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SINOCOKING COAL & COKE CHEMICAL INDUSTRIES, INC. - 10-K - Management's Discussion and Analysis of Financial Conditions and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of the results of our operations and financial condition for the fiscal years ended June 30, 2014 and 2013 should be read in conjunction with the Selected Financial Data, our financial statements, and the notes to those financial statements that are included elsewhere in this Report. All monetary figures are presented in U.S. dollars, unless otherwise indicated. Forward-Looking Statements The statements in this discussion that are not historical facts are "forward-looking statements." The words "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," "continue," the negative forms thereof, or similar expressions, are intended to identify forward-looking statements, although not all forward-looking statements are identified by those words or expressions. Forward-looking statements by their nature involve substantial risks and uncertainties, certain of which are beyond our control. Actual results, performance or achievements may differ materially from those expressed or implied by forward-looking statements depending on a variety of important factors, including, but not limited to, weather, local, regional, national and global coke and coal price fluctuations, levels of coal and coke production in the region, the demand for raw materials such as iron and steel which require coke to produce, availability of financing and interest rates, competition, changes in, or failure to comply with, government regulations, costs, uncertainties and other effects of legal and other administrative proceedings, and other risks and uncertainties. We are not undertaking to update or revise any forward-looking statement, whether as a result of new information, future events or circumstances or otherwise. We are a vertically-integrated coal and coke producer based in Henan Province, China. Our coal products include raw (unprocessed) coal, washed coal, mid-coal and coal slurries. Our coke products include metallurgical coke, coke provider, coal tar and crude benzol. Our business operations are conducted through Hongli, a PRC company that we control by a series of contractual arrangements between Hongli and Hongyuan. Hongyuan is a PRC company wholly-owned by Top Favour, a British Virgin Island company and our wholly-owned subsidiary. 35 As of June 30, 2014: · coke related activities were carried out by Hongli and Hongli's branch operation, Baofeng Coking; · coal related activities were carried out by Hongchang Coal, Shuangrui Coal and Xingsheng Coal, all subsidiaries of Hongli; and · electricity generation was carried out by another Hongli subsidiary, Hongguang Power. We had no coal-related activities for the periods discussed below because Hongchang has been unable to extract coal since September 2011, and our other coal mine companies, Xingsheng and Shuangrui, have halted operations since the province-wide mining moratorium was imposed in June 2010. As of the date of this report, we do not know whether or when the mining moratorium will be lifted or we can resume our mining operations. See "Our Products and Operations - Coal - Coal Mining Moratorium" in Part I, Item I of this Report. We intend to transfer all coal related activities to the joint-venture established with Henan Province Coal Seam Gas Development and Utilization Co., Ltd. ("Henan Coal Seam Gas"), a state-owned enterprise and qualified provincial-level coal mine consolidator. The joint-venture, Henan Hongyuan Coal Seam Gas Engineering Technology Co., Ltd. ("Hongyuan CSG"), has been established, although our planned transfer of coal related activities to Hongyuan CSG has not been carried out as of the date of this report. Our interests in Hongyuan CSG are held by Henan Zhonghong Energy Investment Co., Ltd. ("Zhonghong"), a company established in December 2010 and which equity interests are presently held on Hongli's behalf and for its benefit by three nominees pursuant to share entrustment agreements. In April 2013, we began leasing a coking facility from Pingdingshan Hongfeng Coal Processing and Coking, Ltd. for one year. The leased facility (the "Hongfeng plant") has an annual capacity of 200,000 metric tons, using the new coking technology of recovery stamping coke oven which is the same as our 1,200,000 metric ton facility still under construction (the "new plant"). The leased plant approximately 3 miles from our existing plant. Production began at the Hongfeng plant in August 2013, and we believe