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SCOK > SEC Filings for SCOK > Form 10-Q on 9-Nov-2011All Recent SEC Filings

Show all filings for SINOCOKING COAL & COKE CHEMICAL INDUSTRIES, INC.

Form 10-Q for SINOCOKING COAL & COKE CHEMICAL INDUSTRIES, INC.


9-Nov-2011

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of the results of our operations and financial condition for the three months ended September 30, 2011and 2010, should be read in conjunction with 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.

Overview

We are a vertically-integrated coal and coke producer based in Henan Province, China. We use coal that we extract and buy to produce basic and value-added coal products including raw (unprocessed) coal, washed coal, medium coal and coal slurries (by-products of the coal-washing process), and coke products including chemical and metallurgical coke and coal tar (a by-product of the coke manufacturing process).

Our business operations are conducted through Henan Province Pingdingshan Hongli Coal & Coke Co., Ltd. ("Hongli"), a PRC company that we control by a series of contractual arrangements between Hongli and Pingdingshan Hongyuan Energy Science and Technology Development Co., Ltd. ("Hongyuan"). Hongyuan is a PRC company wholly-owned by Top Favour Limited, a British Virgin Island company and our wholly-owned subsidiary.

Presently, our coke related activities are carried out by Hongli's branch operation, Baofeng Coking Factory ("Baofeng Coking"), coal related activities by four of Hongli's subsidiaries, namely Baofeng Hongchang Coal Co., Ltd. ("Hongchang Coal"), Baofeng Shuangrui Coal Mining Co., Ltd. ("Shuangrui Coal"), Baofeng Xingsheng Coal Mining Co., Ltd. ("Xingsheng Coal") and Baofeng Shunli Coal Mining Co., Ltd. ("Shunli Coal"), and electricity generation by another Hongli subsidiary, Baofeng Hongguang Environment Protection Electricity Generating Co., Ltd. ("Hongguang Power").

In addition, we intend to operate our new coking plant through a newly established subsidiary of Hongli, Baofeng Hongrun Coal Chemical Co., Ltd. ("Hongrun"). We currently expect to complete the plant by the end of calendar year 2011 and commence operations immediately thereafter.

Since the provincial-wide mining moratorium was imposed in June 2010, Hongchang Coal has been operating at approximately 50% capacity while operations at our other three coal mine companies have halted. As such, the coal-related activities for the periods discussed below are those of Hongchang Coal only. In August 2011, both Hongchang Coal and Xingsheng Coal received clearance to resume operations from 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 with whom we formed a joint-venture, Henan Hongyuan Coal Seam Gas Engineering Technology Co., Ltd. ("Hongyuan CSG"). In September 2011, Hongchang Coal halted operations to complete certain mine engineering works and safety upgrades, which have been completed as of the date of this report. Henan Coal Seam Gas has also applied with the appropriate provincial-level agencies to confirm the clearances it has issued to Hongchang Coal and Xingsheng Coal, after which confirmation we expect both companies will be issued the necessary licenses and permits to resume operations at full capacity. As the date of this report, Shuangrui Coal and Shunli Coal are still waiting for clearance from Henan Coal Seam Gas to resume operations.

We intend to transfer all coal related activities from all four companies to Hongyuan CSG, although such transfer 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 benefits by three nominees pursuant to share entrustment agreements.

Results of Operations

General. Revenue for the three months ended September 30, 2011 increased approximately 70.28% from a year ago. Volume of coke and coal products sold (other than raw coal) increased in response to market demands. However, volume of raw coal sold declined in light of the ongoing provincial mining moratorium. Because we have been accumulating processed coal (washed coal) in anticipation of the commencement of operations at our new coking facility that is still under construction, our inventory was sufficient to enable us to also engage in trading, the sales from which greatly contributed to our overall revenue increase. The increased processed coal sales during the quarter are reflected in the revenue breakdown by product type, with 48.97% and 51.03% of total revenue in the first quarter of fiscal 2012 from coke products and coal products, respectively, as compared to 70.15% and 29.85% from a year ago, respectively.

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On a macro level, management has observed the following trends, which may have a direct impact on our operations in the near future: (1) the continuing effects of the ongoing mine consolidation in Henan on the availability of metallurgical coal in the region, and on the prices of coal and coke products in the short- and mid-term; (2) the acceleration of government-mandated closure of small-sized and less-efficient coking facilities; and (3) the central government's continuing efforts to provide economic stimulus to maintain momentum and growth in domestic consumption.

Revenue. Revenue for the three months ended September 30, 2011 was $22,151,334, an increase of $9,142,872 or 70.28% as compared to a year ago. Such increase was a result of the increase in all product categories in terms of both sales volumes and selling prices except for the slight decrease in the raw coal sales volume.

