UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): June 2, 2006
Franklyn Resources III, Inc.
(Exact name of registrant as specified in its charter)
Nevada 0-30017 84-1491682
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(State or other jurisdiction of (Commission File Number) (I.R.S. Employer
incorporation) Identification No.)
234-5149 Country Hills Blvd. NW; Suite 429, Calgary, Alberta, Canada T3A 5K8
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(Address of principal executive offices)
Registrant's telephone number, including area code: (832) 274-3766
Check the appropriate box below if the Form 8-K filing is intended to
simultaneously satisfy the filing obligation of the registrant under any of the
following provisions (see General Instruction A.2. below):
|_| Written communications pursuant to Rule 425 under the Securities Act (17
CFR 230.425)
|_| Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR
240.14a-12)
|_| Pre-commencement communications pursuant to Rule 14d-2(b) under the
Exchange Act (17 CFR 240.14d-2(b))
|_| Pre-commencement communications pursuant to Rule 13e-4(c) under the
Exchange Act (17 CFR 240.13e-4(c))
Item 1.01. Entry into a Material Definitive Agreement.
On June 2, 2006, Franklyn Resources III, Inc. (the "Company") entered into
an exchange agreement pursuant to which the Company acquired all of the equity
of Sinoenergy Holding Limited, a British West Indies corporation ("Sinoenergy")
which owned all of the equity of Qingdau Sinogas General Machinery Corporation,
a Chinese corporation which is qualified as a wholly-owned foreign enterprise
("Sinogas"). Pursuant to the Exchange Agreement, the Company issued 14,215,385
shares of common stock to the owners of Sinoenergy.
In connection with the acquisition of Sinoenegy, the Company entered into:
(a) A securities purchase agreement (the "Purchase Agreement") with Barron
Partners LP, JCAR Funds Ltd., Ray Rivers and Steve Mazur pursuant to which the
investors purchased 6% convertible notes in the principal amount of $3,500,000,
369,000 shares of common stock (the "Initial Shares"), and warrants to purchase
6,000,000 shares of common stock at $.85 per share, 6,000,000 shares of common
stock at $1.20 per share and 6,000,000 shares of common stock at $1.75 per
share. The following table sets forth the investment by each of the investors,
the principal amount of note received, the number of Initial Shares issued and
the number of shares issuable upon exercise of each set of warrants.
Initial
Note Shares Warrants
Barron Partners LP $3,100,000 305,743 4,971,429
JCAR Funds Ltd. 200,000 21,086 342,857
Steven Mazur 100,000 10,543 171,429
Ray Rivers 100,000 10,543 171,429
Total $3,500,000 369,000 6,000,000
The numbers under the column "Warrants" represents the number of shares of
common stock issuable upon exercise of each set of warrants. Thus, each investor
has the same number of warrants exercisable at $.85, $1.20 and $1.75.
(b) A stock redemption agreement with the Company's principal
stockholders. The Company purchased a total of 3,305,000 shares of common stock
for a purchase price of $213,525, which was paid from the proceeds of the notes,
stock and warrants. The following table sets forth the sellers, the number of
shares purchased and the purchase price payable to each seller:
Name Number of Shares Purchase Price
- ---- ---------------- --------------
Frank L. Kramer 1,000,000 $62,600
Deborah Salerno 1,000,000 62,600
John P. O'Shea 1,000,000 62,600
Lynn Suave 150,000 9,690
Mark Lubchenco 100,000 6,465
Gary S. Joiner 35,000 2,270
Marika Xirouhakis 20,000 7,300
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3,305,000 $213,525
========= ========
1
The Company agreed to include in a registration statement the shares of
common stock held by the Company's remaining stockholders.
Purchase Agreement
Pursuant to the Purchase Agreement:
o The Company sold to the investors for $3,500,000, (i) 6% convertible
notes in the aggregate principal amount of $3,500,000, (ii) 369,000
shares of common stock and (iii) warrants to purchase 6,000,000
shares of common stock at an exercise price of $.85 per share,
6,000,000 shares of common stock at an exercise price of $1.20 per
share, and warrants to purchase 6,000,000 shares at an exercise
price of $1.75 per share.
o The Company is required, within 120 days of the closing date, to
amend its articles of incorporation to provide for an authorized
capitalization of 60,000,000 shares of capital stock, of which
10,000,000 will be shares of preferred stock and 50,000,000 will be
shares of common stock and to adopt a certificate of designation
which creates the right of the holders of a series of preferred
stock to be designated as the series A convertible preferred stock.
o Upon the filing of both the restated certificate of incorporation
and the certificate of designation, the notes are automatically
converted into shares of series A preferred stock, at a conversion
price of $.65 per shares, subject to adjustment. Based on the
conversion price of $.65, the Company would issue a total of
5,384,615 shares of series A preferred stock which would be
convertible into 5,384,615 shares of common stock. If the restated
certificate of incorporation and the certificate of designation are
not filed at the time that the notes are converted, the notes are
convertible into common stock at a conversion price of $.65 per
share.
o The conversion price of the note and the conversion rate of the
series A preferred stock are subject to adjustment in certain
instances, including the issuance by the Company of stock at a price
which is less than the conversion price, which is initially $.65.
o In the event that the Company's consolidated pre-tax income, as
defined, for the year ended December 31, 2006 is less than $.212 per
share on a fully-diluted basis, then the Conversion Price shall be
reduced by the percentage shortfall, up to a maximum of 40%.
Fully-diluted pre-tax income is based on the number of shares of
common stock which are outstanding or are otherwise issuable,
regardless of whether such shares would be included in determining
diluted earnings per share under generally accepted accounting
principles.
o In the event the Company's consolidated pre-tax income for the year
ended December 31, 2007 is less than $.353 per share on a
fully-diluted basis, then the Conversion Price shall be reduced by
the percentage shortfall, up to a maximum of 40%.
o The following table sets forth the initial conversion price of the
notes, the conversion ratio for the series A preferred stock and the
exercise price of the $.85 and $1.20 warrants and the adjusted
numbers if (a) the pre-tax income per share for each of the two
years was 20% below the respective targets (a "20% shortfall") and
(b) the pre-tax income per share for each of the two years was 40%
or more below the targets (a "40% shortfall"). No adjustment is
given for the $1.75 warrants, since they expire on December 31.
2006. The number of shares reflects the number of shares of common
stock issuable upon conversion of the note or the series A preferred
stock, and are based on the assumption that no notes or preferred
stock are converted into common stock until the adjustment has been
made for 2007. There is no adjustment in the number of shares
issuable upon exercise of the warrants.
2
Conversion Price/ Conversion Ratio/ $.85 Warrant $1.20 Warrant
Number of Shares Number of Shares Exercise Price Exercise Price
---------------- ----------------- -------------- --------------
Unadjusted $.65/ 1:1/ $.85 $1.20
5,384,615 5,384,615
20% $.416/ 1.5625:1/ $544 $.768
shortfall 8,413,462 8,413,461
40% $.234/ 2.77778:1/ $.306 $432
shortfall 14,957,265 14,957,265
o The Company agreed to have appointed such number of independent
directors that would result in a majority of its directors being
independent directors, that the audit committee would be composed
solely of independent directors and the compensation committee would
have a majority of independent directors. Failure of the Company to
meet these requirements for a period of 60 days for an excused
reason, as defined in the Purchase Agreement, or 75 days for a
reason which is not an excused reason, would results in the
imposition of liquidated damages which are payable in cash or
additional shares of series A preferred stock.. The liquidated
damages are computed in an amount equal to 12% per annum of the
principal amount of notes outstanding, up to a maximum of $420,000,
which is payable in cash or stock, at the election of the investors.
o The Company and investors entered into a registration rights
agreement pursuant to which the Company agreed to file, within 60
days after the closing, a registration statement covering the common
stock issuable upon conversion of notes and the series A preferred
stock and exercise of the warrants. The failure of the Company to
meet this schedule and other timetables provided in the registration
rights agreement would result in the imposition of liquidated
damages, which are payable through the issuance of additional shares
of series A preferred stock. at the rate of 1770 shares of series A
preferred stock for each day, based on the proposed registration of
all of the underlying shares of common stock, with a maximum of
950,000 shares.
o The warrants issued to the investors have a term of five years,
except that the $1.75 warrants expire on December 31, 2006. The
warrants provide for adjustments if the Company does the meet
certain financial targets described above.
o The warrants also provide that, with certain exceptions, if the
Company issues common stock at a price, or warrants or other
convertible securities with an exercise or conversion price which is
less than the exercise price of the warrants, the exercise price of
the warrants will be reduced to the sales price, exercise price or
conversion price, as the case may be, of such other securities.
o The Company also reimbursed Barron Partners for its due diligence
and other expenses in the amount of $50,000.
3
Exchange Agreement
Pursuant to the Exchange Agreement, the Company issued 12,793,847 shares
of common stock to Skywide Capital Management Limited, a British Virgin Islands
corporation owned by Bo Huang, the Company's chief executive officer, and
Tianzhou Deng, the Company's chairman, and 1,421,538 shares to Eastpride Capital
Limited, a British Virgin Islands corporation owned by Wentao Yang.
The shares issued pursuant to the Exchange Agreement are subject to an 18
months lock-up, except that Eastpride can sell up to 50% of its shares
commencing one year after the closing and the remaining shares two years after
the closing. Skywide and Eastpride have demand and piggyback registration rights
commencing December 1, 2007; however, the registration rights provisions do not
include any provisions for liquidated damages.
Item 2.01. Completion of Acquisition or Disposition of Assets.
Information in response to this Item 2.01 is keyed to the Item numbers of Form
10SB.
Part I
Item 1. Description of Business
SUMMARY
On June 2, 2006, the Company acquired the stock of Sinoenergy pursuant to
the Exchange Agreement, which is described under "Item 1.01. Entry into a
Material Definitive Agreement."
References to "we," "us," "our" and similar words refer to the Company
and, where applicable, Sinoenergy, which became a wholly-owned subsidiary of the
Company, and Sinogas, which is wholly-owned by Sinoenergy, unless the context
indicates otherwise. Prior to the effectiveness of the reverse acquisition these
terms refer to Sinogas.
We design, manufacture and market a range of pressurized containers for
compressed natural gas, known as CNG. Compressed natural gas is natural gas,
principally methane, in its gaseous state that has been compressed. Natural gas
is compressed during transportation and storage and, thus, requires pressurized
containers. Our license permits us to operate CNG stations, CNS equipments and
services, as well as non-standard chemical and refinery equipment.
Although our initial business involved the manufacture of non-standard
equipment and pressure containers, our business has evolved as an increasing
market is developing in the People's Republic of China ("PRC") for the use of
CNG as a method of combating air pollution, which is increasing viewed as a
major problem throughout the PRC. We believe that this need will create a market
for CNG powered vehicles. We use our capabilities in this industry to
manufacture equipment for use in CNG gas stations and gas transportation
vehicles.
Our CNG vehicle and gas station equipment business consists of two
divisions, the manufacture of CNG vehicle and gas station equipment, and the
design of construction plans for CNG gas stations, the construction of the CNG
stations, and the installation of CNG station equipment and related systems at
the gas station.
In addition to our CNG related products, we continue to manufacture a wide
variety of pressure containers for use in different industries, including the
design and manufacture of various types of pressure containers in the petroleum
and chemical industries, the metallurgy and electricity generation industries
and the food and brewery industries. In addition, we can design and manufacture
various types of non-standard equipment.
4
We plan to develop a CNG station business in Wuhan City, Hubei province in
the PRC, commencing late 2006, and we expect to have our first project completed
within twelve months thereafter. The first project involve the construction and
operation of 20 CNG stations which will be supplied by two larger supply
stations which provide CNG to the stations.
Organization
Sinogas is an entity known as a wholly-owned foreign enterprise, commonly
referred to as a WOFE, under the laws of the PRC. Its organization is similar to
that of a limited liability company under United States law. Sinogas' term of
existence is for a period of 15 years, ending on October 29. 2019.
Prior to September 2004, Sinogas' business was conducted as a state-owned
equipment manufacturer under the name Qingdao General Machinery Plant. On July
25, 2000, we were privatized, and our equity was owned by three Chinese
companies. In November 2005, Sinoenergy Holding Limited, a British Virgin
Islands corporation which was then owned by Wentao Yang, acquired,subject to
government approval, the equity in Sinogas from the Chinese owners. On November
29, 2005, the local government agency approved the purchase by Sinoenergy of all
the shares of Sinogas, and Sinogas became WOFE.
On February 21, 2006, Sinoenergy entered into a share transfer agreement
with Skywide Capital Management Limited, a British Virgin Islands corporation
which is owned by Tianzhou Deng and Bo Huang, and Eastpride Capital Limited, a
British Virgin Islands corporation owned by Wentao Yang, with the result that
90% of the shares of the Sinogas were held by Skywide and 10% of the shares were
held by Eastpride.
On June 2, 2006, pursuant to the Exchange Agreement, Sinoenergy, which is
the parent of Sinogas, became our wholly-owned subsidiary and the former owners
of Sinoenergy received 14,215,385 shares of common stock, as described under
"Item 1.01 Entry into Definitive Material Agreement." As a result, our business
is the business of Sinoenergy and Sinogas. The acquisition will be accounted for
as a reverse acquisition. The accounting rules for reverse acquisitions require
that beginning with the date of the acquisition, June 2, 2006, our balance sheet
includes the assets and liabilities of Sinogas and its equity accounts were
recapitalized to reflect the net equity of Sinoenergy. In the future, our
historical operating results will be the operating results of Sinogas.
Sinogas's executive offices are located at 45 Jinghua Road, Qingdao,
Shandong, China, telephone 011 86 532 84888827.
Franklyn Resources III, Inc. is a Nevada corporation, organized in 1999.
Its executive offices are located at 234-5149 Country Hills Blvd. NW; Suite 429,
Calgary, Alberta, Canada T3A 5K8, telephone (832) 274-3766.
5
RISK FACTORS
An investment in our securities involves a high degree of risk. In
determining whether to purchase our securities, you should carefully consider
all of the material risks described below, together with the other information
contained in this prospectus before making a decision to purchase our
securities. You should only purchase our securities if you can afford to suffer
the loss of your entire investment.
RISKS ASSOCIATED WITH COMPANIES CONDUCTING BUSINESS IN THE PRC
Because the scope of our business license is limited, we may need government
approval to expand our business.
We are a wholly-owned foreign enterprise, commonly known as a WOFE. The
scope of our business is narrowly defined for all businesses in China and the
WOFE can only conduct business within its approved business scope, which appears
on the business license. Our license permits us to operate CNG stations, CNS
equipments and services, as well as non-standard chemical and refinery
equipment. Any amendment to the scope of our business requires further
application and government approval. Inevitably, there is a negotiation with the
authorities to approve as broad a business scope as is permitted, and we cannot
assure you that we will be able to obtain the necessary government approval for
any change or expansion of our business.
If we are not be able to protect our intellectual property rights, our business
may be impaired.
Our intellectual property relates to our know-how in developing our
products. The protection of intellectual property rights in the PRC is weak, and
we cannot give any assurance that we will be able to protect our intellectual
property rights. To the extent that our business is dependent upon intellectual
property, our ability to generate revenue from these products, would be severely
impaired if we are not able to protect our rights in these products.
If the PRC enacts regulations which forbid or restrict foreign investment, our
ability to grow may be severely impaired.
We intend to expand our business both by increasing our product range,
operating CNG stations and making acquisitions of companies in related
industries. Many of the rules and regulations that we would face are not
explicitly communicated, and we may be subject to rules that would affect our
ability to grow, either internally or through acquisition of other Chinese or
foreign companies. There are also substantial uncertainties regarding the proper
interpretation of current laws and regulations of the PRC. New laws or
regulations that forbid foreign investment could severely impair our businesses
and prospects. Additionally, if the relevant authorities find us in violation of
PRC laws or regulations, they would have broad discretion in dealing with such a
violation, including, without limitation:
o levying fines;
o revoking our business and other licenses;
o requiring that we restructure our ownership or operations; and
o requiring that we discontinue any portion or all of our Internet
related business.
6
Any deterioration of political relations between the United States and the PRC
could impair our operations.
The relationship between the United States and the PRC is subject to
sudden fluctuation and periodic tension. Changes in political conditions in the
PRC and changes in the state of Sino-U.S. relations are difficult to predict and
could adversely affect our operations or cause potential acquisition candidates
or their goods and services to become less attractive. Such a change could lead
to a decline in our profitability. Any weakening of relations between the United
States and the PRC could have a material adverse effect on our operations,
particularly in our efforts to raise capital to expand our CNG station and other
business activities.
Our operations and assets in the PRC are subject to significant political and
economic uncertainties.
Although the government of the PRC has been pursuing economic reform
policies, government policies are subject to rapid change and the government may
adopt policies which have the effect of hindering private economic activity and
greater economic decentralization. There is no assurance that the government of
the PRC will not significantly alter its policies from time to time without
notice in a manner with reduces or eliminates any benefits from its present
policies of economic reform. In addition, a substantial portion of productive
assets in the PRC remains government-owned. For instance, all lands are state
owned and leased to business entities or individuals through governmental
granting of State-owned Land Use Rights. The granting process is typically based
on government policies at the time of granting, which could be lengthy and
complex. This process may adversely affect our future expansion, especially if
we seek to expand manufacturing operations and to develop our CNG station
business. The government of the PRC also exercises significant control over
China's economic growth through the allocation of resources, controlling payment
of foreign currency and providing preferential treatment to particular
industries or companies. Uncertainties may arise with changing of governmental
policies and measures. In addition, changes in laws and regulations, or their
interpretation, or the imposition of confiscatory taxation, restrictions on
currency conversion, imports and sources of supply, devaluations of currency or
the nationalization or other expropriation of private enterprises could have a
material adverse effect on our business, results of operations and financial
condition.