that the skills we gain from operating its coke ovens will be invaluable for operating our new plant. On April 8, 2014, we renewed the lease for another year. On December 9, 2013, we entered into a tripartite agreement with Fangda Special Steel Technology Co., Ltd. ("Fangda Steel"), China's largest automobile spring steel producer, and Henan Shenhuo Group ("Shenhuo Group"), one of the six largest state-owned coal enterprises in Henan Province (the "tripartite agreement"). Pursuant to the tripartite agreement, we have agreed to supply up to 6,000 metric tons of grade II coke and 3,000 metric tons of clean coke to Fangda Steel each month at Fangda Steel's order. As of the date of this report, we have received 23,000 metric tons of coal from Shenhuo Group while delivering 36,000 metric tons of grade II coke to Fangda Steel. Management currently estimates that we will require an additional 367,000 metric tons of washed coal in order to hit our targeted amount of grade II coke available for delivery by the end of calendar year 2014. Results of Operations Our revenue in fiscal 2014 decreased by approximately 24.62% from a year ago as sales of most products slowed, largely as a result of government policies aimed at reducing pollution and softness in the real estate markets, which affected demand for steel and, as a result, coal products. 87% of the revenue was derived from coke products as compared to 59% in fiscal 2013, and 13% from coal products as compared to 41% in fiscal 2013. The change in product mix was largely due to decreased market demand for coal, counterbalanced by a small number of coke product customers continuing to cooperate with our company. Our coke product customers participate in specialty steel industries, including automotive, military and other non-construction industries; if our coke customers were focused in the construction industries, we believe our coke sales would have been negatively impacted. On a macro level, management has observed the following trends, which may have a direct impact on our operations in the near future: (1) domestic coke market can be expected to remain soft until the Chinese steel industry can work through its oversupply of crude steel, which may take some time absent any sudden, sharp uptick in the economy; and (2) the slower economy, along with an oversupply of mid-coal starting in early 2013, will continue to keep mid-coal prices down. 36 Comparison of Years ended June 30, 2014 and 2013 Revenue Revenue decreased by $16,418,608 as compared to fiscal year 2013. Such decrease mainly resulted from decreased sales of raw coal, coal slurries, mid-coal, coke powder, and washed coal, offset by increased sales of coke, coal tar and crude benzol. Revenue and quantity sold by product types for fiscal 2014 and 2013are as follows: Revenues Coke Coal products products Total Revenue Fiscal year 2013 $ 39,056,535 $ 27,629,766 $ 66,686,301 Fiscal year 2014 43,857,331 6,410,362 50,267,693 Increase (decrease) in $ $ 4,800,796 $ (21,219,404 ) $ (16,418,608 ) Increase (decrease) in % 12.29 % (76.80 )% (24.62 )% Quantity sold (metric tons) Fiscal year 2013 196,575 187,943 384,518 Fiscal year 2014 209,074 74,659 283,732 Increase (decrease) in metric tons 12,499 (113,284 ) (100,786 ) Increase (decrease) in % 6.36 % (60.28 )% (26.21 )% Coke products include finished coke (a key raw material for producing steel), coke powder (a smaller-grained coke that can be produced along with coke and used by non-ferrous metallurgical industry), coal tar, and crude benzol. Coal tar and crude benzol are byproducts of the coke manufacturing process with various industrial applications. Coal products include unprocessed metallurgical coal, processed or washed coal, mid-coal and coal slurries, which are by-products of the coal washing process and used primarily to generate electricity and for heating. As used in this discussion and analysis, unless otherwise indicated, "coke" includes both coke and coke powder, and "raw coal" includes coal that is unwashed and relatively unprocessed, as well as mid-coal and coal slurries. Average selling prices per metric ton of our products during fiscal 2014 and 2013 are as follows: Average Selling Price of Coke Products Crude Coke Coal tar benzol Coke powder Fiscal year 2013 $ 208 $ 267 $ 339 $ 152 Fiscal year 2014 203 319 891 159 Increase (decrease) in $ $ (5 ) $ 52 $ 552 $ 7 Increase (decrease) in % (2.18 )% 19.48 % 162.48 % 4.35 % Average Selling Price of Coal Products Coal slurries Mid-coal Washed coal Raw coal Fiscal year 2013 $ 49 $ 58 $ 183 $ 114 Fiscal year 2014 36 49 167 - Increase (decrease) in $ $ (13 ) $ (10 ) $ (16 ) $ (114 ) Increase (decrease) in % (26.30 )% (16.50 )% (8.53 )% (100 )% Generally, our selling prices are driven by a number of factors, including the particular composition and quality of the coal or coke we sell, their prevailing market prices locally and throughout China, as well as in the global marketplace, timing of sales, delivery terms, and our relationships with our customers and our negotiations of their purchase orders. However, the increase of $552 or 162.48% at our crude benzol selling prices over the fiscal years of 2014 and 2013 was contributed from our production quality and quantity of crude benzol. During the year ended June 30, 2014, our production of crude benzol increased from 180 metric tons in fiscal 2013 to 911 metric tons, and we were able to improve the quality of our crude benzol product, both of which gave us more bargaining power with our customers for higher selling prices. Additionally, we started to produce crude benzol using new coking ovens and technology in April 2013. After a one-year learning curve and quality control management, we produced higher quality crude benzol in fiscal 2014. The average price of coke was calculated based on the weighted average price of coke and coke powder. The average price of raw coal was calculated based on the weighted average price of unprocessed coal, coal byproducts and mixed thermal coal. We note that the average selling prices for coal products are also influenced by changes in the coal mixtures (with different grades and heat content) that we sell to our customers. 37 Revenue and quantity sold of each coke product for fiscal 2014 and 2013 are as follows: Coal Product Crude Coke Coke Coal tar benzol powder Total Revenue Fiscal year 2013 $ 31,171,635 $ 1,719,416 $ 61,108 $ 6,104,376 $ 39,056,535 Fiscal year 2014 38,917,211 2,884,303 811,806 1,244,011 43,857,331 Increase in $ $ 7,745,576 $ 1,164,887 $ 750,698 $ (4,860,365 ) $ 4,800,796 Increase in % 24.85 % 67.75 % 1,228.48 % (79.62 )% 12.29 % Quantity sold (metric tons) Fiscal year 2013 149,882 6,433 180 40,080 196,575 Fiscal year 2014 191,303 9,032 911 7,828 209,074 Increase in metric tons 41,421 2,599 731 (32,252 ) 12,499 Increase in % 27.64 % 40.40 % 406.13 % (80.47 )% 6.36 % The coke revenues increased 24.85% as a result of a 27.64% increase of coke quantity, slightly offset by the coke average price decrease of 2.18%. Due to lower demand from our sodium hydroxide and carbon electrode customers for coke powder, revenues from coke powder decreased 79.62%. Revenues of byproduct of coal tar increase 67.75% and revenues of crude benzene increased by 1,228.48%. As result of the technology upgrade with leasing a recovery stamping coke oven in Hongfeng plant, the Baofeng plant yielded more and better quality coal tar and crude benzol. We started to lease a recovery stamping coke oven in Hongfeng plant which is using an upgraded coking technology and conducted trial production in April 2013. With one-year learning curve and quality control management, we were able to produce higher quality crude benzol and coal tar, which resulted in increased production and revenues in fiscal year 2014 compared to fiscal year 2013. Although the market demand of coke has been weak since 2013, our revenues from coke products still increased $4.8 million or 12.29%, resulting from demand from special steel customers such as Fangda Steel, and favorable market and pricing conditions contributed to coal tar and crude benzol revenues. Revenue and quantity sold of each coal product for fiscal 2014 and 2013 are as follows: Coal Product Coal slurries Mid-coal Washed coal Raw coal Total Revenue Fiscal year 2013 $ 819,134 $ 1,933,332 $ 24,272,969 $ 604,331 $ 27,629,766 Fiscal year 2014 598,638 1,610,026 4,201,698 - 6,410,362 Increase in $ $ (220,496 ) $ (323,306 ) $ (20,071,271 ) $ (604,331 ) $ (21,219,404 ) Increase in % (26.92 )% (16.72 )% (82.69 )% (100 )% (76.80 )% Quantity sold (metric tons) Fiscal year 2013 16,589 33,141 132,930 5,283 187,943 Fiscal year 2014 16,450 33,051 25,158 - 74,659 Increase in metric tons (139 ) (90 ) (107,772 ) (5,283 ) (113,284 ) Increase in % (0.84 )% (0.27 )% (81.07 )% (100 )% (60.28 )% Our coal revenue continued to suffer from raw coal supply from our coal mine created by the ongoing mining moratorium. We are unable to predict whether or when the moratorium is likely to end. No raw coal revenues were generated for fiscal year 2014. 