Revenue and quantity sold by product type for the three months ended September 30, 2011 and 2010 are as follows:

                                                               Revenues
                                                   Coke Products       Coal Products         Total
Revenue
Three Months Ended September 30, 2010             $     9,124,983     $     3,883,479     $ 13,008,462
Three Months Ended September 30, 2011                  10,847,621          11,303,713       22,151,334
Increase in $                                     $     1,722,638     $     7,420,234     $  9,142,872
% Increase in $                                             18.88 %            191.07 %          70.28 %
Quantity Sold (metric tons)
Three Months Ended September 30, 2010                      40,322              52,856           93,178
Three Months Ended September 30, 2011                      45,060              84,085          129,145
Increase (decrease)                                         4,738              31,229           35,967
% Increase (decrease)                                       11.75 %             59.08 %          38.60 %

Coke products include finished coke, a key raw material for producing steel, and coal tar, a byproduct of the coke manufacturing process which can be used for various industrial applications. Coal products include both washed and raw coal, which is used by customers primarily for electricity generation and heating applications. As used in this discussion and analysis, the "raw coal" category includes both thermal and metallurgical coal that is unwashed and relatively unprocessed, in addition to coal washing byproducts such as coal slurry.

Average selling prices per metric ton for our four principal product categories for the three months ended September 30, 2011 and 2010 are as follows:

Average Selling Prices                     Coke         Coal Tar        Raw Coal        Washed Coal
Three Months Ended September 30, 2010   $      226             238              60               151
Three Months Ended September 30, 2011          240             252              77               185
Increase (decrease) in $                        14              14              17                34

% Increase (decrease) in $ 6.19 % 5.88 % 28.33 % 22.52 %

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. Management believes that the changes in average selling prices from fiscal 2011 to fiscal 2012 were primarily driven by increased demand for all coal-related products and the general lack of coking coal supply in Henan which was caused by the provincial-wide mining moratorium.

We generally sell our raw coal inventory and other coal products when prices are stable at seasonally high levels, or at levels that are considered above historical norms. The average price of the 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 were also influenced by changes in the coal mixtures (with different grades and heat content) that we sold to our customers.

Revenue and quantity sold by coke product categories for the three months ended September 30, 2011 and 2010 are as follows:

                                              Coke Products
                                            Coke         Coal Tar         Total
Revenue
Three Months Ended September 30, 2010   $  8,709,145       415,838        9,124,983
Three Months Ended September 30, 2011     10,145,826       701,795       10,847,621
Increase in $                              1,436,681       285,957        1,722,638
% Increase in $                                16.50 %       68.77 %          18.88 %
Quantity Sold (metric tons)
Three Months Ended September 30, 2010         38,577         1,745           40,322
Three Months Ended September 30, 2011         42,272         2,788           45,060
Increase                                       3,695         1,043            4,738
% Increase                                      9.58 %       59.77 %          11.75 %

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Revenue from coke for the three months ended September 30, 2011 increased by 16.50% from a year ago as a result of the increased sales volume and price. The increased sales volume was mainly due to the increased demand for coke by steel mills, and the increased selling price was due to the increased demand for coke, as well as the shortage of coking coal in China. Strong market demand from chemical manufacturers also boosted our coal tar revenue for the first quarter 2012, an increase of 68.77% from a year ago.

Revenue and quantity sold by coal product categories for the three months ended September 30, 2011 and 2010 are as follows:

                                                Coal Products
                                         Raw Coal        Washed Coal         Total
Revenue
Three Months Ended September 30, 2010   $ 2,663,592         1,219,887        3,883,479
Three Months Ended September 30, 2011     3,019,933         8,283,780       11,303,713
Increase in $                               356,341         7,063,893        7,420,234
% Increase in $                               13.38 %          579.06 %         191.07 %
Quantity Sold (metric tons)
Three Months Ended September 30, 2010        44,751             8,105           52,856
Three Months Ended September 30, 2011        39,360            44,725           84,085
Increase (decrease)                          (5,391 )          36,620           31,229
% Increase (decrease)                        (12.05 )%         451.82 %          59.08 %

Revenue from raw coal for the three months ended September 30, 2011 increased 13.38% from a year ago. Although we were unable to produce or purchase sufficient raw coal to sell as a result of the mining moratorium, the increased selling price of the raw coal driven by the shortage of raw coal supply generated a 13.38% increase in revenue despite a 12.05% decrease in sales volume.

Revenue from washed coal for the three months ended September 30, 2011 increased by 579.06% from a year ago, as we sold some of our inventory to take advantage of the 23.06% increase in the average selling price of washed coal that resulted from the increase in raw coal prices.