Our operations may not develop in the same way or at the same rate as might be
expected if the PRC economy were similar to the market-oriented economies of
OECD member countries.
The economy of the PRC has historically been a nationalistic, "planned
economy," meaning it functions and produces according to governmental plans and
pre-set targets or quotas. In certain aspects, the PRC's economy has been making
a transition to a more market-oriented economy, although the government may
impose price controls. However, we cannot predict the future direction of these
economic reforms or the effects these measures may have. The economy of the PRC
also differs from the economies of most countries belonging to the Organization
for Economic Cooperation and Development, an international group of member
countries sharing a commitment to democratic government and market economy. For
instance:
o the level of state-owned enterprises in the PRC, as well as the
level of governmental control over the allocation of resources is
greater than in most of the countries belonging to the OECD;
o the level of capital reinvestment is lower in the PRC than in other
countries that are members of the OECD;
7
o the government of the PRC has a greater involvement in general in
the economy and the economic structure of industries within the PRC
than other countries belonging to the OECK; and
o the PRC has various impediments in place that make it difficult for
foreign firms to obtain local currency, as opposed to other
countries belonging to the OECD where exchange of currencies is
generally free from restriction.
As a result of these differences, our business may not develop in the same
way or at the same rate as might be expected if the economy of the PRC were
similar to those of the OECD member countries.
Because our directors and some of our officers reside outside of the United
States, it may be difficult for you to enforce your rights against them or
enforce United States court judgments against them in the PRC.
Our directors and our senior executive officers, including our chief
executive officer and chief financial officer, reside in the PRC and
substantially all of our assets are located in the PRC. It may therefore be
difficult for United States investors to enforce their legal rights, to effect
service of process upon our directors or officers or to enforce judgments of
United States courts predicated upon civil liabilities and criminal penalties of
our directors and officers under federal securities laws. Further, it is unclear
if extradition treaties now in effect between the United States and the PRC
would permit effective enforcement of criminal penalties of the federal
securities laws.
We may have limited legal recourse under Chinese law if disputes arise under
contracts with third parties.
Almost all of our agreements with our employees and third parties,
including our supplier and customers, are governed by the laws of the PRC. The
legal system in the PRC is a civil law system based on written statutes. Unlike
common law systems, such as we have in the United States, it is a system in
which decided legal cases have little precedential value. The government of the
PRC has enacted some laws and regulations dealing with matters such as corporate
organization and governance, foreign investment, commerce, taxation and trade.
However, their experience in implementing, interpreting and enforcing these laws
and regulations is limited, and our ability to enforce commercial claims or to
resolve commercial disputes is unpredictable. The resolution of these matters
may be subject to the exercise of considerable discretion by agencies of the
PRC, and forces unrelated to the legal merits of a particular matter or dispute
may influence their determination. Any rights we may have to specific
performance or to seek an injunction under Chinese law are severely limited, and
without a means of recourse by virtue of the Chinese legal system, we may be
unable to prevent these situations from occurring. The occurrence of any such
events could have a material adverse effect on our business, financial condition
and results of operations.
Because we may not be able to obtain business insurance in the PRC, we may not
be protected from risks that are customarily covered by insurance in the United
States.
Business insurance is not readily available in the PRC. To the extent that
we suffer a loss of a type which would normally be covered by insurance in the
United States, such as product liability and general liability insurance, we
would incur significant expenses in both defending any action and in paying any
claims that result from a settlement or judgment. Since our products are used
for the transportation and storage of CNG and chemicals, any damage caused by
the failure or alleged failure of our products could result in substantial
damages, and if the nature or amount of any uninsured loss is significant, we
may be unable to continue in business.
8
Because our funds are held in banks which do not provide insurance, the failure
of any bank in which we deposit our funds could affect our ability to continue
in business.
Banks and other financial institutions in the PRC do not provide insurance
for funds held on deposit. As a result, in the event of a bank failure, we may
not have access to funds on deposit. Depending upon the amount of money we
maintain in a bank that fails, our inability to have access to our cash could
impair our operations, and, if we are not able to access funds to pay our
suppliers, employees and other creditors, we may be unable to continue in
business.
Failure to comply with the United States Foreign Corrupt Practices Act could
subject us to penalties and other adverse consequences.
We are subject to the United States Foreign Corrupt Practices Act, which
generally prohibits United States companies from engaging in bribery or other
prohibited payments to foreign officials for the purpose of obtaining or
retaining business. Foreign companies, including some that may compete with us,
are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs,
theft and other fraudulent practices occur from time-to-time in the PRC. We can
make no assurance, however, that our employees or other agents will not engage
in such conduct for which we might be held responsible. If our employees or
other agents are found to have engaged in such practices, we could suffer severe
penalties and other consequences that may have a material adverse effect on our
business, financial condition and results of operations.
If the United States imposes trade sanctions on the PRC due to its current
currency, export or other policies, our ability to succeed in the international
markets may be diminished.
The PRC currently "pegs" its currency to a basket of currencies, including
United States dollar. This means that each unit of Chinese currency has a set
ratio for which it may be exchanged for United States currency, as opposed to
having a floating value like other countries' currencies. This policy is
currently under review by policy makers in the United States. Trade groups in
the United States have blamed the cheap value of the Chinese currency for
causing job losses in American factories, giving exporters an unfair advantage
and making its imports expensive. There is increasing pressure for the PRC to
change its currency policies to provide for its currency to float freely on
international markets. As a result, Congress is considering the enacting
legislation which could result in the imposition of quotas and tariffs. If the
PRC changes its existing currency policies or if the United States or other
countries enact laws to penalize the PRC for its existing currency policies, our
business may be adversely affected, even though we do not sell outside of the
PRC. Further, we cannot predict what action the PRC may take in the event that
the United States imposes tariffs, quotas or other sanctions on Chinese
products. Even though we do not sell products into the United States market, it
is possible that such action by the PRC may nonetheless affect our business
since we are a United States company, although we cannot predict the nature or
extent thereof. Any government action which has the effect of inhibiting foreign
investment could hurt our ability to raise cash that we need for our operations.
9
Exchange controls that exist in the PRC may limit our ability to utilize our
cash flow effectively.
We are subject to the PRC's rules and regulations on currency conversion.
Although, as a WOFE, we are permitted to convert Chinese currency, the Renminbi
(People's currency) into United States dollars for remittance to our United
States parent, we cannot assure you that we will continue to have government
approval to remit United States dollars to our United States parent. Any
restrictions on currency exchanges may limit our ability to use our cash flow
for the distribution of dividends to our stockholders or to fund operations we
may have outside of the PRC. Conversion of Renminbi for capital account items,
including direct investment and loans, is subject to governmental approval in
the PRC, and companies are required to open and maintain separate foreign
exchange accounts for capital account items. We cannot be certain that the
regulatory authorities of the PRC will not impose more stringent restrictions on
the convertibility of the Renminbi, especially with respect to foreign exchange
transactions. Because a significant component for many of our products, the
steel vessels, is manufactured in Italy, our inability to pay our foreign
manufacturer may impair our ability to manufacture our products.
Fluctuations in the exchange rate could have a material adverse effect upon our
business.
We conduct our business in the Renminbi. To the extent our future revenue
are denominated in currencies other the United States dollars, we would be
subject to increased risks relating to foreign currency exchange rate
fluctuations which could have a material adverse affect on our financial
condition and operating results since our operating results are reported in
United States dollars and significant changes in the exchange rate could
materially impact our reported earnings.
A downturn in the economy of the PRC may slow our growth and profitability.
The growth of the Chinese economy has been uneven across geographic
regions and economic sectors. There can be no assurance that growth of the
Chinese economy will be steady or that any downturn will not have a negative
effect on our business especially if it results in either a decreased use of
products such as ours or in pressure on us to lower our prices. Since our CNG
station business is dependent upon the development of a market for cars and
truck that run on CNG rather than gasoline, any economic trends which have the
effect of dampening the market for CNG vehicles could affect our ability both to
sell our CNG products and to sell CNG at our proposed CNG stations.
Any recurrence of severe acute respiratory syndrome, or SARS, or another
widespread public health problem, such as bird flu, could adversely affect our
business.
A renewed outbreak of SARS or another widespread public health problem,
including bird flu, in China, where all of our revenues are derived, could have
a negative effect on our operations. Our operations may be impacted by a number
of health-related factors, including the following:
o quarantines or closures of some of our offices which would severely
disrupt our operations,
o the sickness or death of our key officers and employees, and
o a general slowdown in the economy of the PRC.
Any of the foregoing events or other unforeseen consequences of public
health problems could adversely affect our business and results of operations.
10
If certain tax exemptions within the PRC regarding withholding taxes are
removed, we may be required to deduct corporate withholding taxes from any
dividends we may pay in the future.
Under the PRC's current tax laws, regulations and rulings, companies are
exempt from paying withholding taxes with respect dividends paid to stockholders
outside of the PRC. However, if the foregoing exemption is removed, we may be
required to deduct certain amounts from any dividends we pay to our
stockholders.
RISKS ASSOCIATED WITH OUR BUSINESS
Because we are dependent upon a small number of customers, the loss of a major
supplier or customer could impair our ability to operate profitably.
We do not have long-term contracts with almost all of our customers, and
major contracts with a small number of customers accounts for a significant
percentage of our revenue. Our contracts relate to specific projects. As a
result, a customer can account for significant revenue in one year and little if
any in the next. Our largest customer for the year ended December 31, 2006,
Millennium Group Limited (Hong Kong), which accounted for revenue of
approximately $3.8 million, or 46% of our revenue for the year, and is not a
significant customer in the first quarter of 2006.
Because we intend to enter into a new business with our proposed operation of
CNG stations, we will require significant additional funds.
We intend to develop the business of owning and operating CNG stations,
which is a new business for us. To date, our business has been limited to the
manufacture of equipment, including equipment used for CNG stations. The
operation of this business is subject to significant additional risks which are
not related to our equipment manufacturing business. In addition to the normal
risks associated with our business, there are additional risks that relate to
the CNG station business. These risks include, but are not limited to:
We lack experience in operating CNG stations. Although we have
manufactured equipment for use by CNG stations, we have never operated stations,
and we cannot assure you that we will be successful in operating CNG stations.
We require significant additional funds to enable us to develop and expand
the CNG station business. The construction of CNG stations is very capital
intensive, and we will require significant additional funds for this purpose. We
have no agreements to obtain funding, and our agreement with the purchasers of
our securities in our June private placement give them a right of first refusal
on future financings. In addition, if we raise funds at a price which is less
than the conversion price of the note or the exercise price of the warrants, the
conversion or exercise price would be reduced. We cannot assure you that we will
be able to obtain any financing which we may require, either for our CNS station
business or our equipment manufacture and supply business.
The CNG station business is highly regulated. The storage, transportation
and distribution of CNG is subject to PRC regulations, including the price at
which we both buy and sell CNG. The price controls over the purchase and sale of
CNS limits our potential profit from the sale of CNG. Other regulations may
result in increased costs in order to comply with these regulations.
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Because of the nature of CNG, we could be exposed to liability from gas
leaks or explosions. Any leaks or explosions from our CNG stations could cause
severe property damage as well as loss of life, which may not be covered by
insurance. Any such loss could result in a termination of our business or could
subject us to regulatory actions.
The market for CNS stations is dependent upon the increased use of CNG
powered vehicles. CNG-powered vehicles represent only a small fraction of motor
vehicles in the PRC, and most vehicles are powered by gasoline or diesel fuel.
For us to be successful in the CNG gas station business, a market for CNG must
be developed in the area which we propose to enter. Car and truck owners must
either buy a CNG powered vehicle or pay to have a gasoline or diesel powered
vehicle converted for CNG use. Any economic downturn could materially decrease
the market for CNG vehicles. Further, in order for a market to develop for CNG
vehicles, there must be a network of CNG stations on major highways throughout
the PRC. The failure of such a network to develop could hinder the development
of a market for CNG vehicles which would in turn limit the market for our CNG
stations.
We may face liability claims from users of our products.
As the manufacturer of equipment that is used to store and transport CNG
and other products, including petroleum, chemicals and food products. We may be
subject both to liability in the event that any property damages or loss of life
results from our products. Any liability which results could hurt our reputation
and result in the payment of damages which may not be covered by insurance.
As a result of the reverse acquisition, our expenses will increase
significantly.
As a result of the reverse acquisition, our ongoing expenses have
increased significantly, including expenses in compensation to our officers,
additional expenses relating to the anticipated hiring of a chief financial
officer, ongoing public company expenses, and obligations incurred in connection
with the reverse acquisition. Our failure to generate sufficient revenue and
gross profit could result in reduced profits of losses as a result of the
additional expenses.
Because we are dependent on our management, the loss of key executive officers
or a key consultant and the failure to hire additional qualified key personnel
could harm our business.
Our business is largely dependent upon the continued efforts of our
Chairman, Tianzhou Deng, who are also directors. We do not have a long-term
contract with Mr. Deng. The loss Mr. Deng or any of our other key employees
could have a material adverse effect upon our ability to operate profitably.
We may not be able to continue to grow through acquisitions.
In addition to our planned growth through the development of our CNG
station business, an important part of our growth strategy is to expand our
business and to acquire other businesses. Such acquisitions may be made with
cash or our securities or a combination of cash and securities. If our stock
price is less than the exercise price of the outstanding warrants, it is not
likely that that warrants will be exercised at their present exercise price. To
the extent that we require cash, we may have to borrow the funds or sell equity
securities. The issuance of equity, if available, would result in dilution to
our stockholders. We have no commitments from any financing source and we may
not be able to raise any cash necessary to complete an acquisition. If we fail
to make any acquisitions, our future growth may be limited. As of the date of
this report, we do not have any agreement or understanding, either formal or
informal, as to any acquisition. Further, any acquisition may be subject to
government regulations and approval in the PRC.
12
If we make any acquisitions, they may disrupt or have a negative impact on our
business.
If we make acquisitions, we could have difficulty integrating the acquired
companies' personnel and operations with our own. In addition, the key personnel
of the acquired business may not be willing to work for us. We cannot predict
the affect expansion may have on our core business. Regardless of whether we are
successful in making an acquisition, the negotiations could disrupt our ongoing
business, distract our management and employees and increase our expenses. In
addition to the risks described above, acquisitions are accompanied by a number
of inherent risks, including, without limitation, the following:
o the difficulty of integrating acquired products, services or
operations;
o the potential disruption of the ongoing businesses and distraction
of our management and the management of acquired companies;
o the difficulty of incorporating acquired rights or products into our
existing business;
o difficulties in disposing of the excess or idle facilities of an
acquired company or business and expenses in maintaining such
facilities;
o difficulties in maintaining uniform standards, controls, procedures
and policies;
o the potential impairment of relationships with employees and
customers as a result of any integration of new management
personnel;
o the potential inability or failure to achieve additional sales and
enhance our customer base through cross-marketing of the products to
new and existing customers;
o the effect of any government regulations which relate to the
business acquired;
o potential unknown liabilities associated with acquired businesses or
product lines, or the need to spend significant amounts to retool,
reposition or modify the marketing and sales of acquired products or
the defense of any litigation, whether of not successful, resulting
from actions of the acquired company prior to our acquisition.
Our business could be severely impaired if and to the extent that we are
unable to succeed in addressing any of these risks or other problems encountered
in connection with these acquisitions, many of which cannot be presently
identified, these risks and problems could disrupt our ongoing business,
distract our management and employees, increase our expenses and adversely
affect our results of operations.
Our operating results in future periods may vary from quarter to quarter, and,
as a result, we may fail to meet the expectations of our investors and analysts,
which may cause our stock price to fluctuate or decline.
As a manufacturer of specialized equipment, we do not manufacture for
inventory, but pursuant to a specific contract, and our contract flow is not
predictable. To the extent that we do not generate new business upon completion
of existing contracts, our revenue will decline. To the extent that we expand
our facilities to meet present or anticipated increases in sales, our failure to
generate business could have the effect of significantly reducing the
profitability of our business. Because of these factors, our revenue and
operating results have fluctuated from quarter to quarter. We expect that
fluctuations in both revenue and net income will continue due to a variety of
factors, many of which are outside of our control. Due to the risks discussed in
this report, you should not rely on period-to-period comparisons of our results
of operations as an indication of future performance.
13
Certain of our stockholders control a significant amount of our common stock.
Approximately 87.5% of our outstanding common stock is owned by Skywide
Capital Management Limited, which is owned by our chief executive officer and
our chairman, and 9.7% of our outstanding common stock is owned by Eastpride
Capital Limited. Skywide presently has the voting power to elect all of the
directors and approve any transaction requiring stockholder approval.
Efforts to comply with recently enacted changes in securities laws and
regulations will increase our costs and require additional management resources,
and we still may fail to comply.
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC
adopted rules requiring public companies to include a report of management on
the company's internal controls over financial reporting in their annual reports
on Form 10-KSB. In addition, the public accounting firm auditing the company's
financial statements must attest to and report on management's assessment of the
effectiveness of the company's internal controls over financial reporting. These
requirements are not presently applicable to us. If and when these regulations
become applicable to us, and if we are unable to conclude that we have effective
internal controls over financial reporting or if our independent auditors are
unable to provide us with an unqualified report as to the effectiveness of our
internal controls over financial reporting as required by Section 404 of the
Sarbanes-Oxley Act of 2002, investors could lose confidence in the reliability
of our financial statements, which could result in a decrease in the value of
our securities. We have not yet begun a formal process to evaluate our internal
controls over financial reporting. Given the status of our efforts, coupled with
the fact that guidance from regulatory authorities in the area of internal
controls continues to evolve, substantial uncertainty exists regarding our
ability to comply by applicable deadlines.
The terms on which we may raise additional capital may result in significant
dilution and may impair our stock price.