38 We purchase raw coal from third parties and wash it for our coking processing. During fiscal 2014, our business relationships with some of our coal customers terminated due to (1) weak market demand for raw coals and washed coals in 2014 and (2) inability to reach certain sale terms, including payment terms and selling price. In response to the termination, our revenues from raw coal and washed coal had been declined significantly, compared with our performance in 2013. When combined with the effect of lower selling prices, our coal product revenues decreased significantly. We believe this trend may continue for at least the near term, if not long term future, as a result of government initiatives aimed at increasing uses of clean energy. This is one reason we have been focusing on moving into the clean energy industry. Cost of Revenue Cost of revenue decreased to $41,275,791 from $58,478,301 a year ago. This was mainly driven by lower sale volumes for most of our coal products. Gross Profit Gross profit was $8,991,902, an increase of $783,902 or 9.55% from $8,208,000 a year ago, despite decreased revenues as discussed above. Gross profit margin increased to 17.89% from approximately 12.09% for the prior fiscal year, mainly due to stable demand of our coke and improved quality and production capacity of byproducts during the coking procedure, coal tar and crude benzol. Operating Expenses Operating expenses, which consist of selling expenses and general and administrative expenses, was $2,276,565, a decrease of $811,838 or 26.29% from a year ago. Selling expenses decreased by $9,111 or 5.56%, to $154,716, from slight reduction in expenses relating to selling activities. General and administrative expenses decreased by $802,727 or 27.45%, to $2,121,849, due to the following factors: (1) our rental expense decreased by $114,000, from closing our Beijing office; (2) consulting expenses decreased by $382,000 with engaging new consultants with lower charges; (3) lower investor relations expenditures, which were reduced by approximately $163,000, and (4) payroll expense was reduced by $90,000 as well as $54,000 reduction from entertainment expense and travel expense due to our cost control policy. Other Income and Expense Other income and expense includes finance expense (which consists of interest and other finance expenses, net of interest income), income and expense not related to our principal operations, and change in fair value of warrants. Finance expense was $3,982,378, an increase of $626,199 or 18.66% from a year ago. This is largely due to the following factors: (1) we incurred an additional $602,020 in interest in connection with extending Hongli's loans with Bairui Trust Co., Ltd. ("Bairui Trust") due to average interest rate increase from 7.01% to 8.88% and the penalty interest for overdue interest payment; (2) the bank service charge decrease $193,218, or 72.89% for a year ago. The decrease over our bank service charge was from lower bank acceptance note use as a payment tool in fiscal year 2014, and (3) the interest income from $8,032,037 in loan receivable decreased by $217,397, due to collections of $10.8 million in loan receivable and re-loans of $10 million during the fiscal year 2013. We had incomes unrelated to our principal operations of $109,100 in fiscal year 2014, compared to $229,036 in fiscal year 2013. The decrease was mainly from a dividend of $191,160 from our investment in Pingdingshan Rural Cooperative Bank ("PRCB") - Xinhua District Branch in fiscal year 2013. We also recorded other income from the gain in fair value of warrants in the amount of $5 in fiscal year 2014 compared to $716,627 in fiscal year 2013. As a result of the foregoing, we had other expense of $3,873,273 as compared other expense of $2,410,516 a year ago. Provision for Income Taxes Provision for income taxes decreased by $190,094 from a year ago, reflecting our higher taxable incomes from Chinese operations. Net income Net income, including the change in fair value of warrants, was $990,582, as compared to $1,047,693 a year ago. 39 Liquidity and Capital Resources As of June 30, 2014, our working capital was $6,760,391 as compared to negative working capital of $24,312,407 at June 30, 2013, due to reclassification of part of Bairui Trust's short-term loans of $29,243,566 to long-term loans. Our accounts have accordingly been prepared in accordance with U.S. GAAP on a going concern basis. The going concern basis assumes that assets are realized and liabilities are extinguished in the ordinary course of business at amounts disclosed in the financial statements. Our ability to continue as a going concern depends upon expenditure requirement and repayments of our short-term loan and long-term loan facilities with Bairui Trust as and when they become due. In an