily due to decreased operating income from the Extraction segment because of lower oil selling price. The details are as follows:
| | | | Income (loss) from Operations | |
| Segment | | | | Q1, 2010 | | | | | Q1, 2009 | |
| Extraction | | | $ | 1,195 | | | | $ | 103,691 | |
| Subrental | | | | 808,702 | | | | | 807,540 | |
| Steel | | | | (18,131 | ) | | | | (11,352 | ) |
| | | | | | | | | | | |
| Total | | | $ | 791,766 | | | | $ | 899,879 | |
Net Income.
We generated net income of $427,192 after minority interest for the three months ended December 31, 2009, a decrease of $128,161 or 23% as compared to net income for the three months ended December 31, 2008. The decrease in net income is primarily a result of decreased income from our Extraction segment and increase in interest expense. Our net margin was 31%, up from 26% for the same period last year.
Liquidity and Capital Resources
On December 31, 2009, we had cash of $26,973 and working capital deficit of $8,979,665. The working capital deficit was primarily due to our accounts payable of $8,086,607. Our accounts payables are mostly due to drilling companies for drilling expenditure.
Net cash flows used in operating activities were $548,294 for the three months ended December 31, 2009, improved from net cash flows of $613,158 used in operating activities in last period. This was due primarily to less reduction of accounts payable and other payables and accrued liabilities in this period, partially offset by increase in accounts receivable.
Net cash flows provided by investing activities was $11,632 for the three months ended December 31, 2009, as compared to net cash flow used of $954,793 for the same period last year. Capital expenditures have consisted principally of strategic asset acquisition related to the purchase of oil and gas equipments and exploitation and development of oil and gas properties. During this period, we invested $58,638 in exploration and development of oil and gas properties, as compared to $133,295 for the same period last year.
Net cash flows provided by financing activities was $403,057 for the three months ended December 31, 2009, primarily as a result of the proceeds of loan from shareholder. For the same period last year, we borrowed $3,584,352 from unrelated parties and paid down $2,007,437 to shareholder loans.
Principal demands for liquidity are for acquisition of oil and gas properties, development of new oil wells, working capital and general corporate purposes. The Company’s management believes that, in order to develop additional wells, the Company may consider a number of different financing opportunities including loans and future equity financings. If funding is insufficient at any time in the future, we may be unable to develop additional oil wells, and to take advantage of other acquisition opportunities or respond to competitive pressures, any of which could have a material adverse effect on our financial position, results of operations and cash flows.
Critical Accounting Policies
Our significant accounting policies are summarized in Notes 1 of our financial statements included in this quarter report on Form 10-Q for the three months ended December 31, 2009. Our financial statements and related public financial information are based on the application of accounting principles generally accepted in the United States (“GAAP”). GAAP requires the use of estimates; assumptions, judgments and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenues and expense amounts reported. These estimates can also affect supplemental information contained in our external disclosures including information regarding contingencies, risk and financial condition. We believe our use of estimates and underlying accounting assumptions adhere to GAAP and are consistently and conservatively applied. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions. We continue to monitor significant estimates made during the preparation of our financial statements.
Off-Balance Sheet Arrangements
As of the date of this report, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The term “off-balance sheet arrangement” generally means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party, under which we have: (i) any obligation arising under a guarantee contract, derivative instrument or variable interest; or (ii) a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Company is subject to certain market risks, including changes in interest rates and currency exchange rates. The Company does not undertake any specific actions to limit those exposures.
ITEM 4T. CONTROLS AND PROCEDURES
a) Evaluation of Disclosure Controls.
Our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures as of the end of our first fiscal quarter of 2010 pursuant to Rule 13a-15(b) of the Securities and Exchange Act. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, as appropriate to allow timely decisions regarding required disclosure. Based on his evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2009.
It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
There have been no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2009, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 1A. RISK FACTORS.
There have been no material changes from the risk factors included in the Annual Report on Form 10-K for the year ended September 30, 2009.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
31.1 - Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 - Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 - Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