Because of both the absence of a public market for our common stock, the
terms of our recent private placement and the number of outstanding warrants and
the exercise price and other terms on which we may issued common stock upon
exercise of the warrants, it may be difficult for us to raise additional capital
if required for our present business and for any planned expansion. We cannot
assure you that we will be able to get additional financing on any terms, and,
if we are able to raise funds, it may be necessary for us to sell our securities
at a price which is at a significant discount from the market price and on other
terms which may be disadvantageous to us. In connection with any such financing,
we may be required to provide registration rights to the investors and pay
damages to the investor in the event that the registration statement is not
filed or declared effective by specified dates. The price and terms of any
financing which would be available to us could result in both the issuance of a
significant number of shares and significant downward pressure on our stock
price and could result in a reduction of the conversion price of the series A
preferred stock and exercise price of the warrants held by the investors in our
June 2006 private placement.
14
If we fail to achieve certain financial results, we will be required to issue
more shares of common stock upon conversion of the series A preferred stock or
exercise of the warrants.
The notes, the series A preferred stock and the warrants issued in the
June 2006 private placement have antidilution provisions which increase the
number of shares issuable upon conversion of the note or the series A preferred
stock and reduce the exercise price of the warrants if we issue common stock at
a price which is less than the conversion price of the notes or the series A
preferred stock or the exercise price of the warrants or if we fail to meet
full-diluted net income per share targets set forth in the purchase agreement.
If either or both of these adjustments are triggered, the investors in the June
2006 private placement will receive, on such exercise or conversion, a larger
number of shares of common stock, which will increase their percentage interest
in our stock. We cannot assure you that there will not be such an adjustment. If
the maximum downward adjustment based on our pre-tax earnings were made in the
conversion price of the note, the number of shares issuable upon such conversion
would increase from 5,384,615 shares to 15,957,265 shares.
Because the purchasers of our notes have a right of first refusal for future
offering of our securities, we may have difficulty in raising additional funds
if required for our business.
The investor in the June 2006 private placement, have the right to
participate in any future funding. These provisions may prevent us from raising
additional funds.
We may be required to pay liquidated damages if our board does not consist of a
majority of independent directors.
The purchase agreement relating to the June 2006 private placement
requires us to appoint and maintain such number of independent directors that
would result in a majority of our directors being independent directors, that
the audit committee would be composed solely of independent directors and the
compensation committee would have a majority of independent directors. Our
failure to maintain these requirements would results in our payment of
liquidated damages that payable by the issuance of additional shares of series A
preferred stock.
RISKS ASSOCIATED WITH INVESTING IN OUR COMMON STOCK
There is no trading market for our common stock.
Although our common stock is registered pursuant to the Securities
Exchange Act of 1934, there is no market for our common stock and we cannot give
any assurance that there will ever be a market for our common stock. We do not
anticipate that a market for our common stock will develop, if at all, until
after the registration statement of which this prospectus is a part has been
declared effective by the SEC. If a market for our common stock develops, there
is a significant risk that our stock price may fluctuate dramatically in the
future in response to any of the following factors, some of which are beyond our
control:
o variations in our quarterly operating results;
o announcements that our revenue or income are below analysts'
expectations;
o general economic slowdowns;
15
o matters affecting the economy of the PRC and the relationship
between the United States and the PRC;
o changes in market valuations of both similar companies and companies
whose business is primarily or exclusively in the PRC;
o sales of large blocks of our common stock;
o announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
o fluctuations in stock market prices and volumes, which are
particularly common among highly volatile securities of
internationally-based companies.
o concern by potential investors that the large number of shares of
common stock which may be sold pursuant to this prospectus may have
a downward effect upon the market price of the stock.
o the effect of sales pursuant to this prospectus on the trading
volume of our common stock.
The rights of the holders of common stock may be impaired by the potential
issuance of preferred stock.
Although our articles of incorporation do not provide for the issuance of
preferred stock, our agreement with the investors in the June 2006 private
placement requires us to amend and restate our articles of incorporation to
provide for the issuance of preferred stock. As a result, the board of directors
will have the right, without stockholder approval, to issue preferred stock with
voting, dividend, conversion, liquidation or other rights which could adversely
affect the voting power and equity interest of the holders of common stock.,
which could be issued with the right to more than one vote per share, could be
utilized as a method of discouraging, delaying or preventing a change of
control. The possible impact on takeover attempts could adversely affect the
price of our common stock. Although we have no present intention to issue any
additional shares of preferred stock or to create any new series of preferred
stock, other than the proposed issuance of a series of preferred stock to be
designated the series A preferred stock, for issuance upon conversion of the
notes.
Shares may be issued pursuant to our stock plans which may affect the market
price of our common stock.
We may issue stock upon the exercise of options or pursuant to stock
grants covering a total of 2,000,000 shares of common stock pursuant to our 2006
long-term incentive plan. The exercise of any options we may grant under this
plan and the sale of the underlying shares of common stock and the sale of stock
issued pursuant to stock grants may have an adverse effect upon the price of our
stock.
Because we are not subject to compliance with rules requiring the adoption of
certain corporate governance measures, our stockholders have limited protections
against interested director transactions, conflicts of interest and similar
matters.
The Sarbanes-Oxley Act of 2002, as well as rule changes proposed and
enacted by the SEC, the New York and American Stock Exchanges and the Nasdaq
Stock Market as a result of Sarbanes-Oxley require the implementation of various
measures relating to corporate governance. These measures are designed to
enhance the integrity of corporate management and the securities markets and
apply to securities which are listed on those exchanges or the Nasdaq Stock
16
Market. Because we are not presently required to comply with many of the
corporate governance provisions and because we chose to avoid incurring the
substantial additional costs associated with such compliance any sooner than
necessary, we have not yet adopted all of these measures. Because none of our
present directors are independent directors, we do not have independent audit or
compensation committees. We also are not in compliance with requirements
relating to the distribution of annual and interim reports, the holding of
stockholders meetings and solicitation of proxies for such meeting and
requirements for stockholder approval for certain corporate actions. Until we
comply with such corporate governance measures, regardless of whether such
compliance is required, the absence of such standards of corporate governance
may leave our stockholders without protections against interested director
transactions, conflicts of interest and similar matters and investors may be
reluctant to provide us with funds necessary to expand our operations.
Failure to achieve and maintain effective internal controls in accordance with
Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on
our business and operating results and stockholders could lose confidence in our
financial reporting.
Effective internal controls are necessary for us to provide reliable
financial reports and effectively prevent fraud. If we cannot provide reliable
financial reports or prevent fraud, our operating results could be harmed. We
may be required to document and test our internal control procedures in order to
satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which
requires increased control over financial reporting requirements, including
annual management assessments of the effectiveness of such internal controls and
a report by our independent certified public accounting firm addressing these
assessments. Failure to achieve and maintain an effective internal control
environment, regardless of whether we are required to maintain such controls,
could also cause investors to lose confidence in our reported financial
information, which could have a material adverse effect on our stock price.
Because we have significant related party transactions, institutional and other
investors may be reluctant to purchase our stock which could affect both the
price and the market for our stock.
During 2005, we purchase real property rights from a related party for
approximately $11.9 million of which $5.0 million was paid. In addition, we have
significant aged receivables from a related party and we subcontract services
to, and purchase equipment from, a related party. As a result, investors may be
reluctant to invest in our common stock, which would affect both the stock price
and the trading volume in our stock.
We do not anticipate paying dividends on our common stock.
We are prohibited from paying dividends on our common stock while the
notes or the series A preferred stock issuable upon conversion of the notes is
outstanding.
Because we may be subject to the "penny stock" rules, you may have difficulty in
selling our common stock.
If a public market develops for our common stock and if our stock price is
less than $5.00 per share, our stock may be subject to the SEC's penny stock
rules, which impose additional sales practice requirements and restrictions on
broker-dealers that sell our stock to persons other than established customers
and institutional accredited investors. The application of these rules may
affect the ability of broker-dealers to sell our common stock and may affect
your ability to sell any common stock you may own.
17
According to the SEC, the market for penny stocks has suffered in recent
years from patterns of fraud and abuse. Such patterns include:
o Control of the market for the security by one or a few
broker-dealers that are often related to the promoter or issuer;
o Manipulation of prices through prearranged matching of purchases and
sales and false and misleading press releases;
o "Boiler room" practices involving high pressure sales tactics and
unrealistic price projections by inexperienced sales persons;
o Excessive and undisclosed bid-ask differentials and markups by
selling broker-dealers; and
o The wholesale dumping of the same securities by promoters and
broker-dealers after prices have been manipulated to a desired
level, along with the inevitable collapse of those prices with
consequent investor losses.
As an issuer of "penny stock" the protection provided by the federal securities
laws relating to forward looking statements does not apply to us.
Although the federal securities law provide a safe harbor for
forward-looking statements made by a public company that files reports under the
federal securities laws, this safe harbor is not available to issuers of penny
stocks. As a result, if we are a penny stock we will not have the benefit of
this safe harbor protection in the event of any based upon an claim that the
material provided by us contained a material misstatement of fact or was
misleading in any material respect because of our failure to include any
statements necessary to make the statements not misleading.
Fluctuations in our operating results and announcements and developments
concerning our business affect our stock price.
Historically, there has been volatility in the market price for common
stock of companies such as us. Our quarterly operating results, the number of
stockholders desiring to sell their shares, changes in general economic
conditions and the financial markets, changes relating to the PRC, the execution
of new contracts and the termination or expiration of existing contracts and the
success if constructing and developing a CNG station business and other
developments affecting us, could cause the market price of our common stock to
fluctuate substantially.
We cannot predict when or whether an active market for our common stock will
develop.
In the absence of an active trading market, you may have difficulty buying
and selling or obtaining market quotations; the market visibility for our stock
may be limited, and the lack of visibility for our common stock may have a
depressive effect on the market price for our common stock.
18
Our stock price may be affected by our failure to meet projections and estimates
of earnings developed either by us or by independent securities analysts.
Although we do not make projections relating to our future operating
results, our operating results may fall below the expectations of securities
analysts and investors. In this event, the market price of our common stock
would likely be materially adversely affected.
The registration and potential sale by our stockholders of a significant number
of shares could encourage short sales by third parties.
Because there is no public market for our stock, there may be significant
downward pressure on our stock price caused by the sale or potential sale of a
significant number of shares pursuant to this prospectus, which could allow
short sellers of our stock an opportunity to take advantage of any decrease in
the value of our stock. The presence of short sellers in our common stock may
further depress the price of our common stock.
If the investor in the June 2006 private placement sells a significant
number of shares of common stock, the market price of our common stock may
decline. Furthermore, the sale or potential sale the offered shares pursuant to
a registration statement and the depressive effect of such sales or potential
sales could make it difficult for us to raise funds from other sources.
FORWARD-LOOKING STATEMENTS
Statements in this current report on Form 8-K may be "forward-looking
statements." Forward-looking statements include, but are not limited to,
statements that express our intentions, beliefs, expectations, strategies,
predictions or any other statements relating to our future activities or other
future events or conditions. These statements are based on current expectations,
estimates and projections about our business based, in part, on assumptions made
by management. These statements are not guarantees of future performance and
involve risks, uncertainties and assumptions that are difficult to predict.
Therefore, actual outcomes and results may, and are likely to, differ materially
from what is expressed or forecasted in the forward-looking statements due to
numerous factors, including those described above and those risks discussed from
time to time in this prospectus, including the risks described under "Risk
Factors," and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in this current report and in other documents which we
file with the Securities and Exchange Commission. In addition, such statements
could be affected by risks and uncertainties related to the ability to conduct
business in the PRC, product demand, including the demand for CNG, our ability
to develop, construct and operate a CNG station business, our ability to raise
any financing which we may require for our operations, competition, government
regulations and requirements, pricing and development difficulties, our ability
to make acquisitions and successfully integrate those acquisitions with our
business, as well as general industry and market conditions and growth rates,
and general economic conditions. Any forward-looking statements speak only as of
the date on which they are made, and we do not undertake any obligation to
update any forward-looking statement to reflect events or circumstances after
the date of this current report.
BUSINESS
We design, manufacture and market a range of pressurized containers for
compressed natural gas, known as CNG. Compressed natural gas is natural gas,
principally methane, in its gaseous state that has been compressed. Natural gas
is compressed during transportation and storage and, thus, requires pressurized
containers. Our license permits us to operate CNG stations, CNS equipments and
services, as well as non-standard chemical and refinery equipment.
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Although our initial business involved the manufacture of non-standard
equipment and pressure containers, our business has evolved as an increasing
market is developing in the People's Republic of China ("PRC") for the use of
CNG as a method of combating air pollution, which is increasing viewed as a
major problem throughout the PRC. We believe that this need will create a market
for CNG powered vehicles. We use our capabilities in this industry to
manufacture equipment for use in CNG gas stations and gas transportation
vehicles.
Our CNG vehicle and gas station equipment business consists of two
divisions.
The manufacture of CNG vehicle and gas station equipment, including
following products:
o CNG trailer, which is a truck which includes a steel vessel storage
system to transport CNG among CNG stations. This system consists of
several steel pressure containers on a steel frame which have an
input/output for the delivery of CNG.
o CNG deposited system for gas station usage, which is a similar
storage system that is installed at the CNG station, which consists
of electronic parts that are installed on gasoline powered vehicles
to transform gasoline burning engines into CNG burning engines.
o Conversion kits for various types of vehicle to enable them to use
CNG rather than gasoline.
o CNG compressor skid, which is a natural gas compression system used
to compress and store as CNG under pressure.
o CNG dispenser which is a CNG release system used to transform CNG
into natural gas at a specified pressure level in a manner to enable
the station to measure the amount of CNG used.
Our CNG gas station system business includes the design of construction
plans for CNG gas stations, the construction of the CNG stations, and the
installation of CNG station equipment and related systems at the gas station.
In addition to our CNG related products, we continue to manufacture a wide
variety of pressure containers for use in different industries, including the
design and manufacture of various types of pressure containers in the petroleum
and chemical industries, the metallurgy and electricity generation industries
and the food and brewery industries. In addition, we can design and manufacture
other types of non-standard equipment.
Our Proposed CNG Station Business
Our business plan contemplates the establishment of a network of CNG
stations at various locations in the PRC. We intend to develop our first CNG
station project in Wuhan city, Hubei province in the PRC. We chose that location
because of its proximity to a natural gas pipeline. At this project we intend to
build and operate two supply stations and twenty CNG stations at which we will
sell CNG at retail. As an industry standard, one supply station usually supplies
ten CNG stations. Each CNG supply station will have designed capacity to process
and supply natural gas at 100,000 cubic meters/per day, while one CNG station
will have designed capacity to supply natural gas at 10,000 cubic meters/per
day.
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Marketing and Sales
We rely primarily on "in-house" salesmen, who directly contact and build
relationship with end user customers, and we sell to the end users. We market
our products through business connections, trade shows and conferences.
When we develop of CNG station business, we intend to market our services
to taxi and bus companies, who are the largest segment of end-users of the
company's CNG product. We will seek to market not only the CNG from our
stations, but the conversion of their gasoline engines to CNG engines.
Principal Customers
Since our products are, in general, specially designed to meet the
requirements of a specific customer and we do not sell products from inventory,
our revenue is dependent upon our developing a continuing stream of business so
that we will not incur a significant lag between the time we complete one
contract and start another. Further, because are products are durable products
with a relatively long useful life, not consumables, once we deliver the product
to the customer, there is little ongoing business from one period to the next.
Our major customers vary from period to period. For example, our largest
customer for the year ended December 31, 2006, Millennium Group Limited (Hong
Kong), accounted for revenue of approximately $3.8 million, or 46% of our
revenue for the year, and is not a significant customer in the first quarter of
2006. Our contract with Millenium Group related to the construction of CNG
stations for Millenium, and that contract was completed in 2005, and does not
require any significant products or services after the completion of the
station.
Our principal customers are China National Petroleum Corporation, China
Petroleum and Chemical Corporation and their affiliates to whom we sell CNG
station equipment and pressure containers. For the retail filling station
segment of the business, the company will target taxi and bus companies in
various cities in the area where our CNG stations are located.
Source of Supply
The principal components of our products are compressors, steel vessels
and raw steel, as well as electronic parts for the conversion kits used to
convert a gasoline engine to a CNG engine. We can obtain most of these products
from a number of suppliers in the PRC. We are not dependent upon any supplier
for these products.
Our steel vessels, which were manufactured in Italy by Dalmine Spa, an
Italian corporation, through Dalmine's distributors in the PRC. Because of the
nature of these products, Dalmine requires six months advance notice for
delivery. We have not experienced any difficulty in obtaining raw materials for
our products.
Competition
The two largest state owned energy companies, CNPC (China National
Petroleum Corporation) Group, and SINOPEC (China Petroleum and Chemical
Corporation), engaged in the upstream supply of energy and are major companies
in exploration and transportation of oil and gas. They build much of the PRC's
high pressure pipeline infrastructure. Natural gas is distributed to smaller
regional firms that redistribute the gas to the end user.
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The company is aware of three privately owned companies which may be
considered to be direct competitors of the company: Xinjiang Guanghui LNG
Development Corporation Ltd, which is primarily involved in the transportation
of LNG in China; Dalmine SPA, Italy, which is primarily involved in CNG storage
equipments; and Lovato Spa, Italy, which is a gas vehicle kits producer.
When we operate CNG stations, we will have to compete based on our
locations and service, since both the price we pay and the amount we charge are
subject to price control.
Government Regulations
Any company that conducts business in the PRC must have a business license
that covers a particular type of work. Our business license covers our present
manufacturing business and the operation of CNG stations. If we propose to
engage in other businesses, The operation of any business in the PRC, including
the manufacture or distribution of pressure containers and CNG stations is
subject to government regulations. These regulations cover a wide range of
matters including the transportation, storage and delivery of CNG and other
materials for which special protection is sought.
In addition, we sell pressure containers for the storage and
transportation of products such as chemicals, petroleum and food, and our
products must comply with the applicable regulations before the customer will
accept the products.