effort to improve our financial position, we intend to negotiate with Bairui Trust to extend our loan maturity date, and to increase sales of higher margin products such as coal tar and crude benzol. In the meantime, we are still waiting for the mining moratorium to conclude. If and when that occurs, we should be able to obtain a line of credit to facilitate additional liquidity by pledging our mining rights. Management believes that these and other actions taken can provide us the opportunity to continue as a going-concern. In summary, our cash flows are as follows: Year ended June 30, 2014 2013Net cash provided by (used in) operating activities $ (648,578 ) $ 6,627,554 Net cash provided by investing activities $ - $ 866,920 Net cash provided by (used in) financing activities $ 59,320 $ (8,815,001 ) Net Cash Provided by (Used in) Operating Activities Net cash used in operating activities for fiscal 2014 was approximately $0.65 million, as compared to net cash used in operating activities of approximately $6.6 million for fiscal 2013. Except for $1,311,859 in non-cash adjustment such as depreciation, amortization and depletion, bad debt, change in fair value of warrants, inventory impairment, and gain from forgiven payables which increased our cash-based net income, net operating inflow for fiscal 2014 resulted from the following factors: (1) our accounts receivable decreased by $427,486, due to improved collection of receivables from our customers; (2) advances to suppliers decreased by $128,205, due to tightening control of our prepayments; (3) our accounts payable decreased by $2,800,529 due to more credit from the suppliers; and (4) our other payables and liabilities increased by $323,870, including interest payables to Bairui Trust, salary payables, and others related to general and administrative expenses. Cash inflow was mainly offset by the following factors: (1) other receivable increase by $1,558,667 mainly due to a security deposit we made in connection with a not-yet-completed land use right auction; (2) inventory increased by $4,568,625 mainly due to soft market demand for our products, and (3) tax payable decreased by $373,545 due to less VAT payables recognized at the end of fiscal year 2014 because of reduction of our revenues during the same period. Net cash provided by operating activities for fiscal 2013 was approximately $6.6 million, as compared to net cash used in operating activities of approximately $12.2 million for fiscal 2012. Except for $1,107,666 in non-cash adjustment such as depreciation, amortization and depletion, bad debt and change in fair value of warrants which increased our cash-based net income, net operating inflow for fiscal 2013 resulted from the following factors: (1) our account receivable decreased by $2,757,701, due to improved collection of receivables from our customers; (2) advances to suppliers decreased by $3,681,517, due to tightening control of our prepayments; (3) we did not have prepaid expense, which increased our cash inflow by $636,908; and (4) our other payables and liabilities increased by $1,405,131, including interest payables to Bairui Trust, salary payables, and others related to general and administrative expenses. Cash inflow was mainly offset as follows: (1) notes receivable decreased by $398,250 due to the maturity and cashing of such notes; (2) inventory increased by $576,227 mainly due to soft market demands for our products; and (3) tax payable decreased by $414,772 due to lower taxable income in the fourth quarter of fiscal 2013, as compare to the same period last year. Net Cash Provided by Investing Activities We had no cash provided by or used in investing activities in fiscal year 2014. Net cash provided by investing activities for fiscal 2013 reflects: (1) $9,558,000 in loan receivable to an unrelated party, which was repaid in April 2013; and (2) $1,234,300 in loan receivable we collected from a borrower. Net Cash Provided by (Used in) Financing Activities Net cash provided by financing activities in fiscal year 2014 included: (1) restricted cash release from the notes payable maturity amount to $9,770,396; (2) a $385,000 loan from the CEO; and (3) a short-term loan from an individual of $163,700, offset by (A) repayment of the notes payable in the same amount $9,770,396; (B) $325,680 repaid loan to Barirui Trust in April 2014; and (C) a repayment of $163,700 on October 2013. 