Cost of Revenue. Cost of revenue for the three months ended September 30, 2011 increased from $8,364,109 to $14,947,457 as compared to a year ago. Despite the drop in raw coal sales volume, sales of all other products increased. In addition, our weighted average purchase cost of raw materials increased due to higher raw coal price driven by the shortage of supply.

Gross Profit. Gross profit for the three months ended September 30, 2011 increased by $2,559,524 or 55.11%, to $7,203,877, from $4,644,353 for the three months ended September 30, 2010, reflecting our higher revenue period over period.

Operating Expenses. Operating expenses, which consist of selling expenses and general and administrative expenses, decreased by $294,142 or 28.85% during the three months ended September 30, 2011 as compared to the same period in 2010, largely due to a decrease in general and administrative expenses. As a result of warrants issued to a consultant during the three months ended September 30, 2010, general and administrative expenses for such period was higher by $291,218 as compared to the same period in 2011, when no such warrants were issued.

Other Income and Expense. Other income and expense includes finance expense (income), expense not related to our principal operations, and change in fair value of warrants.

Finance expense (income) consists of interest expense (income). We had finance income of $107,326 for the three months ended September 30, 2011 as compared to finance expense of $56,950 for the three months ended September 30, 2010. Such income was the result of $537,113 of interest income related to loan receivables, offset by $415,559 of interest expense, net of capitalized interest, related to loans from a local bank and Bairui Trust Co., Ltd. ("Bairui Trust"), and $14,228 of other bank charges and expenses.

Provision for Income Taxes. Provision for income taxes increased by $527,616 for the three months ended September 30, 2011 from a year ago, due primarily to an increase in income from operations.

Net income. Net income, including the change in fair value of warrants, was $8,308,713 for the three months ended September 30, 2011, as compared to $15,481,998 for the same period in 2010.

We use non-GAAP adjusted net income to measure the performance of our business internally by excluding non-cash charges related to warrants, and believe that the non-GAAP adjusted financial measure allows us to focus on managing business operating performance because the measure reflects the Company's essential operating activities and provides a consistent method of comparison to historical periods. We believe that providing this non-GAAP measure that the Company uses internally is useful to investors for a number of reasons. The non-GAAP measure provides a consistent basis for investors to understand our financial performance in comparison to historical periods without variation of non-recurring items and non-operating related charges. In addition, it allows investors to evaluate the Company's performance using the same methodology and information as that used by our management. Non-GAAP measures are subject to inherent limitations because they do not include all of the expenses included under GAAP and because they involve the exercise of judgment regarding which charges are excluded from the non-GAAP financial measure. However, we compensate for these limitations by providing the relevant disclosure of the items excluded.

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The following table provides a non-GAAP financial measure and a reconciliation of that non-GAAP measure to the GAAP net income:

                                                               Three Months Ended September 30
                                                                   2011                 2010
Net income                                                   $      8,308,713       $  15,481,998
Change in fair value of warrant liabilities                        (3,019,722 )       (12,919,675 )
Adjusted net income                                          $      5,288,991       $   2,562,323

Earnings per share- basic                                    $           0.39       $        0.74
Earnings per share- diluted                                  $           0.39       $        0.73

Adjusted earnings per share - basic                          $           0.25       $        0.12
Adjusted earnings per share - diluted                        $           0.25       $        0.12

Weighted average number of common shares - basic                   21,093,604          20,871,192
Weighted average number of common shares - diluted                 21,093,604          21,288,959

Liquidity and Capital Resources

In summary, our cash flows are as follows:

                                                               Three Months Ended September 30
                                                                   2011                  2010
Net cash used in operating activities                        $     (6,981,242)       $ (4,525,463 )
Net cash used in investing activities                              (6,711,702)         (7,214,359 )
Net cash provided by (used in) financing activities                  (381,190)            496,213

Net Cash Used in Operating Activities

Net cash used in operating activities for the three months ended September 30, 2011 was $6,981,242. Net operating outflows resulted from increases in notes receivable, accounts receivable, and inventories. Although our accounts receivable increased by approximately $7.9 million, our customers' creditworthiness remained relatively consistent as our collections maintained at less than 90 days. We increased our raw and washed coal inventories during the quarter ended September 30, 2011 in order to have sufficient raw materials for our new coking plant, the construction of which is expected to be completed by the end of calendar 2011.

Net Cash Used in Investing Activities

Net cash used in investing activities for the three months ended September 30, 2011 was $6,711,702, which included: (1) approximately $20.1 million for purchasing the equipment and machineries, as well as the payment for the construction of the buildings and other infrastructures for the new coking facilities, (2) approximately $1.2 million for the land use rights to the land underlying our new coking plant, (3) approximately $1.9 million in loans to two unrelated parties. We were refunded approximately $7.8 million in refundable deposits made to owners of four coal companies that we were planning to acquire, when they were allocated by government to be acquired by Pingdingshan Coal Group. We also received approximately $8.7 million in repayments from unrelated-party loans.