Research and Development
We do not engage in research and development. We do, however, work with
our customers to design a product, typically a pressure container for the
customer's product. However, those services are included in the services for the
customer's product.
Employees
On May 31, 2006, we had 107 employees, of whom ten are executive and
administrative, twelve are marketing and sales, 85 are technical and
manufacturing personnel.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion of the results of our operations and financial
condition should be read in conjunction with the financial statements of Sinogas
and the related notes, which appear elsewhere in this Form 8-K. The following
discussion includes forward-looking statements. For a discussion of important
factors that could cause actual results to differ from results discussed in the
forward-looking statements, see "Forward Looking Statements."
Overview
Neither Franklyn Resources nor Sinoenergy conducted any operations during
2004, 2005 or the first three months of 2006. Because of the reverse
acquisition, the following discussion relates to the separate financial
statements of Sinogas, and reference to "we," "our" and words of similar import
refer to Sinogas.
We design, manufacture and market a range of pressurized containers for
CNG. Although our initial business involved the manufacture of non-standard
equipment and pressure containers, our business has evolved as an increasing
market is developing in the PRC for the use of CNG. Our CNG vehicle and gas
station equipment business consists of two divisions, the manufacture of CNG
vehicle and gas station equipment, and the design of construction plans for CNG
gas stations, the construction of the CNG stations, and the installation of CNG
station equipment and related systems at the gas station.
22
In addition to our CNG related products, we continue to manufacture a wide
variety of pressure containers for use in different industries, including the
design and manufacture of various types of pressure containers in the petroleum
and chemical industries, the metallurgy and electricity generation industries
and the food and brewery industries. In addition, we can design and manufacture
various types of non-standard equipment.
All of our products and services are performed pursuant to agreements with
our customers, which provide the specifications for the products and services.
We do not sell our products from inventory. As a result, our revenue is
dependent upon the flow of contracts. In any fiscal period, a small number of
customers may represent a disproportionately large percentage of our business in
one period and a significantly lower percentage, if any, in a subsequent period.
For example, our largest customer for the year ended December 31, 2006,
Millennium Group Limited (Hong Kong), which accounted for revenue of
approximately $3.8 million, or 46% of our revenue for the year, and is not a
significant customer in the first quarter of 2006. Our contract with Millenium
Group related to the construction of CNG stations for Millenium, and that
contract was completed in 2005, and does not require any significant products or
services after the completion of the station.
We commenced operations on October 29, 2004, did not have any business
activity until the first quarter of 2005, and during the first quarter of 2005
we were in a start-up phase. As a result, there is no meaningful comparison
between the period October 29, 2004 to December 31, 2004 and the year ended
December 31, 2005. Also, since the first quarter of 2005 does not reflect fully
developed operations, the comparisons between the first quarters of 2005 and
2006 reflects our ability to scale up our operations and not any indication of a
quarter to quarter growth rate.
We intend to construct and operate CNG stations during 2006. This aspect
of our business is different from our present business whereby we will be
operating CNG stations. Since 2005 our business included the planning,
construction and equipping of CNG stations. The business of operating CNG
stations will require a substantial capital investment, and we anticipate that
we will seek debt funding for a portion of the costs. Further, the nature of the
operation of the business and the risks associated with that business are
significantly different from the manufacture of equipment or the construction of
CNG stations. One aspect of the operation of CNG stations is the price controls,
whereby both the price at which we purchase CNG and the price at which we sell
CNG are subject to by price controls. The operation of CNG stations will be
reported as a separate segment.
We have a 55% interest in our subsidiary, Qingdao Sinogas Yuhen Chemical
Equipment Co., Ltd. ("Yuhen"), with the other 45% being owned by Qingdao Kangtai
Machinery Equipment Manufacture Co. Limited ("Kangtai"). We subcontract
construction work for CNG stations to Kangtai on terms that are commercially
reasonable. We paid Kangtai $427,160 for these services during the three months
ended March 31, 2006 and $658,025 for the year ended December 31, 2006.
Yuhen was set up by Sinogas and Kangtai on May 25, 2005. In connection
with Yuhen's organization, Kangtai transferred equipment to Yuhen as part of its
investment in Yuhen. Prior to Yuhen's organization, Kangtai had contracts with
third parties that were to have been performed by Yuhen. In order for Kangtai to
complete these contracts, Kangtai transferred those contracts to Yuhen, and
Yuhen assumed the manufacturing obligations under these contract and purchased
the related inventories from Kangtai at fair market value. Kangtai purchased the
manufactured products from Yuhen at fair market value and sold the products to
the end user. The sales of these products to Kangtai amounted to $673,000 for
the three months ended March 31, 2006 and $979,000 for the year ended December
31, 2005. Because a portion of these transactions relate to sales to third
parties through Kangtai, we treat that portion as a third-party receivable.
23
Critical Accounting Policies and Estimates
The discussion and analysis of Sinogas' financial condition and results of
operations is based upon our financial statements which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets and liabilities. On an
on-going basis, we evaluate our estimates including the allowance for doubtful
accounts, the salability and recoverability of inventory, income taxes and
contingencies. We base our estimates on historical experience and on other
assumptions that we believes to be reasonable under the circumstances, the
results of which form our basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
In estimating the collectability of accounts receivable we analyze
historical write-offs, changes in our internal credit policies and customer
concentrations when evaluating the adequacy of our allowance for doubtful
accounts. Differences may result in the amount and timing of expenses for any
period if we make different judgments or uses difference estimates.
Inventories comprise raw materials work on process, finished goods and low
value consumable articles are stated at the lower of cost or market.
Substantially all inventory costs are determined using the weighted average
basis. Costs of finished goods include direct labor, direct materials, and
production overhead before the goods are ready for sale. Inventory costs do not
exceed net realizable value.
Property, plant and equipment are stated at cost. Depreciation is provided
principally by use of the straight-line method over the useful lives of the
related assets. Expenditures for maintenance and repairs, which do not improve
or extend the expected useful life of the assets, are expensed to operations
while major repairs are capitalized. The gain or loss on disposal of property,
plant and equipment is the difference between the net sales proceeds and the
carrying amount of the relevant assets, and, if any, is recognized in the
statements of operations.
Intangible assets are reviewed at least annually for impairment, or more
frequently if we have reason to believe that there is an impairment. Intangible
assets are tested by comparing net book value of the to fair value. Our
assumptions about fair values require significant judgment because broad
economic factors, industry factors and technology considerations can result in
variable and volatile fair values.
We cannot predict what future laws and regulations might be passed that
could have a material effect on our results of operations. We assess the impact
of significant changes in laws and regulations on a regular basis and update the
assumptions and estimates used to prepare our financial statements when we deem
it necessary.
We recognizes product sales generally at the time the product is shipped.
Shipping and handling costs are included in cost of goods sold. Revenue is
presented net of any sales tax and value added tax.
24
Our functional currency is Renminbi ("RMB"), which is the currency of the
PRC, and our reporting currency is United States dollars. Our balance sheet
accounts are translated into United States dollars at the year-end exchange
rates prevailing during the periods in which these items arise. Translation
gains and losses are deferred and accumulated as a component of other
comprehensive income in owners' equity. Transaction gains and losses that arise
from exchange rate fluctuations from transactions denominated in a currency
other than the functional currency are included in the statement of operations
as incurred. The translation and transaction gains and losses were immaterial in
the statement of operations as incurred. The translation and transaction gains
and losses were immaterial for the years ended December 31, 2005 and 2004 and
the three months ended March 31, 2006 and 2005.
The PRC government imposes significant exchange restrictions on fund
transfers out of the PRC that are not related to business operations. These
restrictions have not had a material impact on our operations because we have
not previously engaged in any significant transactions that are subject to the
restrictions.
New Accounting Pronouncements
In March 2004, the FASB issued EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF
03-1 includes new guidance for evaluating and recording impairment losses on
debt and equity investments, as well as new disclosure requirements for
investments that are deemed to be temporarily impaired. In September 2004, the
FASB issued Staff Position EITF 03-1-1, which delays the effective date until
additional guidance is issued for the application of the recognition and
measurement provisions of EITF 03-1 to investments in securities that are
impaired; however, the disclosure requirements are effective for annual periods
ending after June 15, 2004. Management does not currently believe adoption will
have a material impact on our financial position or results of operations.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
amendment of ARB No. 43, Chapter 4. This statement amends the guidance in ARB
No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal
amounts of idle facility expense, freight, handling costs, and wasted material
(spoilage). Paragraph 5 of ARB No. 43, Chapter 4, previously stated that
"...under some circumstances, items such as idle facility expense, excessive
spoilage, double freight, and rehandling costs may be so abnormal as to require
treatment as current period charges..." SFAS No. 151 requires that those items
be recognized as current-period charges regardless of whether they meet the
criterion of "so abnormal." In addition, this requires that allocation of fixed
production overhead to the costs of conversion be based on the normal capacity
of the production facilities. The provisions of SFAS 151 shall be applied
prospectively and are effective for inventory costs incurred during fiscal years
beginning after June 15, 2005, with earlier application permitted for inventory
costs incurred during fiscal years beginning after the date this Statement was
issued. Our adoption of SFAS No. 151 is not currently expected to have a
material impact on our financial position or results of operations.
In December 2004, the FASB issued SFAS No. 123(R) (revised 2004),
"Share-Based Payment," which amends FASB Statement No. 123 and will be effective
for us for the year ending December 31, 2006. The revised standard requires,
among other things, that compensation cost for employee stock options be
measured at fair value on the grant date and charged to expense over the
employee's requisite service period for the option. Due to the absence of
observable market prices for employee stock options, the standard indicates that
the fair value of most stock options will be determined using an option-pricing
model. As a result of the reverse acquisition, our adoption of SFAS No. 123(R)
will result is compensation expense upon the grant of options or other
equity-based incentives. Prior to the reverse acquisition we did not grant any
options or other equity-based incentives.
25
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29,
Accounting for Nonmonetary Transactions, is based on the principle that
exchanges of nonmonetary assets should be measured based on the fair value of
assets exchanged. The guidance in that Opinion, however, included certain
exceptions to that principle. This Statement amends Opinion 29 to eliminate the
exception for nonmonetary exchanges of similar productive assets that do not
have commercial substance. A nonmonetary exchange has commercial substance if
the future cash flows of the entity are expected to change significantly as a
result of the exchange. SFAS No. 153 is effective for nonmonetary exchanges
occurring in fiscal periods beginning after June 15, 2005. Our adoption of SFAS
No. 153 is not expected to have a material impact on our financial position or
results of operations.
In March 2005, the FASB published FASB Interpretation No. 47, "Accounting
for Conditional Asset Retirement Obligations," which clarifies that the term,
conditional asset retirement obligations, as used in SFAS No. 143, "Accounting
for Asset Retirement Obligations," refers to a legal obligation to perform an
asset retirement activity in which the timing and (or) method of settlement are
conditional on a future event that may or may not be within the control of the
entity. The uncertainty about the timing and (or) method of settlement of a
conditional asset retirement obligation should be factored into the measurement
of the liability when sufficient information exists. The interpretation also
clarifies when an entity would have sufficient information to reasonably
estimate the fair value of an asset retirement obligation. This interpretation
is effective no later than the end of 2006. The adoption of this Interpretation
is not expected to have a material effect on our financial position or results
of operations.
In June 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS No. 154"). SFAS No. 154 replaces APB No. 20 ("APB 20") and
SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements," and
applies to all voluntary changes in accounting principle, and changes the
requirements for accounting for and reporting of a change in accounting
principle. APB 20 previously required that most voluntary changes in accounting
principle be recognized by including in net income of the period of change a
cumulative effect of changing to the new accounting principle whereas SFAS No.
154 requires retrospective application to prior periods' financial statements of
a voluntary change in accounting principle, unless it is impracticable. SFAS No.
154 enhances the consistency of financial information between periods. SFAS No.
154 will be effective beginning with the Company's first quarter of fiscal year
2006. We do not expect that the adoption of SFAS No. 154 will have a material
impact on our results of operations, financial position or cash flows.
In June 2005, the EITF reached a consensus on Issue No. 05-06,
"Determining the Amortization Period for Leasehold Improvements" (EITF 05-06).
EITF 05-06 provides guidance for determining the amortization period used for
leasehold improvements acquired in a business combination or purchased after the
inception of a lease, collectively referred to as subsequently acquired
leasehold improvements). EITF 05-06 provides that the amortization period used
for the subsequently acquired leasehold improvements to be the lesser of (a) the
subsequently acquired leasehold improvements' useful lives, or (b) a period that
reflects renewals that are reasonably assured upon the acquisition or the
purchase. EITF 05-06 is effective on a prospective basis for subsequently
acquired leasehold improvements purchased or acquired in periods beginning after
the date of the FASB's ratification, which was on June 29, 2005. The Company
does not anticipate that EITF 05-06 will have a material impact on its
consolidated results of operations.
26
In July 2005, the Financial Accounting Standards Board (FASB) issued an
Exposure Draft of a proposed Interpretation "Accounting for Uncertain Tax
Positions--an interpretation of FASB Statement No. 109." Under the proposed
Interpretation, a company would recognize in its financial statements its best
estimate of the benefit of a tax position, only if the tax position is
considered probable of being sustained on audit based solely on the technical
merits of the tax position. In evaluating whether the probable recognition
threshold has been met, the proposed Interpretation would require the
presumption that the tax position will be evaluated during an audit by taxing
authorities. The proposed Interpretation would be effective as of the end of the
first fiscal year ending after December 15, 2005, with a cumulative effect of a
change in accounting principle to be recorded upon the initial adoption. The
proposed Interpretation would apply to all tax positions and only benefits from
tax positions that meet the probable recognition threshold at or after the
effective date would be recognized. We are currently analyzing the proposed
Interpretation and have not determined its potential impact on our Consolidated
Financial Statements. While we cannot predict with certainty the rules in the
final Interpretation, there is risk that the final Interpretation could result
in a cumulative effect charge to earnings upon adoption, increases in future
effective tax rates, and/or increases in future interperiod effective tax rate
volatility.
Results of Operations
Three Months Ended March 31, 2006 and 2005
Net revenue- Our operations commenced in October 29, 2004. As a result, during
the first three months of 2006, we were in the start-up phase of our operations
and did not generate significant revenue. Thus, net revenue for the first
quarter of 2006 increased $1.93 million, or 335%, from $574,000 in the
comparable period of 2005 to $2.5 million in the first quarter of 2006.
Cost of revenue; gross margin - Our cost of revenue for the March 31, 2006
quarter increased $1.14 million, from $104,000 in 2005 to $1.245 million in
2006, reflecting the same factors that affected our revenue during those period.
Our gross margin for the first quarter of 2005 was 81.9% as compared with 50.2%
in the first quarter 2006. Since the first quarter of 2005 does not reflect
fully developed operations, the comparisons between the first quarters of 2005
and 2006 reflects our ability to scale up our operations and not any indication
of a quarter to quarter gross margin.
Operating Expenses- Operating expenses were $329,000 for the quarter ended March
31, 2006, compared to $115,000 for the comparable quarter of 2005. This
represents an increase of $214,000, or 186%, primarily due to an increase in our
market development and activities.
Income from Operations- Our operating profit for the first quarter March 31,
2006 increased $571,000, or 161%, from $355,000 in 2005 to $926,000 in 2006. The
increase was primarily the result of production operation started in second half
of 2005.
Income Taxes- Income taxes for the first quarter March 31, 2006 increased
$204,000, from $109,000 in 2005 to $313,000 in 2006. Since the first quarter of
2005 does not reflect fully developed operations, the comparisons between the
first quarters of 2005 and 2006 reflects our ability to scale up our operations
and not any indication of a quarter to quarter income taxes difference.
Net Income- Net income was $548,000 for the first quarter of 2006, compared to
$246,000 in the first quarter of 2005, an increase of $302,000, or 122%,
reflecting the factors described above.
Years Ended December 31, 2005 and period from October 29, 2004 to December 31,
2004
27
Net Revenue- Net revenue for the year ended December 31, 2005 was $8.2 million.
Since we were incorporated on October 29, 2004 and did not commence business
activity until 2006, we did not generate any revenue in the 2004 period.
Cost of Revenues; gross margin - Our cost of revenue for 2005 was $3.8 million,
generating a gross margin of 53.6%.
Operating Expenses- Operating expenses were $695,000 for the year ended December
31, 2005, compared to $64,000 for the 2004. The operation expenses in the 2004
period were incidental to the commencement of our operations.
Income from Operations- Operating profit was $3.7 million in 2005, from a loss
of $112,000 in the 2004 period, reflecting the fact that our business did not
commence until 2005, with our production operation starting in second half of
2005.
Income Taxes- Income taxes were $1.2 million for the year ended December 31,
2005.
Net Income- Net income was $2.46 million for the year ended December 31, 2005,
compared to loss of $112,000 in the 2004 period.
Liquidity and Capital Resources
Net cash provided by operating activities was $2.60 million for the year
ended December 31, 2005, compared to negative $1.25 million in 2004, an increase
of $3.85 million from the prior year. The improvement was primarily due to
improved working capital cash flows in 2005 compared to 2004 resulting from the
commencement of our business operation in 2005. We used $157,000 for our
operations in the quarter ended March 31, 2006. One factor which accounted for
the use of cash was the increase in accounts receivable $1.7 million from
December 31, 2005 to March 31, 2006. At March 31, 2006, there was an $1.3
million account receivable from Kangtai, which is a related party, that was also
outstanding on December 31, 2005 and remains outstanding as of June 8, 2006. We
lease a portion of our facilities to Kangtai, and the receivable include amounts
due from Kangtai's for rental fees, water, power payment. We have obligations to
Kangtai for construction work which we subcontracted to Kangtai, and our
obligations to Kangtai are almost as great as Kangtai's obligations to us.