40 Net cash used in financing activities for fiscal 2013 included: (1) $9,558,000 in notes payable we obtained from Shanghai Pudong Development Bank ("SPDB") in February 2013, which matured and was fully repaid in August 2013; (2) a loan of $9,558,000 we received from SPDB, which was fully repaid in April 2013; (3) $4,779,000 in notes payable from SPDB that we repaid in September and October 2012 when they matured; and (4) $5,734,800 of Hongyuan's loan from SPDB that was repaid in June 2013. We also repaid a total of $7,965,000 to Bairui Trust in December 2012 and April 2013. Capital Resources Funding for our business activities has historically been provided by cash flow from operations, short-term bank loan financing, and loans from our Chairman. On April 2, 2011, Hongli entered into a loan agreement with Bairui Trust, pursuant to which Bairui Trust agreed to loan Hongli RMB 360 million (approximately $57.06 million), of which RMB 180 million was due on April 2, 2013, and RMB 180 million on April 2, 2014, with annual interest rate of 6.3%. Bairui Trust made the loan to Hongli on April 3, 2011. On November 30, 2011, Hongli entered into a supplemental agreement with Bairui Trust to amend the terms such that RMB 30 million (approximately $4.8 million) would be due on October 2, 2012, RMB 100 million (approximately $15.8 million) on April 2, 2013, RMB 50 million (approximately $7.9 million) on October 2, 2013, and RMB 180 million (approximately $28.5 million) on April 2, 2014. We made the October 2, 2012 payment on December 25, 2012, including outstanding interest charge for late payment. We repaid $3.2 million (RMB 20 million) on April 3, 2013, and entered into another supplemental agreement with Bairui Trust on April 23, 2013 to extend the due date for the remaining $12.7 million (RMB 80 million). Of such remaining principal, the due date for $3.2 million (RMB 20 million) has been extended to December 2, 2013 with an annual interest rate of 6.3% starting from April 23, 2013. The due date for $4.8 million (RMB 30 million) has been extended to January 2, 2014 with an annual interest rate of 6.3% starting from April 23, 2013. The due date for $4.8 million (RMB 30 million) has been extended to February 2, 2014 with an annual interest rate of 6.3% starting from April 23, 2013. Between April 3, 2013 and April 23, 2013, Bairui Trust charged a 9.45% annual interest rate on the entire $12.7 million outstanding. On October 1, 2013, the parties executed an extension agreement, for the remaining balance of approximately $50.7 million (RMB 310 million) with 9.9% interest rate as follows: Loan Amount Loan Amount Extended Loan (in USD) (in RMB) Repayment Date New Interest Rate Period $ 8,185,000 ¥ 50,000,000 October 2, 2016 October 3, 2013 - October 2, 2016 3,274,000 20,000,000 December 2, 2016 December 3, 2013 - December 2, 2016 4,911,000 30,000,000 January 2, 2017 January 3, 2014 - January 2, 2017 4,911,000 30,000,000 February 2, 2017 February 3, 2014 - February 2, 2017 29,466,000 180,000,000 April 2, 2017 April 3, 2014 - April 2, 2017 $ 50,747,000 ¥ 310,000,000 On April 2, 2014, the parties entered into another supplement agreement which replaced the extension agreement dated October 1, 2013, as follows: Loan Amount Loan Amount Extended Loan (in USD) (in RMB) Repayment Date New Interest Rate Period $ 3,245,752 ¥ 18,000,000 April 2, 2015 December 3, 2013 - April 2,2015 4,868,628 30,000,000 April 2, 2015 January 3, 2014 - April 2,2015 4,868,628 30,000,000 April 2, 2015 February 3, 2014 - April 2,2015 8,114,380 50,000,000 January 2, 2015 October 3, 2013 -January 2,2015 29,211,770 180,000,000 October 2, 2015 April 3, 2014 - October 2, 2015 $ 50,309,158 ¥ 308,000,000 According to the new supplement agreement, the annual interest rate was changed from 9.9% to 11.88% and, for the period between December 3, 2013 and April 2, 2014, Bairui Trust charged an additional 7.2% annual interest rate on $12.9 million (RMB 80 million) of the outstanding $50.3 million (RMB 310 million) loan principal. We paid back Bairui Trust RMB2,000,000 on April 2014 after the supplement. We intend to negotiate with Bairui Trust to further extend the maturity dates by an additional two to three years, and to repay the loans through our operational cash flow. We cannot guarantee that we will be successful in negotiating toextend such maturity dates. 