Net Cash Used in Financing Activities

Net cash used in financing activities for the three months ended September 30, 2011 was $381,190. Restricted cash increased by $500,000, because of a cash guarantee for a $ 5 million (RMB 32 million) loan from Shanghai Pudong Development Bank ("SPDB"), which we extended for another six months. We also received $118,810 from Mr. Jianhua Lv, our CEO as working capital to support our operations.

Capital Resources

Funding for our business activities has historically been provided by cash flow from operations, short-term bank loan financing, and loans from individuals including our CEO.

We also have arrangements with certain banks pursuant to which we are able to issue short-term notes to pay our vendors, secured against our deposits with the banks of 50% of the face value of the notes as well as a guarantee from our CEO, Hongli or an unrelated third party. We currently have such arrangements with two banks. Under our arrangements with SPDB, we are subject to a diligence review for each note issued, and SPDB charges us a processing fee based on 0.05% of the face value of each note. Under our arrangement with Pingdingshan Rural Cooperative Bank ("PRCB"), we have a line of credit of $30.3 million. Although PRCB also charges the same processing fee as SPDB, we are not subject to a diligence review for each note so long as the aggregate amount of notes issued does not exceed our credit limit.

On April 2, 2011, Hongli entered into a loan agreement with Bairui Trust, pursuant to which Bairui Trust agreed to loan Hongli the sum of RMB 360 million (approximately $54.9 million), of which RMB 180 million is due on April 2, 2013, and RMB 180 million on April 2, 2014, with an annual interest rate of 6.3%. Bairui Trust made the loan to Hongli on April 3, 2011.

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Our business plan involves growing our business through: (1) expansion and modernization of our production facilities and achieving greater energy efficiency while also lessening any environmental impact; (2) recapturing more coking by-products for refinement into useful industrial chemicals, and production of more high value-added chemical products; (3) acquisition of other coal mines to source raw materials; and (4) strategic cooperation with Zhengzhou Coal Industry Group Co., Ltd. ("Zhengzhou Coal") to indirectly control coal resources, secure our internal material requirements (including for our new coking facility still under construction) and ensure stable supply for coal trading, although our arrangement with Zhengzhou Coal is currently halted due to its lack of coal supply.

Of the foregoing, the following is expected to require capital resources:

New Coking Facility. On March 3, 2010, we announced that we began construction of our new coking facility to be located beside our current facilities in Pingdingshan City. Because the new facility will share the electricity, water and heating systems of our existing facilities, we have revised our previously estimated cost for the new facility from approximately $70 million to approximately $60 million, including the cost of acquiring additional land use rights to expand the site of the new facility, estimated at $10.6 million. Construction is expected to be completed by the end of December 2011, and production is expected to commence immediately thereafter. On October 12, 2010, PRCB extended by one year its non-binding letter of intent to lend us up to RMB 300 million (approximately $45 million) for construction of this facility. Such loan would be subject to the approval of our loan application, which had not been submitted as of September 30, 2011.

During the three months period ended September 30, 2011, we had capital expenditures of $20,118,594. Such expenditures were for equipment and machinery purchases and site expansion for our new coking plant.

Our management presently anticipates that the proceeds from our prior equity issuance, access to credit and cash flow from operations will provide sufficient capital resources to pursue and complete the construction of our new coking facility. We intend to utilize existing cash, cash flow from operations and bank loans to complete our new coking plant. Any future facility expansion and acquisitions will require additional financing and/or equity capital and will be dependent upon the availability of financing arrangements and capital at the time.

We have not experienced any material losses since inception relating to accidents or other similar events. See "Risk Factors - We may suffer losses resulting from industry-related accidents and lack of insurance" in our annual report on Form 10-K for the fiscal year ended June 30, 2011, filed with the SEC on September 13, 2011.

Contractual Commitments

The following table sets forth payments due by period for fixed contractual
obligations as of September 30, 2011:

                                                                     Payments due by period
                                                Less than                                            More than
                                 Total           1 year         1-3 years         3-5 years           5 years
Operating Lease Obligations   $    394,839     $   168,346     $    226,493     $            -     $            -
Capital Lease Obligations                -               -                -                  -                  -
Purchase Obligations                     -               -                -                  -                  -
Long-term Debt                  56,304,000               -       56,304,000                  -                  -
Total                         $ 56,698,839     $   168,346     $ 56,530,493     $            -     $            -

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 . . .

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