During 2005, we purchased from an affiliated company the a certificate of
property right for the property on which our offices and manufacturing
facilities are located. Since the government of the PRC owns title to the land,
it issues a certificate of land use which is a transferable right to use the
land. The purchase price was $11.9 million of which $5.0 million was paid during
2005. The balance is due at such time as the use of the land is changed from
industrial to commercial. The nature of the zoning does not affect our right to
use the land, but we believe that it has a higher value if it is zoned
commercial. In our agreement with the investors in the June 2006 private
placement, we agreed that we would not pay approximately $3.2 million until the
rights are sold and we would not pay the balance except that we may apply up to
50% of net income to make such payments. This restriction terminates after the
investors have sold all of the shares of common stock issued in the private
placement, including the shares of common stock issuable upon conversion of the
note or the series A preferred stock or the notes or exercise of the warrants.
28
In June 2006, Franklyn completed the private placement of securities
pursuant to which we raised net proceeds of approximately $3.1 million. We
expect that these funds, together with anticipated cash flow from our
operations, should enable us to continue our current operations without
additional financing for the next year. However, we intend to construct CNG
stations during 2006. This activity will require additional funding. Although we
anticipate that we will be able to obtain bank financing from a Chinese bank for
approximately 50% of the cost, we do not have any agreement with respect to this
funding. If we are unable to raise the necessary funding we may not be able to
develop our CNG station business.
Item 3. Description of Property.
In China, there in no private ownership of land. Rather, all real property
is owned by the government. Instead the government issues a certificate of
property right, which is transferable, has a term of 50 years and permits the
holder to use the property. We have certificates of property rights covering
parcels of approximately 265,000 square feet and 394,000 square feet where we
maintain our offices and manufacturing facilities. Both parcels are located on
Jinhua Road in the Si'fang District of Qingdao province in the PRC. Our
certificate of property right for both parcels expires in 2055.
During 2005, we purchased from an affiliated company the a certificate of
property right for the property described in the preceding paragraph. The
purchase price was $11.9 million of which $5.0 million was paid during 2005. The
balance is due at such time as the use of the land is changed from industrial to
commercial. The nature of the zoning does not affect our right to use the land.
In our agreement with the investors in the June 2006 private placement, we
agreed that we would not pay approximately $3.2 million until the rights are
sold and we would not pay the balance except that we may apply up to 50% of net
income to make such payments. This restriction terminates after the investors
have sold all of the shares of common stock issued in the private placement,
including the shares of common stock issuable upon conversion of the note or the
series A preferred stock or the notes or exercise of the warrants.
Item 4. Security Ownership of Certain Beneficial Owners and Management.
The following table provides information at to shares of common stock
beneficially owned as of June 5, 2006 by:
o each director;
o each officer named in the summary compensation table;
o each person owning of record or known by us, based on information
provided to us by the persons named below, to own beneficially at
least 5% of our common stock; and
o all directors and executive officers as a group.
Shares of Common Stock
Name Beneficially Owned Percentage
- ---- ------------------ ----------
TianZhou Deng 6,396,923.5 43.8%
45 Jinghua Road
Qingdao, Shandong, China
Bo Huang 6,396,923.5 43.8%
45 Jinghua Road
Qingdao, Shandong, China
Eastpride Capital Limited 1,421,538.0 9.8%
234-5149 Country Hills Blvd. NW; Suite 429
Calgary, Alberta, Canada T3A 5K8
All officers and directors as a group (two
individuals beneficially owning stock) 12,793,847.0 87.5%
* Less than 1%.
29
Except as otherwise indicated each person has the sole power to vote and
dispose of all shares of common stock listed opposite his name. Each person is
deemed to own beneficially shares of common stock which are issuable upon
exercise or warrants or options or upon conversion of convertible securities if
they are exercisable or convertible within 60 days of June 5, 2006.
Mr. Deng and Mr. Huang each own a 50% interest in Skywide, which owned
12,793,847 shares of commons stock. Since Mr. Deng and Mr. Huang are deemed to
beneficially own 50% of the shares owned by Skywide.
Wentao Yang beneficially owns the shares held of record by Eastpride.
Barron Partners owns notes and warrants which, if fully converted and
exercised, would result in the ownership of more than 5% of our outstanding
common stock. However, the note, by their terms, may not be converted and the
warrants may not be exercised if such conversion or exercise would result in
Barron Partners owning more than 4.9% of our outstanding common stock. This
limitation may not be waived.
Item 5. Directors and Executive Officers, Promoters and Control Persons.
Directors and Executive Officers
The following table sets forth certain information with respect to our
directors and executive officers.
Name Age Position
Bo Huang 36 Chief executive officer and director
Tianzhou Deng 50 Chairman and director
Qiong (Laby) Wu 31 Chief financial officer
Yanying Liu 41 Secretary
Bo Huang has been our chief executive officer and a director since the
completion of the reverser acquisition in June 2006. He has been chief executive
officer and chairman of Sinogas since its organization in 2005. He and Mr. Deng
are the founders of Sinogas. He was president of Beijing Tricycle Technology
Development Co., Ltd , a company engaged in the development of natural gas
conversion kits from 2003 to 2005, and vice president of Chengchen Group, an
investment and trading company from 1997 to 2003. Mr. Huang graduated from
Renmin University of China in Beijing in 1993 with a bachelor's degree in
international finance.
30
Tianzhou Deng has been our chief executive officer and a director since
the completion of the reverser acquisition in June 2006. He is also a founder of
Sinogas. He was been the chief executive officer and chairman of Beijing Sinogas
Co., Ltd ., a company engaged in research and development with respect to CNG
stations from 2001 to 2005, chairman of Shanghai CNPC Group Co., Ltd. , an
investment and trading company from 2003 to 2005, president and director of
Beijing Tricycle Technology Development Co., Ltd. , a company engaged in the
development of natural gas conversion kits from 1999 to 2001, president and
director of Natural Gas Vehicle Development Center, from 1997 to 1999. Mr. Deng
graduated from University of Petroleum, China in 1982 with a chemical bachelor
degree, and we received a master of management degree from China Science &
Technology University. Mr. Deng holds a senior engineer with professor rank in
China. Mr. Deng is recognized a a leader in the CNG/LPG industry in China.
Luby Wu has been our chief financial officer since June 2006. Ms. Wu was a
senior auditor with the accounting firm of Ernst & Young Hua Ming Accounting
Firm from February 2002 until June 2006. From May 2003 until January 2004, Ms.
Wu was a consultant in the accounting and tax planning department of the
accounting and tax consulting firm of HLB-Beijing Yongtuo CPAs. From November
2001 until May 2003, Ms. Wu was an auditor with HLB - Yongtuo Certified Public
Accountants Co., Ltd., and from May 1998 until March 2003, Ms. Wu was an
administrative manager and office manager for the manufacturing firm of Trend
Ceramic Group Co., Ltd. Ms. Wu, a certified public accountant, received her
bachelor's degree in material science and engineering from Ji Nan University in
China, her bachelor's degree in accounting and economics from Deaken University
in Australia, and her master's of professional accounting from Deaken
University.
Yanging Liu has been our secretary since June 2006, and she held a similar
position with Sinogas since 2004. In addition, Ms. Liu serves as a business
development manager.. From 1999 until 2004, Ms. Liu was manager of business
development and finance for Beijing Sanhuan Technology Development Co., Ltd. Ms.
Liu received her bachelor's degree in management from the University of
Jianghan.
Committees
Our board of directors has no separate committees and it acts as the audit
committee at this time. We have no qualified financial expert at this time. We
intend to search for qualified individuals to serve as independent directors and
members of an audit and compensation committee.
Item 6. Executive Compensation.
SUMMARY COMPENSATION TABLE
Prior to the reverse acquisition, we did not pay any compensation to any
executive officers. Set forth below is information for Sinogas's chief executive
officer. No other officer received compensation in excess of $100,000 for 2005.
Other
Name and Position Year Salary Compensation
- ----------------- ---- ------ ------------
Bo Huang, chief executive officer 2005 $1,000 -0-
We did not make any payments or distributions of any kind to Mr. Huang
from our organization in October 2004 through 2005.
31
Employment Agreements
We have no employment agreements with any of our officers.
2006 Long-Term Incentive Plan
In June 2006, we adopted, subject to stockholder approval, the 2006
long-term incentive plan covering 2,000,000 shares of common stock. The plan
provides for the grant of incentive and non-qualified options, stock grants,
stock appreciation rights and other equity-based incentives to employees,
including officers, and consultants. The 2006 Plan is to be administered by a
committee of not less than two directors each of which is to be an independent
directors. In the absence of a committee, the plan is administered by the board
of directors. Independent directors are not eligible for discretionary options.
However, each newly elected independent director receives at the time of his
election, a five-year option to purchase 30,000 shares of common stock at the
market price on the date of his or her election. In addition, the plan provides
for the annual grant of an option to purchase 5,000 shares of common stock on
April 1st of each year, commencing April 1, 2007.
Item 7. Certain Relationships and Related Transactions.
From the time of our organization until Sinoenergy acquired our stock in
November 2005, our principal stockholder was Beijing Sanhuan Technology
Development Co., Ltd., which was owned by Bo Huang and Tianzhou Deng. During
2005, we purchased the a certificate of property right for the property on which
are facilities are located from Beijing Sanhuan for $11.9 million, of which $5.0
million was paid during 2005. The balance is due at such time as the use of the
land is changed from industrial to commercial. In our agreement with the
investors in the June 2006 private placement, we agreed that we would not pay
approximately $3.2 million until the rights are sold and we would not pay the
balance except that we may apply up to 50% of net income to make such payments.
This restriction terminates after the investors have sold all of the shares of
common stock issued in the private placement, including the shares of common
stock issuable upon conversion of the note or the series A preferred stock or
the notes or exercise of the warrants.
We own 55% of our subsidiary, Yuhan, and the other 45% is owned by
Kangtai. Yuhen was set up by Sinogas and Kangtai on May 25, 2005. In connection
with Yuhen's organization, Kangtai transferred equipment to Yuhen as part of its
investment in Yuhen. Prior to Yuhen's organization, Kangtai had contracts with
third parties that were to have been performed by Yuhen. In order for Kangtai to
complete these contracts, Kangtai transferred those contracts to Yuhen, and
Yuhen assumed the manufacturing obligations under these contract and purchased
the related inventories from Kangtai at fair market value. Kangtai purchased the
manufactured products from Yuhen at fair market value and sold the products to
the end user. The sales of these products to Kangtai amounted to $673,000 for
the three months ended March 31, 2006 and $979,000 for the year ended December
31, 2005. Because a portion of these transactions relate to sales to third
parties through Kangtai, we treat that portion as a third-party receivable.
In addition, during 2005, we engaged Kangtai as a subcontractor on a
project for which we paid Kangtai $447,000, and we rented Kangtai space at our
facilities for which we billed Kangtai $1.1 million. At both December 31, 2005
and March 31, 2006 we had an outstanding account receivable from Kangtai in the
amount of $1.3 million which was still outstanding on June 8, 2006. At March 31,
2006, we had an outstanding payable to Kangtai in the amount of $621,514.
32
During 2005, we also made purchases from Beijing Sanhuan in the amount of
$31,000.
We believe that all transactions with Beijing Sanhuan and Kangtai were at
prices and on terms no less favorable to us that would be available from
non-affiliated third parties.
On June 2, 2006, We entered into an exchange agreement pursuant to which
we acquired all of the equity of Sinoenergy which owned all of the equity of
Sinogas. Pursuant to the exchange agreement, we issued 14,215,385 shares of
common stock to the owners of Sinoenergy - Skywide, to which we issued
12,793,847 shares of common stock, and.Eastpride, to which we issued 1,421,538
shrares of common stock.
On June 2, 2006, A stock redemption agreement with the Company's principal
stockholders. The Company purchased a total of 3,305,000 shares of common stock
for a purchase price of $213,525, which was paid from the proceeds of the notes,
stock and warrants. The following table sets forth the sellers, the number of
shares purchased and the purchase price payable to each seller:
Name Number of Shares Purchase Price
- ---- ---------------- --------------
Frank L. Kramer 1,000,000 $62,600
Deborah Salerno 1,000,000 62,600
John P. O'Shea 1,000,000 62,600
Lynn Suave 150,000 9,690
Mark Lubchenco 100,000 6,465
Gary S. Joiner 35,000 2,270
Marika Xirouhakis 20,000 7,300
--------- --------
3,305,000 $213,525
========= ========
The Company agreed to include in a registration statement the shares of
common stock held by the Company's remaining stockholders.
Item 8. Description of Securities.
We are authorized to issue 25,000,000 shares of common stock, par value
$.0001 per share.
The following summary of certain provisions of our common stock, preferred
stock, certificate of incorporation and by-laws is not intended to be complete.
It is qualified by reference to the provisions of applicable law and to our
certificate of incorporation and by-laws.
Common Stock
Holders of common stock are entitled to one vote for each share held on
all matters submitted to a vote of stockholders and do not have cumulative
voting rights. Accordingly, holders of a majority of the shares of common stock
entitled to vote in any election of directors may elect all of the directors
standing for election. Holders of common stock are entitled to receive
proportionately any dividends as may be declared by our board of directors,
subject to any preferential dividend rights of outstanding preferred stock.
Pursuant to the certificate of designation relating to the series A preferred
stock, we are prohibited from paying dividends on our common stock while the
preferred stock is outstanding. Upon our liquidation, dissolution or winding up,
the holders of common stock are entitled to receive proportionately our net
assets available after the payment of all debts and other liabilities and
subject to the prior rights of any outstanding preferred stock. Holders of
common stock have no preemptive, subscription, redemption or conversion rights.
Our outstanding shares of common stock are fully paid and non-assessable. The
rights, preferences and privileges of holders of common stock are subject to,
and may be adversely affected by, the rights of the holders of shares of any
series of preferred stock that we may designate and issue in the future.
33
Proposed Restated Articles of Incorporation
Pursuant to the agreement with the investors in the June 2006 private
placement, we are required, within 120 days of the closing date, to amend our
articles of incorporation to provide for an authorized capitalization of
60,000,000 shares of capital stock, of which 10,000,000 will be shares of
preferred stock and 50,000,000 will be shares of common stock and to adopt a
certificate of designation which creates the right of the holders of a series of
preferred stock to be designated as the series A convertible preferred stock.
Upon the filing of both the restated certificate of incorporation and the
certificate of designation, the notes are automatically converted into shares of
series A preferred stock, at a conversion price of $.65 per shares, subject to
adjustment. Based on the conversion price of $.65, the Company would issue a
total of 5,384,615 shares of series A preferred stock which would be convertible
into 5,384,615 shares of common stock. If the restated certificate of
incorporation and the certificate of designation are not filed at the time that
the notes are converted, the notes are convertible into common stock at a
conversion price of $.65 per share.
Our board of directors has approved, subject to stockholder approval, the
restated articles of incorporation.
The Nevada General Corporation Law
We are incorporated in Nevada and are subject to the provisions of the
Nevada General Corporation Law. Under certain circumstances, the following
selected provisions may delay or make more difficult acquisitions or changes of
control. Our articles of incorporation and by-laws do not exclude us from such
provisions. These provisions also may have the effect of preventing changes in
our management. It is possible that these provisions could make it more
difficult to accomplish transactions that stockholders may otherwise deem to be
in their best interests.
Restrictions on Control Share Acquisitions
Sections 78.378 to 78.3793 of the Nevada General Corporation Law relate to
acquisitions of control of an issuing corporation, which is defined as a Nevada
corporation that has 200 or more stockholders, at least 100 of whom have
addresses in Nevada appearing on our stock ledger. These provision will not
apply unless we meet the definition of an issuing corporation.
Under these provisions, acquiring person who acquires a controlling
interest in an issuing corporation and those acting in association with an
acquiring person obtain only such voting rights in the control shares as are
conferred upon them by a resolution of the stockholders of the corporation,
approved by a majority of the voting power at a special or annual meeting of the
stockholders, with the votes of interested stockholders not counted. The meeting
of stockholders is held upon the request and at the expense of the acquiring
person.
34
In the event that the control shares are accorded full voting rights and
the acquiring person acquires control shares with a majority or more of all the
voting power, any stockholder, other than the acquiring person, who does not
vote in favor of authorizing voting rights for the control shares is entitled to
demand payment for the fair value of his or her shares, and the corporation must
comply with the demand. A controlling interest means the ownership of
outstanding voting shares sufficient to enable the acquiring person,
individually or in association with others, directly or indirectly, to exercise
(i) one-fifth or more but less than one-third, (ii) one-third or more but less
than a majority and/or (iii) a majority or more of the voting power of the
issuing corporation in the election of directors. Voting rights must be
conferred by a majority of the disinterested stockholders as each threshold is
reached and/or exceeded.
These provisions do not apply if the articles of incorporation or bylaws
in effect on the 10th day following the acquisition of a controlling interest by
an acquiring person provide that said provisions do not apply.
Restrictions on Certain Business Combinations
Sections 78.411 to 78.444 of the Nevada General Corporation Law restrict
the ability of a resident domestic corporation to engage in any combination with
an interested stockholder for three years after the interested stockholder's
acquisition of the shares that cause such stockholder to become an interested
stockholder, unless the combination or the purchase of shares by the interested
stockholder that cause such stockholder to become an interested stockholder is
approved by our the company's board of directors before that date. If the
combination was not previously approved, the interested stockholder may effect a
combination after the three-year period only if such stockholder receives
approval from a majority of the disinterested shares or the offer meets certain
fair price criteria.
For purposes of the above provisions, a resident domestic corporation is a
Nevada public corporation that has 200 or more stockholders and an interested
stockholder is any person, other than the company and its subsidiaries, who is
(i) the beneficial owner, directly or indirectly, of 10% or more of the voting
power of the outstanding voting shares of the company or (ii) an affiliate or
associate of the company and, at any time within three years immediately before
the date in question, was the beneficial owner, directly or indirectly, of 10%
or more of the voting power of the company.