41 Our business plan involves growing our business through: (1) Expand production capability of higher margin coke products such as crude benzol and other derivative byproducts in order to hedge against the unfavorable market conditions for coal and coke that we are facing; (2) Look for opportunities to build long-term relationships with quality coal producers to ensure our supply. To that end, Shenhuo Group is already supplying us under the tripartite agreement. Under such arrangement, we do not need to make any prepayments or purchase inventory until all coke products ordered by Fangda Steel are delivered, and our receivables from Fangda Steel are settled. As such, we can increase coke sales without significant demand on working capital; (3) Develop and install the system of green facility for the conversion of carbon dioxide into a clean-burning synthetic gas (syngas) to expand our product into the high margin product of syngas. Syngas, a clean-burning fuel, is increasingly utilized as a clean-energy alternative to burning coal. Comprised primarily of hydrogen and carbon monoxide, syngas can also be used to produce a range of widely-used industrial products such as fertilizers, solvents and assorted synthetic materials. The following are expected to require further capital resources: · New Coking Facility. We intend to use existing cash, cash flow from operations, bank loans, collection of our loan receivables, along with other finance arrangements such as extending our long term loan from Bairui Trust, to complete the construction of our new coking facility. Due to ongoing market conditions, however, we have once again slowed down construction, but plan to resume at full pace if and when the market improves. · Coal Mine Safety Improvement Project. The total estimated cost for government-mandated safety upgrades is approximately $31.5 million. We will be responsible for approximately 70% of the total estimated cost, approximately $22.0 million, under the structure of our joint-venture with Henan Coal Seam Gas. These projects have not commenced as of the date of this Report, and we are not sure if or when it will commence at this time. Off-balance Sheet Arrangements We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. Other than warrants liability, we have not entered into any derivative contracts that are indexed to its shares and classified as shareholder's equity or that are not reflected in its consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or that engages in leasing, hedging or research and development services with us. Critical Accounting Policies Our management's discussion and analysis of our financial condition and results of operations are based on our financial statements that 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 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 as well as the reported net sales and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and assumptions. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in Note 2 to our financial statements elsewhere in this Report, we believe that the following accounting policies are the most critical to aid you in fully understanding and evaluating this management discussion and analysis: Revenue recognition We recognize revenue from the sale of coal and coke, our principal products, at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations on our part exist and collectability is reasonably assured. This generally occurs when coal or coke is loaded onto trains or trucks at one of our loading facilities or at third-party facilities. Accordingly, management is required to apply its own judgment regarding collectability based on its experience and knowledge of its current customers, and thus exercise a certain degree of discretion. Most, if not all, of the electricity generated by Hongguang Power is typically used internally by Baofeng Coking. Supply of surplus electricity generated by Hongguang Power to the national power grid is mandated by the local utilities board. The value of the surplus electricity supplied, if it exists, is calculated based on actual kilowatt-hours produced and transmitted and at a fixed rate determined under contract. 42 Coal and coke sales represent the invoiced value of goods, net of a value-added tax ("VAT"), sales discounts and actual returns at the time when product issold to the customer. Accounts receivables, trade During the normal course of business, we extend unsecured credit not exceeding three months to our customers. Management regularly reviews aging of receivables and changes in payment trends by its customers, and records allowance when management believes collection of amounts due are at risk. Accounts receivables are considered past due after three months from the date credit was granted. Accounts considered uncollectible after exhaustive efforts to collect are written off. We regularly review the credit worthiness of our customers and, based on the results of such credit review, determine whether extended payment terms can be granted to or, in some cases, partial prepayment is required