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AMCF > SEC Filings for AMCF > Form 10-Q on 14-Nov-2011All Recent SEC Filings

Show all filings for ANDATEE CHINA MARINE FUEL SERVICES CORP

Form 10-Q for ANDATEE CHINA MARINE FUEL SERVICES CORP


14-Nov-2011

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q (including the section regarding Management's Discussion and Analysis of Financial Condition and Results of Operations) contains certain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, as well as information relating to Andatee China Marine Fuel Services Corporation that is based on management's exercise of business judgment and assumptions made by and information currently available to management. Although forward-looking statements in this Quarterly Report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. When used in this document and other documents, releases and reports released by us, the words "anticipate," "believe," "estimate," "expect," "intend," "the facts suggest" and words of similar import, are intended to identify any forward-looking statements. You should not place undue reliance on these forward-looking statements. These statements reflect our current view of future events and are subject to certain risks and uncertainties as noted below. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, our actual results could differ materially from those anticipated in these forward-looking statements. Actual events, transactions and results may materially differ from the anticipated events, transactions or results described in such statements. Although we believe that our expectations are based on reasonable assumptions, we can give no assurance that our expectations will materialize. Many factors could cause actual results to differ materially from our forward looking statements. Other unknown, unidentified or unpredictable factors could materially and adversely impact our future results. You should read the following discussion and analysis in conjunction with our unaudited financial statements contained in this report , as well as the audited financial statements, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and "Risk Factors" contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. We undertake no obligation and do not intend to update, revise or otherwise publicly release any revisions to our forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of any unanticipated events.

Except where the context otherwise requires and for purposes of this Quarterly Report:

the terms "we," "us," "our company," "our" refer to Andatee China Marine Fuel Services Corporation, a Delaware corporation, its subsidiaries Goodwill Rich International Limited and Dalian Fusheng Consulting Co. Ltd., its variable interest entity (VIE), Dalian Xingyuan Marine Bunker Co. Ltd., through which entity we conduct all of our business operations, and the subsidiaries of our VIE entity, which are Donggang Xingyuan Marine Bunker Company Ltd., Xiangshan Yongshinanlian Petrol Company Ltd., Rongcheng Mashan Marine Bunker Company and Rongcheng Xinfa Petrol Company Ltd.;


the term "Andatee" refers to Andatee China Marine Fuel Services Corporation, the parent company;

the term "Goodwill'' refers to Goodwill Rich International Limited, a subsidiary of Andatee, which for financial reporting purposes is the predecessor to Andatee; and

"China" and "PRC" refer to the People's Republic of China, and for the purpose of this Annual Report only, excluding Taiwan, Hong Kong and Macau.

Critical Accounting Policies

We prepare financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect the amounts reported in our combined and consolidated financial statements and related notes. We periodically evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

We primarily generate revenue from blended products sales to distributors and end users. We also generate revenue from raw materials sales. We consider revenue from the sale of our blended products and raw materials realized or realizable and earned upon meeting all of the following criteria: persuasive evidence of a sale arrangement exists, delivery has occurred, the price to the distributor is fixed or determinable, and collectability of payment is reasonably assured. These criteria are met at the time of shipment when the risk of loss passes to the distributor or end user. Revenue represents the invoiced value of sold goods, net of VAT. Our products, all of which are sold in China, are subject to a Chinese VAT at a rate of 17% of the gross sales price or at a rate approved by the Chinese local government. This VAT may be offset by VAT we paid on raw materials and other materials included in the cost of producing the finished product. The VAT amounts paid and available for offset are maintained in our current liabilities.

Accounts Receivable

During the normal course of business, we extend to some of our customers interest-free unsecured credit for an initial term of 30 - 60 days, depending on a customer's credit history, as well as local market practices. Our accounts receivable turnover for the nine months ended September 30, 2011 and 2010 were 4.7 and 6.7 times, respectively. We review our accounts receivable quarterly and determined the amount of allowances, if any, necessary for doubtful accounts. Historically, we have not had any bad debt write-offs and, as such, we do not provide a general reserve amount for possible bad debts based upon a percentage of sales or accounts receivable balances. Rather, we review our accounts receivable balances to determine whether specific reserves are required due to such issues as disputed balances with customers, declines in customers' credit worthiness, or unpaid balances exceeding agreed-upon terms. Based upon the results of these reviews, we determine whether a specific provision should be made to provide a reserve for possible bad debt write-offs.


We also communicate with our customers each month to identify any potential issues and reassess our credit limits and terms with them based on their prior payment history and practices. We also plan to continue building upon our existing relationships and history with each of our customers to assist us in the full and timely collection of outstanding receivable balances.

Assessment of Impairment for Long-lived Assets

Our long-lived assets include fixed assets, intangible assets and goodwill. Fixed assets comprise property and buildings, marine bunkers, boiler equipment, laboratory equipment, transportation vehicles and other office equipment, and are depreciated over the estimated economic useful lives of the assets on a straight-line basis. Intangible assets mainly comprise land use rights and other finite-lived intangible assets. We amortize the cost of intangible assets over their expected future economic lives. Goodwill represents the excess of the purchase price over the net of the fair value of the identifiable tangible and intangible assets acquired and the fair value of liabilities assumed upon the business acquisitions. Goodwill is stated at cost less provision for impairment loss. Management's judgment is required in the assessment of the economic lives of intangible assets and useful lives of the fixed assets. Based on the existence of one or more indicators of impairment, we measure any impairment of fixed assets, intangible assets and goodwill based on a projected discounted cash flow method using a discount rate determined by our management which is commensurate with the risk inherent in our business model. An impairment charge would be recorded if we determined that the carrying value of fixed assets, intangible assets and goodwill may not be recoverable. Our estimates of future cash flows require significant judgment based on our historical results and anticipated results and are subject to many factors.