These restrictions do not apply to corporations that elect in a charter
amendment approved by a majority of the disinterested shares to be excluded from
these provisions. Such an amendment would not become effective for 18 months
after its passage and would apply only to stock acquisitions occurring after its
effective date. Our articles of incorporation and bylaws do not exclude us from
the restrictions imposed by such provisions.
PART II
Item 1. Market Price of and Dividends on the Registrant's Common Equity and
Related Stockholder Matters.
There is no public marker for our common stock, and we have not paid
dividends. Our agreement with the investors in the June 2006 private placement
and the notes and the proposed certificate of designation relating to the series
A preferred stock prohibit our payment of dividends while the note or the shares
of series A preferred stock are outstanding.
35
As of June 2, 2006, we had approximately 40 stockholders of record. None
of the shares were eligible for sale pursuant to Rule 144.
As of June 5, 2006, we had the following shares of common stock reserved
for issuance:
o 5,384,615 shares issuable upon conversion of the series A preferred
stock.
o 18,000,000 shares issuable upon exercise of the warrants issued to
the investors in the June 2006 private placement.
o 2,000,000 shares issuable upon exercise of stock options or other
equity-based incentives pursuant to our 2006 long-term incentive
plan, which is subject to stockholder approval.
Equity Compensation Plan Information
The following table summarizes the equity compensation plans under which
our securities may be issued as of June 5, 2006.
Number of securities to be Weighted-average Number of securities
issued upon exercise of exercise price of remaining available for
outstanding options and outstanding options future issuance under
Plan Category warrants and warrants equity compensation plans
- ------------- -------- ------------ -------------------------
Equity compensation plans approved by -0- -- --
security holders
Equity compensation plan not approved by -0- -- 2,000,000
security holders
The 2006 long-term incentive plan was approved by the board of directors,
subject to stockholder approval, and the outstanding options are subject to
stockholder approval of the plan. The plan has not yet been submitted to the
stockholders for their approval.
Item 2. Legal Proceedings.
We are not a defendant in any material legal proceedings.
Item 3. Changes in and Disagreements with Accountants.
NA
Item 4. Recent Issuances of Unregistered Securities.
See Item 3.02 of this Form 8-K for information relating to recent
issuances of unregistered securities.
36
Item 5. Indemnification of Officers and Directors.
Our Article of Incorporation provides that we will indemnify and hold
harmless, to the fullest extent permitted by Section 145 of the Delaware General
Corporation Law, as amended from time to time, each person that such section
grants us the power to indemnify.
Section 78.138 of the Nevada Revised Statutes ("NRS") provides that, with
certain specified exceptions, or unless the articles of incorporation or an
amendment thereto, in each case filed on or after October 1, 2003, provide for
greater individual liability, a director or officer is not individually liable
to the corporation or its stockholders or creditors for any damages as a result
of any act or failure to act in his capacity as a director or officer unless it
is proven that his act or failure to act constituted a breach of his fiduciary
duties as a director or officer; and his breach of those duties involved
intentional misconduct, fraud or a knowing violation of law.
NRS Sections 78.7502, 78.751 and 78.752 provide broad indemnification for
officers and directors, as follows:
Subsection 1 of NRS 78.7502 empowers a corporation to indemnify any person
who was or is a party or is threatened to be made a party to any threatened,
pending or completed action, suit or proceeding, whether civil, criminal,
administrative or investigative (other than an action by or in the right of the
corporation) by reason of the fact that he or she is or was a director, officer,
employee or agent of the corporation or is or was serving at the request of the
corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise (an "Indemnified Party"),
against expenses (including attorneys' fees), judgments, fines and amounts paid
in settlement actually and reasonably incurred by the Indemnified Party in
connection with such action, suit or proceeding if the Indemnified Party acted
in good faith and in a manner the Indemnified Party reasonably believed to be in
or not opposed to the best interests of the corporation, and, with respect to
any criminal action or proceedings, had no reasonable cause to believe the
Indemnified Party's conduct was unlawful.
Subsection 2 of NRS 78.7502 of the Nevada Law empowers a corporation to
indemnify any Indemnified Party who was or is a party or is threatened to be
made a party to any threatened, pending or completed action or suit by or in the
right of the corporation to procure a judgment in its favor by reason of the
fact that such person acted in the capacity of an Indemnified Party against
expenses, including amounts paid in settlement and attorneys' fees actually and
reasonably incurred by the Indemnified Party in connection with the defense or
settlement of such action or suit if the Indemnified Party acted under standards
similar to those set forth above, except that no indemnification may be made in
respect of any claim, issue or matter as to which the Indemnified Party shall
have been adjudged to be liable to the corporation or for amounts paid in
settlement to the corporation unless and only to the extent that the court in
which such action or suit was brought determines upon application that in view
of all the circumstances the Indemnified Party is fairly and reasonably entitled
to indemnity for such expenses as the court deems proper.
NRS 78.7502 further provides that to the extent an Indemnified Party has
been successful on the merits or otherwise in the defense of any action, suit or
proceeding referred to in subsection (1) or (2) described above or in the
defense of any claim, issue or matter therein, the corporation shall indemnify
the Indemnified Party against expenses (including attorneys' fees) actually and
reasonably incurred by the Indemnified Party in connection therewith.
37
Subsection 1 of NRS 78.751 provides that any discretionary indemnification
under NRS 78.7502, unless ordered by a court or advanced pursuant to Subsection
2 of NRS 78.751, may be made by a corporation only as authorized in the specific
case upon a determination that indemnification of the Indemnified Person is
proper in the circumstances. Such determination must be made (a) by the
stockholders, (b) by the board of directors of the corporation by majority vote
of a quorum consisting of directors who were not parties to the action, suit or
proceeding, (c) if a majority vote of a quorum of such disinterested directors
so orders, by independent legal counsel in a written opinion, or (d) by
independent legal counsel in a written opinion if a quorum of such disinterested
directors cannot be obtained. Subsection 2 of NRS 78.751 provides that a
corporation's articles of incorporation or bylaws or an agreement made by the
corporation may require the corporation to pay as incurred and in advance of the
final disposition of a criminal or civil action, suit or proceeding, the
expenses of officers and directors in defending such action, suit or proceeding
upon receipt by the corporation of an undertaking by or on behalf of the officer
or director to repay the amount if it is ultimately determined by a court that
he is not entitled to be indemnified by the corporation. Said Subsection 2
further provides that the provisions of that Subsection 2 do not affect any
rights to advancement of expenses to which corporate personnel other than
officers and directors may be entitled under contract or otherwise by law.
Subsection 3 of NRS 78.751 provides that indemnification and advancement of
expenses authorized in or ordered by a court pursuant to NRS 78.751 does not
exclude any other rights to which the Indemnified Party may be entitled under
the articles of incorporation or any by-law, agreement, vote of stockholders or
disinterested directors or otherwise, for either an action in his official
capacity or in another capacity while holding his office. However,
indemnification, unless ordered by a court pursuant to NRS 78.7502 or for the
advancement of expenses under Subsection 2 of NRS 78.751, may not be made to or
on behalf of any director or officer of the corporation if a final adjudication
establishes that his or her acts or omissions involved intentional misconduct,
fraud or a knowing violation of the law and was material to the cause of action.
Additionally, the scope of such indemnification and advancement of expenses
shall continue as to an Indemnified Party who has ceased to hold one of the
positions specified above, and shall inure to the benefit of his or her heirs,
executors and administrators. NRS 78.752 empowers a corporation to purchase and
maintain insurance or make other financial arrangements on behalf of an
Indemnified Party for any liability asserted against such person and liabilities
and expenses incurred by such person in his or her capacity as an Indemnified
Party or arising out of such person's status as an Indemnified Party whether or
not the corporation has the authority to indemnify such person against such
liability and expenses.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to our directors, officers and controlling persons pursuant
to the foregoing provisions, or otherwise, we have been advised that in the
opinion of the SEC such indemnification is against public policy as expressed in
the Securities Act and is, therefore, unenforceable. In the event that a claim
for indemnification against such liabilities (other than director, officer or
controlling person in the successful defense of any action, suit or proceeding)
is asserted by such director, officer or controlling person in connection with
the securities being registered, we will, unless in the opinion of our counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by us is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
PART F/S
Reference is made to the filings by Franklyn on Form 10SB and 10-QSB for
Franklyn's financial statements.
The financial statements of Sinogas begin on Page F-1.
38
The pro forma financial information is filed as Exhibit 99.6 to this Form
8-K.
PART III
The exhibits are listed and described in Item 9.01 of this Form 8-K.
Item 3.02. Unregistered Sale of Equity Securities.
On June 2, 2006:
(a) We entered into an exchange agreement pursuant to which we acquired
all of the equity of Sinoenergy which owned all of the equity of Sinogas.
Pursuant to the exchange agreement, we issued 14,215,385 shares of common stock
to the owners of Sinoenergy - Skywide, to which we issued 12,793,847 shares of
common stock, and.Eastpride, to which we issued 1,421,538 shrares of common
stock.
(c) A securities purchase agreement (the "Purchase Agreement") with Barron
Partners LP, JCAR Funds Ltd., Ray Rivers and Steve Mazur pursuant to which the
investors purchased 6% convertible notes in the principal amount of $3,500,000,
369,000 shares of common stock (the "Initial Shares"), and warrants to purchase
6,000,000 shares of common stock at $.85 per share, 6,000,000 shares of common
stock at $1.20 per share and 6,000,000 shares of common stock at $1.75 per
share. The following table sets forth the investment by each of the investors,
the principal amount of note received, the number of Initial Shares issued and
the number of shares issuable upon exercise of each set of warrants.
Initial
Note Shares Warrants
Barron Partners LP $3,100,000 305,743 4,971,429
JCAR Funds Ltd. 200,000 21,086 342,857
Steven Mazur 100,000 10,543 171,429
Ray Rivers 100,000 10,543 171,429
Total $3,500,000 369,000 6,000,000
The numbers under the column "Warrants" represents the number of shares of
common stock issuable upon exercise of each set of warrants. Thus, each investor
has the same number of warrants exercisable at $.85, $1.20 and $1.75.
Section 5.06 Change in Shell Company Status.
As a result of the reverse acquisition with Sinoenergy, we are no longer a
shell company.
See "Item 1.01 Entry into a Material Definitive Agreement" for information
relating to the agreements pursuant to which the reverse merger was consummated
and financed and "Item 2.01 Completion of Acquisition or Disposition of Assets"
for a description of our business following the completion of the reverse
merger.
39
Item 9.01 Financial Statements and Exhibits.
(a) Financial statements of Sinogas. See Page F-1.
(b) Pro forma financial information. See Exhibit 99.6.
(c) See (a) and (b) of this Item 9.01.
(d) Exhibits
2.1 Exchange Agreement dated as of June 2, 2006, among the Registrant and the
former stockholders of Sinoenergy
4.1 Form of note
4.2 Form of "A" warrants issued to investors in the June 2006 private
placement
4.3 Form of "B" warrants issued to investors in the June 2006 private
placement
4.4 Form of "C" warrants issued to investors in the June 2006 private
placement
99.1 Securities purchase agreement dated June 2, 2006, between the Company and
the investors in the June 2006 private placement
99.2 Registration rights agreement dated June 2, 2006, between the Registrant
and the investors in the June 2006 private placement
99.3 Registration rights provisions pursuant to the stock exchange agreement
99.4 Agreement for former holders of the Registrant's common stock
99.5 2006 Long-term incentive plan
99.6 Pro forma financial information
40
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets at
December 31, 2005 and 2004 and March 31, 2006 and 2005 F-3
Consolidated Statements of Operations for the Years F-4
Ended December 31, 2005 and 2004 And Quarters Ended
March 31, 2006 and 2005
Consolidated Statements of Changes in Stockholders' F-5
Equity for the Years Ended December 31, 2005 and 2004
and Quarters Ended March 31, 2006 and 2005
Consolidated Statements of Cash Flows for the Years F-6
Ended December 31, 2005 and 2004 and Quarters Ended
March 31, 2006 and 2005
Notes to Consolidated Financial Statements F-7-F-27
F-1
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Qingdao Sinogas General Machinery Limited Corporation and Subsidiary
Qingdao City, Shandong Province
People's Republic of China
We have audited the accompanying consolidated balance sheets of Qingdao
Sinogas General Machinery Limited Corporation and Subsidiary as of December 31,
2005 and 2004, and the related consolidated statements of operations, changes in
owners' equity and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with The Public Company Accounting
Oversight Board Standards. Those standards require that we plan and perform the
audits to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Qingdao Sinogas General Machinery Limited Corporation and Subsidiary as of
December 31, 2005 and 2004 and the results of their operations and their cash
flows for the years then ended in conformity with accounting principles
generally accepted in the United States of America.
/s/ Rotenberg and Co. LLP
ROTENBERG AND CO. LLP
Rochester, New York
March 21, 2006
F-2
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION AND SUBSIDIARY
Consolidated Balance Sheets
As at December 31, 2005 and 2004 (Audited) and
March 31, 2006 and 2005 (Un-audited)
December 31, 2005 December 31, 2004 March 31, 2006 March 31, 2005
------------------- ------------------- ------------------- -------------------
Note(s)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 332 $ 41 $ 112 $ 38
Accounts receivable (net) 3
-Related parties 1,346 -- 1,347 --
- Third parties 1,780 209 3,435 200
Other receivables- 4
-Related party 464 -- 236 --
-Third party 275 119 917 1,040
Deposits and prepayments 5
-Related parties 4,986 988 4,986 598
- Third parties 1,027 258 951 150
Inventories 6 1,825 41 2,060 12
------------------- ------------------- ------------------- -------------------
TOTAL CURRENT ASSET 12,035 1,573 14,044 2,038
------------------- ------------------- ------------------- -------------------
------------------- ------------------- ------------------- -------------------
LONG TERM ASSETS
Property, plant and equipment 7 3,455 3,337 3,470 3,336
(net)
Intangible assets 8 268 79 257 75
Long term deferred tax asset 17 -- 17 10
------------------- ------------------- ------------------- -------------------
TOTAL ASSETS $ 15,775 $ 4,990 $ 17,788 $ 5,459
=================== =================== =================== ===================
LIABILITIES AND OWNERS' EQUITY
CURRENT LIABILITIES
Short term loan 9 $ 2,478 $ -- $ 2,495 $ --
Accounts payable-third party 480 -- 1,213 2
Other payables
- Related party 10 396 -- 622 --
- Third parties 830 122 1,057 2
Accrued expenses 23 -- 24 --
Warranty accrual 14 19
Advances from customers 11 2,234 8 1,914 231
Income taxes payable 12 1,162 -- 1,662 119
------------------- ------------------- ------------------- -------------------
Total current liabilities 7,616 131 9,006 354
------------------- ------------------- ------------------- -------------------
LONG TERM DEFERRED TAX LIABILITIES 13 28 -- 28 --
MINORITY INTERESTS 14 641 -- 665 --
------------------- ------------------- ------------------- -------------------
TOTAL LIABILITIES 8,285 131 9,699 354
OWNERS' EQUITY
Paid-in capital 4,950 4,950 4,950 4,950
Capital surplus 67 21 67 21
Statutory surplus reserve fund 16 329 -- 331 --
Retained earnings 2,019 -112 2,566 134
Accumulated other comprehensive 124 173 --
income
------------------- ------------------- ------------------- -------------------
Total owners' equity 7,489 4,859 8,088 5,105
------------------- ------------------- ------------------- -------------------
TOTAL LIABILITIES AND OWNERS'
EQUITY $ 15,775 $ 4,990 $ 17,788 $ 5,459
=================== =================== =================== ===================
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION AND
Subsidiary Consolidated Statements of Operations for the Years Ended
December 31, 2005 and 2004 (Audited)
and Quarters Ended March 31, 2006 and 2005 (Un-audited)
--------------- ------------------------ ------------------ ---------------
Note(s) For the Year From October 29, 2004 For the Quarter For the Quarter
Ended (date of incorporation) Ended Ended
December 31, to December 31, March 31, March 31,
2005 2004 2006 2005
--------------- ------------------------ ------------------ ---------------
NET REVENUE 17 $ 8,236 $ -- $ 2,500 $ 574
COST OF REVENUE (3,821) -- (1,245) (104)
--------------- ------------------------ ------------------ ----------------
GROSS PROFIT 4,415 -- 1,255 470
OPERATING EXPENSES
Selling expenses 110 7 64 34
General and administrative 586 57 265 81
expenses
--------------- ------------------------ ------------------ ----------------
TOTAL OPERATING EXPENSES 695 64 329 115
--------------- ------------------------ ------------------ ----------------
INCOME(LOSS) FROM OPERATIONS 3,719 926 355
OTHER INCOME(EXPENSES)
Other non-operating income 76 2 --
Interest expense (41) (42) --
Other expenses (106) (48) (3) --
--------------- ------------------------ ------------------ ----------------
OTHER INCOME (LOSS) NET (71) (112) (43) --
INCOME (LOSS) BEFORE INCOME TAXES 3,647 (112) 883 355
Income tax (1,173) -- (313) (109)
--------------- ------------------------ ------------------ ----------------
INCOME (LOSS) BEFORE MINORITY 2,474 (112) 570 246
INTEREST
Minority interest 14 14 -- 22 --
--------------- ------------------------ ------------------ ----------------
NET INCOME $ 2,460 $ (112) $ 548 $ 246
=============== ======================== ================== ================
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION AND SUBSIDIARY
Statements of Changes in Owners' Equity
for the Years Ended December 31, 2005 and 2004 (Audited)
and Quarters Ended March 31, 2006 and 2005 (Un-audited)
STATUTORY ACCUMULATED TOTAL
PAIN-IN SURPLUS COMPREHENSIVE RETAINED CAPTIAL OWNERS'
CAPITAL RESERVE INC0ME EARNINGS SURPLUS EQUITY
------------- ------------- ------------- ------------- ------------- -------------
Oct.29, 2004 (date of 4,950 -- -- -- 21 4,971
incorporation)
Net income for the period from -- -- -- (112) -- (112)
Oct. 29 to Dec. 31, 2004
------------- ------------- ------------- ------------- ------------- -------------
Balance, December 31, 2004 4,950 -- -- (112) 21 4,859
Net income for 2005 -- -- 2,460 2,460
Transfer -- 329 124 (329) 46 170
------------- ------------- ------------- ------------- ------------- -------------
Balance, December 31, 2005 4,950 329 124 2,019 67 7,489
============= ============= ============= ============= ============= =============
Net income for the quarter ended -- -- 548 548
March 31 2006
Transfer -- -- 50 -- -- 50
------------- ------------- ------------- ------------- ------------- -------------
Balance, March 31, 2006 4,950 329 179 2,567 67 8,088
============= ============= ============= ============= ============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
for the Years Ended December 31, 2005 and 2004 (Audited)
and Quarters Ended March 31, 2006 and 2005 (Un-audited)
For the Year Ended From October29, 2004 For the First Quarter ended Mar. 31
December 31, (date of
incorporation)
to December 31,
------------------ -------------------- ------------------ ------------------
2005 2004 2006 2005
------------------ -------------------- ------------------ ------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,460 $ (112) $ 547 $ 246
Depreciation 289 50 73 50
Amortization of intangible assets 14 3 13 4
Provision for doubtful debts 4 -- -- --
Changes in operating assets and liabilities:
Increase in accounts receivable (2,181) -- (1,781) 9
Increase in other receivables, deposits and (1,203) (1,281) (150) (477)
prepayments
(Decrease)/increase in inventories (1,783) (41) (223) 28
(Decrease)/increase in accounts payable 479 -- 730 2
Increase in accrued expenses 23 -- 5 --
Decrease/(increase) in deferred expenses 3 (2) 2 (28)
Increase in advance from customers 2,225 -- (334) 222
(Decrease)/increase in other payables 1,100 131 469 (120)
Increase in income tax payable 1,162 -- 492 119
Deferred tax credit/(debit) 11 -- -- (10)
------------------ -------------------- ------------------ ------------------
Net cash provided by operating activities $ 2,603 $ (1,252) $ (157) $ 45
CASH FLOWS FROM INVESTING ACTIVITES
Payment for purchase of property, plant and $ (134) $ (55) $ (65) $ (48)
equipment
Purchase of property rights (4,986)
------------------ -------------------- ------------------ ------------------
Net cash used in investing activities $ (5,120) $ (55) $ (65) $ (48)
------------------ -------------------- ------------------ ------------------
CASH FLOWS FROM FINANCING ACTIVITES
Cash received from short term borrowing $ 2,478 $ -- $ -- $ --
Cash received from capital contribution 1,329 -- --
Cash received /(paid) for other financing 328 19 -- --
activities
------------------ -------------------- ------------------ ------------------
Net cash used in financing activities $ 2,807 $ 1,348 $ -- $ --
------------------ -------------------- ------------------ ------------------
Net increase/(decrease) in cash and cash
Equivalents $ 290 $ 41 $ (222) $ (3)
Cash and cash equivalents at beginning of year 42 -- 334 41
------------------ -------------------- ------------------ ------------------
Cash and cash equivalents at end of year $ 332 $ 41 $ 112 $ 38
================== ==================== ================== ==================
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company
(1) The History of the Company
Qingdao Sinogas General Machinery Limited Corporation (herein after referred to
as the "Company") was registered in Qingdao, China in September 2004, as a
limited liability company under the laws of the People's Republic of China
("PRC") and the registered capital was US$7.5 million (one USD converts into 8
RMB), which was paid in full.