from certain customers. As of June 30, 2014 and 2013, $140,158 and $0 allowance for doubtful accounts was provided, respectively. Intangible assets - mining rights, net Mining rights are capitalized at fair value when acquired, including amounts associated with any value beyond proven and probable reserves, and amortized to operations as depletion expense using the units-of-production method over the estimated proven and probable recoverable tons. Our coal reserves are controlled through direct ownership by our VIEs which generally last until the recoverable reserves are depleted. Long-term investment Entities in which we have the ability to exercise significant influence, but do not have a controlling interest, are accounted for under the equity method. Significant influence is generally considered to exist when we have between 20% and 50% of ownership interest in the voting stock, but other factors, such as representation on the board of directors, voting rights and the impact of commercial arrangements, are considered in determining whether the equity method of accounting is appropriate. Impairment of long-lived assets We evaluate long-lived tangible and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable from its estimated future cash flows, in accordance with the accounting guidance regarding "Disposal of Long-Lived Assets." Recoverability is measured by comparing an asset's carrying value to the related projected undiscounted cash flows generated by the long-lived asset or asset group, considering a number of factors including past operating results, budgets, economic projections, market trends and product development cycles. When the carrying value of the asset exceeds the related undiscounted cash flows, the asset is considered impaired, and a second test is performed to measure the amount of impairment loss to the extent that the carrying value exceeds its fair value. As of June 30, 2014 and 2013, there was no impairment of long-lived assets. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and/or third party independent appraisals. Recently issued accounting pronouncements In July 2013, the FASB issued Accounting Standards Update 2013-11, "Income Taxes (Topic 740)-Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" ("ASU 2013-11"). The objective of ASU 2013-11 is to eliminate diversity in practice of presenting unrecognized tax benefits as a liability or presenting unrecognized tax benefits as a reduction of a deferred tax asset for a net operating loss or tax credit carryforward in certain circumstances by requiring that an unrecognized tax benefit be presented in the financial statements as a reduction to deferred tax assets excluding certain exceptions. ASU 2013-11 will be effective prospectively for the Company in its first quarter of 2014. The Company does not expect ASU 2013-11 to have a material effect on its financial statements. In April 2014, the Financial Accounting Standards Board (the "FASB") issued an accounting standard that raises the threshold for disposals to qualify as discontinued operations and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. The standard revised the definition of a discontinued operation to cover only asset disposals that are considered to be a strategic shift with a major impact on an entity's operations and finances, such as the disposal of a major geographic area or a significant line of business. Application of the standard, which is to be applied prospectively, is required for fiscal years beginning on or after December 15, 2014, and for interim periods within that year. The Company currently plans to adopt the standardin January 2015. In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-9, "Revenue from Contracts with Customers" ("ASU 2014-9"). ASU 2014-9 provides for a single comprehensive principles-based standard for the recognition of revenue across all industries through the application of the following five-step process: 43 Step 1: Identify the contract(s) with a customer. Step 2: Identify the performance obligations in the contract. Step 3: Determine the transaction price. Step 4: Allocate the transaction price to the performance obligations in the contract. Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation. The updated guidance related to revenue recognition that affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The guidance requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance is effective for us starting on January 1, 2017. We are currently evaluating the impact this guidance will have on our combined financial position, results of operations and cash flows. |