The Company was jointly owned by the following three entities: (a) Beijing
Sanhuan Technology Development Co., Ltd. (Beijing Sanhuan), with an agreed
contribution of US$6.75 million, representing 90% of the aggregate capital; (b)
Qingdao Machinery Industry Co., Ltd., with an agreed contribution of US$375,000,
representing 5% of the aggregate capital; (c) Jiangsu Dong Fang Hong Chemical
Fertilizer Co., Ltd. ("Jiangsu"), with an agreed contribution of US$375,000,
representing 5% of the aggregate capital.
The predecessor of the Company was Qingdao General Machinery Plant (the
"Plant"), a state-owned entity. With the approval from Qingdao Municipal
Government, Beijing Sanhuan acquired the Plant's total assets provided that it
paid the Plant's debts. After Beijing Sanhuan paid the Plant's debts, Bejing
Sanhuan was entitled to all the assets of the Plant, and having obtained
government approval, reorganized the Plant into the Company. On July 30, 2004,
PRC government approved the acquisition by Beijing Sanhuan of the Plant. On
October 29, 2004, the Company acquired its business license from Qingdao
Municipal Government to operate business in industries of Compressed Natural Gas
(CNG) station and equipments/services, as well as non-standard chemical and
refinery equipments.
In October 2005 Beijing Sanhuan purchased the 5% interest in the Company held by
Qingdao Machinery Industry Co., Ltd., with the result that Beijing Sanjuan held
95% of the Company's equity and Jiangsu held the remaining 5%. In November,
2005, Beijing Sanhuan and Jiangsu transferred 100% of their equity to Sinoenergy
Holding Limited, a British Virgin Islands corporation which is owned by Wentao
Yang.
On November 29, 2005, Qingdao Foreign Trade and Economic Cooperation Bureau
approved the Sinoenergy Holding Limited purchase of all the shares from the
former shareholders of the Corporation and the Corporation changed from the
local investment limited liability company into the wholly-owned foreign
investment enterprise.
On February 21, 2006, Sinoenergy entered into a share transfer agreement with
Skywide Capital Management Limited, a British Virgin Islands corporation which
is owned by Tianzhou Deng and Bo Huang ("Skywide") and Eastpride Capital
Limited, a British Virgin Islands corporation owned by Wentao Yang
("Eastpride"), with the result that 90% shares of the Corporation were held by
Skywide and 10% share of the Corporation were held by Eastpride.
F-7
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company (continued)
(2) The Business of the Company
In accordance with provisions of Articles of Association and Business License,
the business term of the Corporation is fifteen years, from October 29, 2004 to
October 29, 2019.
The Company manufactures pressure containers of class 1, 2, 3 petroleum refinery
equipment, designs and installs compressed natural gas station equipment, and
compressed natural gas storage and transportation equipment.
(3) Subsidiary of the Company
Together with Qingdao Kangtai Machinery Equipment Manufacture Co. Limited
(Kantai), the Company established Qingdao Sinogas Yuhen Chemical Equipment Co.,
Ltd. (Qingdao Yuhen). The Company contributed capital totaling US$681,000 in the
form of Property and equipment, representing 55% of the registered capital, and
Qingdao Kangtai Machinery Equipment Manufacture Co. Limited contributed capital
of US$558,000 in the form of cash and cash equivalents ($352,708) and intangible
assets ($205,292), which represents 45% of the registered capital.
The term of the business of Qingdao Yuhen is from May 25, 2005 to April 30, 2009
and the business scope is to manufacture, process and install machinery
facilities (not including special equipments and cars); as the wholesaler and
retailer of steels, machinery and electronic products, hardware, chemical
equipments (not including dangerous equipments).
The accompanying consolidated financial statements include the accounts of the
Company and subsidiary Qingdao Yuhen for the seven months ended 31 December
2005.
2. Summary of Significant Accounting Policies
(a) Basis of Presentation
The accompanying financial statements and its subsidiary were prepared in
accordance with the accounting principles generally accepted in the United
States of America ("US GAAP").
F-8
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies (continued)
(b) Use of Estimates
In preparing financial statements in conformity with accounting principles
generally accepted in the United States of America, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and revenues and expenses during the reported
periods. Significant estimates include depreciation and allowance for doubtful
accounts receivable. Actual results could differ from those estimates.
(c) Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of
three months or less at the time of purchase to be cash equivalents. As of
December 31, 2004 and 2005 the Company did not have any cash equivalents.
(d) Allowance for Doubtful Accounts
The Company recognizes an allowance for doubtful accounts to ensure accounts
receivable are not overstated due to uncollectibility. An allowance for doubtful
accounts is maintained for all customers based on a variety of factors,
including the length of time the receivables are past due, significant one-time
events and historical experience. An additional reserve for individual accounts
is recorded when the Company becomes aware of a customer's inability to meet its
financial obligations, such as in the case of bankruptcy filings or
deterioration in the customer's operating results or financial position. If
circumstances related to customers change, estimates of the recoverability of
receivables would be further adjusted.
(e) Inventories
Inventories comprise of raw materials, work in process, finished goods and low
value consumable articles. Amounts are stated at the lower of cost or market.
Substantially all inventory costs are determined using the weighted average
basis. Costs of finished goods include direct labor, direct materials, and
production overhead before the goods are ready for sale. Inventory costs do not
exceed net realizable value.
F-9
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies (continued)
(f) Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is provided
principally by use of the straight-line method over the useful lives of the
related assets. Expenditures for maintenance and repairs, which do not improve
or extend the expected useful life of the assets, are expensed to operations
while major repairs are capitalized.
Management estimates a 10% residual value for its property, plant and equipment
according to industry standards in the PRC. The estimated useful lives are as
follows:
Building and facility 20 years
Machinery and equipment 8 years
Motor vehicles 10 years
Office equipment and others 5~8 years
The gain or loss on disposal of property, plant and equipment is the difference
between the net sales proceeds and the carrying amount of the relevant assets,
and, if any, is recognized in the statements of operations.
(g) Intangible Assets
Intangible assets, representing patents and technical know-how acquired, are
stated at cost less accumulated amortization and impairment losses. Amortization
is calculated on the straight-line method over the estimated useful lives of 10
years. The technical know how, which is acquired in the end of year 2004 is
valued and amortized according to relative industry standard. The patent is
acquired in May of 2005, and is amortized according to its validated period.
Till the balance sheet date, the patent is evaluated with no value change.
(h) Impairment of Assets
In accordance with Statement of Financial Accounting Standards (`SFAS") No. 144,
"Accounting for Impairment or Disposal of Long-Lived Assets", the Company
evaluates its long-lived assets to determine whether later events and
circumstances warrant revised estimates of useful lives or a reduction in
carrying value due to impairment. If indicators of impairment exist and if the
value of the assets is impaired, an impairment loss would be recognized.
F-10
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies (continued)
(i) Revenue Recognition
Revenue Recognition - The Company recognizes revenue when the significant risks
and rewards of ownership have been transferred to the customer pursuant to PRC
law, including factors such as when persuasive evidence of an arrangement
exists, delivery has occurred, the sales price is fixed or determinable, sales
and value added tax laws have been complied with, and collectibility is
probable. The Company recognizes product sales generally at the time the product
is shipped.
The Company has a large construction contract open at the fiscal year end.
Revenue is recognized at the balance sheet date on the percentage of completion
basis, measured by reference to the proportion of physical construction work
completed to the total estimated work according to the report provided by
technical department of the Company.
Revenue is presented net of any sales tax and value added tax.
Sales Taxes - The Company is subject to value added tax ("VAT"). The applicable
VAT tax rate is 17% for products sold in the PRC. The amount of VAT liability is
determined by applying the applicable tax rate to the invoiced amount of goods
sold less VAT paid on purchases made with the relevant supporting invoices. VAT
is collected from customers by the Company on behalf of the PRC tax authorities
and is therefore not charged to the consolidated statements of operations.
(j) Warranty Reserves
Warranty reserves represent the Company's obligation to repair or replace
defective products under certain conditions. The estimate of the warranty
reserves is based on historical experience. In 2005, the warranty rate was
determined to be 0.2 % of gross sales.
At present, the nearly all the products sold are pressure vessels, of which the
operating permission is firmly controlled by PRC government. As a result, all
the pressure vessels being sold must be tested by the Qingdao Bureau of Quality
and Technical Supervision.
F-11
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies (continued)
(k) Income Taxes
The Company accounts for income taxes under SFAS No. 109, "Accounting for Income
Taxes". Under SFAS No. 109, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. Under
SFAS No. 109, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.
The Company reviewed the differences between the tax basis under PRC tax laws
and financial reporting under PRC GAAP. Timing differences, relative deferred
tax asset or liabilities have been recognized.
(k) Foreign Currency Transactions
The Company's functional currency is Renminbi ("RMB") and its reporting currency
is U.S. dollars. The Company's balance sheet accounts are translated using the
closing exchange rate in effect at the balance sheet date and operating accounts
are translated using the average exchange rate prevailing during the reporting
period. Translation gains and losses are deferred and accumulated as a component
of other comprehensive income in owners' equity. Transaction gains and losses
that arise from exchange rate fluctuations from transactions denominated in a
currency other than the functional currency are included in the statement of
operations as incurred.
(l) Fair Value of Financial Instruments
SFAS No. 107, "Disclosures about Fair Values of Financial Instruments", requires
disclosing fair value to the extent practicable for financial instruments that
are recognized or unrecognized in the balance sheet. The fair value of the
financial instruments disclosed herein is not necessarily representative of the
amount that could be realized or settled, nor does the fair value amount
consider the tax consequences of realization or settlement.
For certain financial instruments, including cash, account receivable, related
party and other receivables, accounts payable, other payables and accrued
expenses, it was assumed that the carrying amounts approximate fair value
because of the near term maturities of such obligations.
(m) Minority Interest
The minority shareholders' interest refers to the percentage of the owner's
equity of Qingdao Yuhen owned by Kangtai. The minority shareholders' interest in
the consolidated financial statements means the percentage of the Company's net
assets owned by Kangtai other than the Company, according to their respective
investment ratios.
F-12
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies (continued)
(n) Earnings Per Share
Basic earnings per share is computed by dividing the earnings for the year by
the weighted average number of common shares outstanding for the year. Diluted
earnings per share reflects the potential dilution of securities by including
other potential common stock, including stock options and warrants, in the
weighted average number of common shares outstanding for a period, if dilutive.
For the years ended December 31, 2004 and 2005, and for the first quarter of
year 2005 and 2006, earnings per share are not shown as there are no shares
outstanding.
F-13
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Account Receivables and Allowance for Doubtful Receivables
Details of allowance for doubtful receivables deducted from accounts receivable
are as follows:-
------------------------------------------ ------------------------------------------
December 31 March 31
--------------------- -------------------- -------------------- ---------------------
2005 2004 2006 2005
--------------------- -------------------- -------------------- ---------------------
US$'000 US$'000 US$'000 US$'000
3,131 209
Accounts receivable 4,786 204
Less: allowance for doubtful
accounts 4 - 4 4
--------------------- -------------------- -------------------- ---------------------
Balance, end of year 3,127 209 4,782 200
===================== ==================== ==================== =====================
The Company did not have any bad debts in the years ended December 31, 2004 and
2005.
The Company began operations in the second half year of 2005. Consistent with
few sales, the AR balance as at March 31, 2005 was small. Within the balance at
March 31 2006, US$2.443 million represents receivables for sales of CNG gas
station construction contracts, which have not been completed at the balance
sheet date, and the relative revenue is recognized according to percentage of
completion basis.
4. Other Receivables
(1) Other Receivable With Related Party
The related party receivable balance at December 31 2005 represents power and
water fee receivables from Qingdao Kangtai Machinery Equipment Manufacture Co.
Limited. The balance as at March 31, 2006 also includes unsecured demand loans
with different related parties. Please refer to note 15 for detailed
information.
(2) Other Receivable With Third Party
Other receivables consist of receivable amount to unrelated parties as unsecured
demand loans, with no stated interest rate or due date.
5. Deposits and Prepayments
The related parties balance as at December 31, 2005 and March 31, 2006 consisted
of a US$4,956,691 prepayment to Beijing Sanhuan for land use right transferring;
And the related party balances as at December 31, 2004 and March 31, 2005 are
related to the prepayment for the above mentioned transaction.
The third parties balances represent advance payments to suppliers by the
Company, as well as its subsidiary for routine operations.
F-14
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Inventories
Inventories at December 31, 2005 and 2004 and March 31, 2005 and 2006 are
summarized as follows:
December 31, March 31,
------------------------------------------- -----------------------------------------
2005 2004 2006 2005
------------------------ ------------------ -------------------- --------------------
US$'000 US$'000 US$'000 US$'000
Raw materials 423 11 370 11
Work in progress 1,249 30 1,179 -
Finished goods 55 - 462 1
Low value consumable articles 48 - -
------------------------ ------------------ -------------------- --------------------
Total 1,825 41 2,060 12
======================== ================== ==================== ====================
There was no allowance for losses on inventories as of December 31, 2004 and
2005 and March 31, 2005 and 2006.
As production expanded gradually since the Company's corporation, the volume of
raw material purchasing, work in progress, and overall inventory levels have
increased.
F-15
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Property, Plant and Equipment
As of December 31, 2004 and 2005 and March 31, 2005 and 2006, property, plant
and equipment consist of following:
December 31, March 31,
------------------------------------------- ------------------------------------------
2005 2004 2006 2005
---------------------- -------------------- -------------------- ---------------------
US$'000 US$'000 US$'000 US$'000
Cost
Buildings and facility 2,571 2,451 2,587 2,451
Machinery equipment 2,031 905 2,110 941
Motor vehicles 36 24, 36 36,
Office equipment and others 21 6 21 7
---------------------- -------------------- -------------------- ---------------------
4,659 3,387 4,755 3,435
---------------------- -------------------- -------------------- ---------------------
Accumulated depreciation
Buildings and facility 215 33 252 59
Machinery equipment 985 17 1,011 40
Motor vehicles 19 - 20 1
Office equipment and others 1 - 2 -
---------------------- -------------------- -------------------- ---------------------
1,204 50 1,204 100
---------------------- -------------------- -------------------- ---------------------
Carrying value
Buildings and facility 2,356 2,418 2,335 2,292
Machinery equipment 1,046 888 1,099 901
Motor vehicles 17 24 16 35
Office equipment and others 20 6 19 7
---------------------- -------------------- -------------------- ---------------------
3,455 3,337 3,469 3,335
====================== ==================== ==================== =====================
Within the fixed asset balance as at March 31, 2006, there is US$64,053 of work
in progress on self made machinery.
8. Intangible Assets
---------------------------------------- ----------------------------------------
December 31, March 31,
-------------------- ------------------- --------------------- ------------------
2005 2004 2006 2005
-------------------- ------------------- --------------------- ------------------
Patent US$'000 US$'000 US$'000 US$'000
Cost 285 82 285 82
Accumulated amortization 17 3 28 7
-------------------- ------------------- --------------------- ------------------
Carrying value 268 79 257 75
==================== =================== ===================== ==================
Patents of the Company are amortized over 10 years up to September 2014 (see
Note 5).
To the cost of intangible assets as at December 31, 2005, $82,000 is the
technical know how purchased from the Plant and $203,000 is paid in capital
input by Kangtai (minority shareholder) when the Qingdao Yuhen was incorporated.
F-16
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Short Term Loan
The balance totaled UD$ 2,478,455 represents the short term loan borrowed from
the Qingdao First Branch of Shibei District, Agriculture Bank of China,
(hereafter refers to as 1st Branch) on November 1, 2005. According to the Loan
Contract, the type of loan is specified as short-term working capital loan with
the borrowing date starting from November 2, 2005 for US$1,487,073 and from
November 7, 2005 for US$991,382 and maturing on November 1, 2006. The interest
rate for the short term loan is 6.669% annually.
The 1st Branch and Beijing Zhongyou Environment Tech. Corp. (a third party of
the Company), signed the Ceiling Guarantee Contract, with the latter providing a
voluntary guarantee for the loan contract. According to this contract, the
guarantee period starts from the next day after the loan matures as specified in
the master contract and lasts for two years.
10. Other Payables
(1) Other Payables to Related Party:
The balances as at December 31, 2005 and March 31, 2006 consist of unsecured
demand loans from related party Qingdao Kangtai Machinery Equipment Manufacture
Co. Limited, with no stated interest rate or due date;
(2) Other Payables to Third Party
The balances are mainly for payables for sales tax (VAT and business tax),
unsecured demand loans from third parties and miscellaneous payables to other
creditors.
11. Advance from Customers
The balances as at December 31, 2005 and March 31, 2006 consist of a $2,152,060
advance from Qindao Yuheng.
F-17
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Income Taxes Payable
Pursuant to the PRC Income Tax Laws, the Company is subject to enterprise income
tax at a statutory rate of 33% (30% national income tax plus 3% local income
tax).
Being licensed as wholly foreign owned enterprises, the Company is in the
process of applying a tax-free permission, so no income tax payment for the
accrual has been done, the balance increase is in line with the accumulated
operating profit increase.
13. Long Term Deferred Tax Liabilities
During the establishment of Qingdao Yuhen, the actual contributed capital amount
by minority shareholder Qingdao Kangtai Machinery Equipment Manufacture Co.
Limited is $158,084 higher than shared registered capital. Under PRC accounting
policy, the Company records that pro rata over contributed capital amount
$86,946 into capital surplus. Under PRC tax law, that capital surplus would not
be regarded as taxable income until the investment to Qingdao Yuhen is sold.
Under US GAAP recording, that negative goodwill amount is recognized in
operating income. Deferred tax liabilities resulting from timing differences are
recognized.
14. Minority Interests' Equity
The activities of the minority interests' equity during the year ended December
31, 2005 (see note 2 (m) Minority Interest) are summarized as follows:
Beginning balance (May 2005) $ --
Add: contribution by minority shareholders 557,835
Minority interests' income 13,893
Others 69,236
------------------
Balance, December 31, 2005 $ 640,964
Add: contribution by minority shareholders 24,413
Minority interests' income
Balance, March 31, 2006 $ 665,377
------------------
F-18
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. Related Party Relationships and Transactions
The principal related companies with which the Company had transactions
during the year are as follows:
Name of the Company Relationship
Beijing Sanhuan Parent company before November 8, 2005.
Qingdao Yuhen Subsidiary from May 2005
Kangtai Minority investor of Qingdao Yuhen from May 2005
Significant transactions between the Company and its related company
during the year are as follows:
(1) Sales and purchase transactions with related parties
For the first quarter as at
Name of the Company December 31 March 31
2005 2004 2006 2005
Kangtai Sales with amount Sales with
ofUSD978,587; USD amount of
446,767 purchases; USD672,945
Rental services sold
USD1,054,301
Beijing Sanhuan USD30,517 purchase
Qingdao Kantai Machinery Equipment Manufacture Company (Kangtai) is the
predecessor Company of Qingdao Yuhen. Kangtai purchases products from
Qingdao Yuhen to fulfill open purchase orders. Qingdao Yuhen completes
those contracts fulfilled by Kantai prior the separation.
The sales and purchases to and from related parties were made according
to a price mutually agreed after taking into account prevailing market
prices.
F-19
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. Related Party Relationships and Transactions (continued)
(2) Inter-company receivables
December 31, March 31,
Name of the 2005 2004 2006 2005
Company
Beijing Sanhuan USD4,986,279 USD 988,027 USD4,986,279 USD 616,965
prepayment for land use prepayment for asset prepayment for land prepayment
right transferring transferring use right transfer
Qingdao Yuhen USD 155,971 USD 122,230
inter-company loan inter-company loan
Kangtai USD2,921,415 USD 129,860
Including the receivable on inter-company loan
a rental of1,063,606
(3) Inter-company payables
December 31, March 31,
Name of the Company 2005 2004 2006 2005
Beijing Sanhuan USD 128,543
Inter-company loan
Kangtai USD395,726 USD621,514
inter-company inter-company loan
loan
The amount due from/to related parties are interest-free, unsecured and
have no fixed terms.
F-20
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. Statutory Surplus Reserve Fund
In accordance with PRC regulations, the Company is required to make
appropriations to the statutory surplus reserve fund, based on after-tax net
income determined in accordance with PRC GAAP. According to the PRC corporate
regulation, appropriation to the statutory surplus reserve fund should be at
least 10% of the after-tax net income determined in accordance with the PRC GAAP
until the reserve fund is equal to 50% of the entity's registered capital.
Appropriations to the statutory public welfare fund should be at least 5% of the
after-tax net income determined in accordance with the PRC GAAP. Statutory
surplus reserve is established for the purpose of expanding operations, or
increasing registered capital, and is non-distributable other than in
liquidation.
17. Revenue Gross Profit Margin
According to products sold, the revenue is mainly composed of the following:
-------------------- ------------------------------------ -------------------
For the year For the three moths ended March 31 GP margin
Ended December
31,
-------------------- ------------------- ---------------- -------------------
2005 2006 2005
-------------------- ------------------- ---------------- -------------------
US$'000 US$'000 US$'000 %
CNG Tow truck trailers i (1) 1,570 243 107 22%
CNG Gas stations i (2) 3,741 1,064 467 67%
Pressure Containers (ii) 2,035 1,193 -- 23%
Rental income and others 890 -- --
-------------------- ------------------- ---------------- -------------------
8,236 2,500 574
==================== =================== ================ ===================
(i) CNG/LPG vehicle and gas station equipment business
CNG/LPG vehicle and gas station equipment business include two parts of
divisions/services. (1) CNG/LPG vehicle and gas station equipment
manufacture and installation, which include following products:
(ss.)CNG trailer
(ss.)CNG deposited system for gas station usage
(ss.)Conversion kits for various types of vehicle
(ss.)CNG compressor skid
(ss.)CNG dispenser (retail measurement system)
F-21
- --------------------------------------------------------------------------------
QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. Revenue Gross Profit Margin (continued)
(2) CNG station system business
It includes the design of CNG station construction plans, construction of
CNG stations, and installation of CNG station equipment and related
systems. Due to rapid development and early stage of CNG station business
in China, the company enjoys a very high profit margin in this segment by
utilizing its specialty in this area.
(ii) Non-standard equipment and pressure container business:
Non-standard equipment and pressure container business has been carried
over from the predecessor since Qingdao Sinogas was set up. It is a
traditional chemical equipment manufacture business with low profit
margin. It includes:
(ss.)design and manufacture of various types of pressure containers in
the petroleum and chemical industries.
(ss.)design and manufacture of various types of pressure containers in
the metallurgy and electricity generation industries
(ss.)design and manufacture of various types of pressure containers in
the food and brewery industries
(ss.)design and manufacture of various types of non-standard equipment
The gross profit margin for CNG Gas stations is much higher than others which is
the result of technology and low market competition for Gas stations in China.
In 2005, the revenue of CNG Gas stations represents the sale of one big contract
for 22 CNG Gas stations, including designing, construction, equipment
installation, and related engineering work. The total contract price is
RMB25,600,000 ($2,976,433) .
18. Concentrations and Credit Risk
The Company operates principally in the PRC and grants credit to its customers
in this geographic region. Although the PRC is economically stable, it is always
possible that unanticipated events in foreign countries could disrupt the
Company's operations.
At December 31, 2005, the Company has a credit risk exposure of uninsured cash
in banks of approximately US$331,528. The Company does not require collateral or
other securities to support financial instruments that are subject to credit
risk.
F-22
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QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. Concentrations and Credit Risk (continued)
The net sales to customers representing at least 10% of net total sales as well
as relative account receivable balance are as follows:-
Sales AR Sales AR
December 31, December 31, March 31, March 31,
Customers 2005 2005 2006 2006
US$'000 % US$'000 % US$'000 % US$'000 %
Customer A 3,740 46 1,494 67
Customer B 831 10 - -
Customer C 1,064 42% - -
Customer D 358 14% - -
19. Commitments and Contingencies
(1) Legal Proceedings - The Company is not currently a party to any threatened
or pending legal proceedings, other than incidental litigation arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations or cash flows.
The Company has the following material contractual obligations and capital
expenditure commitments:
(a) CNG Gas Station Construction Contract signed between the Company and CNPC
New Energy Enterprise Group Corp. on December 26, 2005. According to the
contract, the Company will construct 22 CNG Gas stations for CNPC New Energy
Enterprise Group Corporation. The construction project includes design,
construction, equipment installation, and related engineering work. The total
contract price is US$3.2 million. It goes into effect after being signed by both
parties and is legally binding to. The fulfillment of this contract is ongoing.
To the contract, no liability insurance has been made for the contracted
construction. Of which the situation is common in PRC circumstance.
(b) the Agreement signed between the Corporation (Party A) and Beijing Sanhuan
(Party B) on April 6, 2005. According to the agreement, with the precondition
that Party A is responsible for the procedures of designating the land as land
for commercial use, Party B transfers the 24,593 square meters land of the south
factory site at No. 45, Jinhua Road, Qingdao and the 34,604.02 square meters
land of the north factory site at No. 66, Jinhua Road, Qingdao city to Party A
at the price of US$11,900,482. It goes into effect after being signed by both
parties and is legally binding to. According to the Corporation, the fulfillment
of this contract is proceeding normally.
F-23
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QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
19. Commitments and Contingencies (continued)
(c) The Contract signed between the Corporation and Qingdao Jinyu Industrial
Development Co., Ltd. on May 20, 1997. According to the Contract, the
Corporation leases its own land at No. 18, Siliu South Road (within its factory
site) to Qingdao Jinyu Industrial Development Co., Ltd.. The contractual rate is
US$7,500 for the first year and is specified to yearly increase by 6%
afterwards. Starting from the ninth year, the yearly increase with the rent
should be 8%, with the total lease duration being 20 years. It goes into effect
after being signed by both parties and is legally binding to. Meanwhile, the
rights and obligations of both parties are protected by Chinese laws. According
to the Corporation, the fulfillment of this contract is proceeding normally.
(2) Capital commitments - the Company has entered into an agreement with Beijing
Sanhuan (see note 1 about Beijing Sanhuan). Per the agreement, the Company would
purchase the land use right for the land on which the Company located from
Beijing Sanhuan, the predecessor shareholder of the Company, with the price of
US$11,900,482. In current year, $4,956,691 has been prepaid. The land use right
ownership transferring process is in process.
20. Retirement Benefits
The full-time employees of the Company are entitled to staff welfare benefits
including medical care, casualty, housing benefits, education benefits,
unemployment insurance and pension benefits through a Chinese
government-mandated multi-employer defined contribution plan. The Company is
required to accrue the employer-portion for these benefits based on certain
percentages of the employees' salaries. The total provision for such employee
benefits was US$148 and US$38,696 for the year ended December 31, 2004 and 2005,
respectively and were recorded as other payables. The PRC government is
responsible for the staff welfare benefits including medical care, casualty,
housing benefits, unemployment insurance and pension benefits to be paid to
these employees. The Company is responsible for the education benefits to be
paid.
F-24
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QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
21. Subsequent Events
On June 2, 2006, a securities purchase agreement (the "Purchase Agreement") with
Barron Partners LP, JCAR Funds Ltd., Ray Rivers and Steve Mazur pursuant to
which the investors purchased 6% convertible notes in the principal amount of
$3,500,000, 369,000 shares of common stock (the "Initial Shares"), and total
warrants to purchase 18,000,000 shares of common stock, which include: 6,000,000
shares of common stock at $.85 per share, 6,000,000 shares of common stock at
$1.20 per share, and 6,000,000 shares of common stock at $1.75 per share. The
following table sets forth the investment by each of the investors, the
principal amount of note received, the number of Initial Shares issued and the
number of shares issuable upon exercise of each set of warrants.
Initial
Note Shares Warrants
Barron Partners LP $3,100,000 305,743 4,971,429
JCAR Funds Ltd. 200,000 21,086 342,857
Steven Mazur 100,000 10,543 171,429
Ray Rivers 100,000 10,543 171,429
TOTAL $3,500,000 369,000 6,000,000
The numbers under the column "Warrants" represents the number of shares of
common stock issuable upon exercise of each set of warrants. Thus, each investor
has the same number of warrants exercisable at $.85, $1.20 and $1.75.
22. New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board ("FASB") issued
interpretation No. 46 "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" ("FIN 46"). FIN 46 clarifies when a company should
consolidate in its financial statements the assets, liabilities and activities
of a variable interest entity. FIN 46 provides general guidance as to the
definition of a variable interest entity and requires a variable interest entity
to be consolidated if a company absorbs the majority of the variable interest
entity's expected losses, or is entitled to receive majority of the variable
interest entity's residual returns, or both. In December 2003, the FASB issued a
revised interpretation of FIN 46 ("FIN 46-R"), which supersedes FIN 46 and
clarifies and expands current accounting guidance for variable interest
entities. Both interpretations are effective immediately for any variable
interest entity created subsequent to January 31, 2003, and for variable
interest entities created before February 1, 2003, no later than the end of the
first reporting period after March 15, 2004. The adoption of FIN 46-R has no
impact on the Company's financial statements.
F-25
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QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
22. New Accounting Pronouncements (continued)
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities", which clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 149 is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June 30,
2003. The adoption of SFAS No. 149 has no impact on the Company's financial
reporting and disclosures.
In May 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity" ("SFAS No.
150"). SFAS No. 150 revises the accounting for certain financial instruments
that previously could be classified as liabilities (or, in some circumstances,
assets) in the statement of financial condition. SFAS No. 150 also requires
disclosure of the terms of those instruments and settlement alternatives. SFAS
No. 150 generally is effective for all financial instruments entered into or
modified after May 31, 2003, and is otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. The adoption of SFAS No. 150
has no impact on the Company's financial statements.
In December 2003, the FASB issued SFAS No. 132R "Employers' Disclosures about
Pensions and Other Postretirement Benefits" ("SFAS No. 132R"). This Statement
revises disclosures by employers about pensions and other postretirement
benefits. The additional disclosures are about the asset, obligations, cash
flows and net periodic benefit cost of defined benefit pension plans and other
defined benefit postretirement plans. The required information must be provided
separately for pension plans and other postretirement benefit plans. New
disclosures for interim periods beginning after December 15, 2003 are also
required by SFAS No. 132R. The adoption of SFAS No. 132R has no impact on the
Company's financial statements.
In December 2003, the staff of the Securities and Exchange Commission ("SEC")
issued Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition, which
supersedes SAB 101, "Revenue Recognition in Financial Statements." The primary
purpose of SAB 104 is to rescind the accounting guidance included in SAB 101
about multiple element revenue arrangements. SAB 104 also revises the SEC's
"Revenue Recognition in Financial Statements Frequently Asked Questions and
Answers that have been codified in Topic 13. SAB 104 was effective immediately
upon issuance and did not have a material impact of the Company's financial
reporting and disclosures.
F-26
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QINGDAO SINOGAS GENERAL MACHINERY LIMITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
22. New Accounting Pronouncements (continued)
The FASB has issued SFAS No. 148 "Accounting for Stock-Based Compensation -
Transition and Disclosures". SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. The
Company has adopted the disclosure requirements of SFAS No. 148. The Company has
no stock-based compensation.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment, an
Amendment of SFAS No. 123." SFAS No. 123R requires companies to recognize in the
statement of operations the grant-date fair value of stock options and other
equity-based compensation issued to employees. The Company has no stock-based
compensation.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-monetary
Assets." The Statement is an amendment of APB Opinion No. 29. SFAS No. 153
eliminates the exception for non-monetary exchanges of similar productive assets
and replaces it with a general exception for exchanges of non-monetary assets
that do not have commercial substance. The adoption of SFAS No. 153 has no
impact on the Company's financial statements.
F-27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
FRANKLYN RESOURCES III, INC.
(Registrant)
Date: June 15, 2006 /s/ Bo Huang
----------------------------------
Bo Huang, CEO