Determination of Functional Currencies

Our reporting currency is the U.S. dollar. The functional currency of Andatee and Goodwill are the U.S. dollar. The functional currency of our PRC subsidiary, our VIE and its subsidiaries in China is the RMB. An entity's functional currency is the currency of the primary economic environment in which it operates. Normally, that is the currency of the environment in which it primarily generates and expends cash. Management's judgment is essential in the determination of the functional currency which is made by assessing various indicators, such as cash flows, sales price and market, expenses, financing and inter-company transactions and arrangements. Assets and liabilities of our subsidiary and VIE entities in China are translated into U.S. dollars, our reporting currency, at the exchange rate in effect at the balance sheet date and revenues and expenses are translated at the current exchange rate in effect during the reporting period. Foreign currency translation adjustments are not included in determining net income for the period but are accumulated in a separate component of consolidated equity on the balance sheet. The foreign currency translation gain reflected within Other Comprehensive Income for the nine-months ended September 30, 2011 and 2010 was $1,875,614 and $898,471, respectively.


Business and Operations Overview

Andatee China Marine Fuel Services Corporation is a Delaware corporation. Our executive offices are located in the City of Dalian, a key international shipping hub and international logistics center in North China. Our main offices are located in the city of Dalian, Dalian Ganjingzi District, Dalian Wan Lijiacun, at Unit C, No. 68 West Binhai Road, Xigang District Dalian, China.

We carry out all of our business through our Hong Kong subsidiary, Goodwill, its wholly-owned Chinese subsidiary, Fusheng, Fusheng's subsidiaries and Fusheng's variable interest entity (VIE), Xingyuan, and Xingyuan's subsidiaries (Xingyuan and its subsidiaries being collectively referred to as the VIE entities). A VIE is an entity where equity investors do not have the characteristics of a controlling financial interest (see Note 1 of Notes to Consolidated Financial Statements). Through Fusheng and Xingyuan, we are a leading marine fuel supplier along the coast of east China. Our products include cargo vessel fuel classified as CST180 and CST120, fishing boat fuel classified as#1,#2, #3 and #4, which are close substitutes for diesel used throughout the region's fishing industry. We produce, store, distribute and trade the blended marine fuel oil for cargo and fishing vessels. Backed by core facilities, including storage tanks, tankers and berths, our sales network covers major depots along the towns of Dandong, Tianjin, Shidao and Shipu, which are famous for their fishing tradition and industry.

Currently, we sell approximately 56.1% of our products through distributors and approximately 43.9% to retail customers. Our products are substitutes for diesel used throughout east coast of China fishing industry by small to medium sized cargo vessels. Our core facilities include storage tanks, berths (the space allotted to a vessel at the wharf), marine fuel pumps, blending facilities and tankers. Our sales network covers major depots along the towns of Dandong, Tianjian, Shidao and Shipu along the east coast of China.

Our marine fuel for cargo vessels is classified as CST180 and CST120; our marine fuel for fishing boats/vessels, - #1 fuel (for engines with 2,000 rpm capacity or higher), #2 fuel (for engines with 1,800 rpm capacity), #3 fuel (for engines with 1,600 rpm capacity) and #4 fuel (for engines with 1,400 rpm capacity). We also produce blended marine fuel according to customer specifications using our proprietary blending technology. Our own blend of marine diesel oil, #1, #3 fuel and #4 fuel are substitutes for the traditional diesel oil, commonly known as #0 diesel oil, used by most small to medium vessels. We generate virtually all of our revenues from our own brands of blended oil products.

Business Development and Outlook

Since our inception in 2001, we have taken several steps to increase investment in facilities and product line expansion in order to provide our customers with easier access to our products and services and to build a delivery network closer to target market. These steps include acquiring additional local companies and facilities, and development of new products, all aimed at meeting customer demands in various markets. Historically, we have funded these activities from our working capital.


We continue to ramp up expansion of our distribution network by expanding organically through the opening of new sales and marketing branches in new port locations, building new facilities improving our existing facilities, and signing sole supply agreements with long-term supply partners.

Furthermore, we also plan to set up market developing offices in large cities, such as Shanghai, Shenzhen, etc. to recruit capable local hands in a bid to establish effective network of information for providing solid foundations to pursue our acquisition-driven growth strategy in neighboring areas around the cities.

Facility Expansion

In September 2010, we commenced the constructions of new blending facilities in Panjin City, Liaoning province and Zibo City, Shandong province, both of which are aimed at improving our production capabilities in blending.

The facilities with 17,000m3 tanks located in Zibo City was completed on May 26, 2011, and the Company believes that this new facility's close proximity to a network of refineries in Shandong province will help to reduce the cost of procuring raw materials and the cost of transportation incurred by shipping products to customers in Shidao City, Shandong province. Total capital expenditure is at RMB 56 million (US$ 8.7 million).

Construction of the Panjin City facilities was completed on June 21, 2011, which will provide additional 15,000 m3-tank capacities in a region close to the areas where our current major suppliers operate. The cost for construction is at approximately RMB 64 million (US$ 9.3 million)

Operational Initiatives in 2011

In 2011, we undertook the following steps designed to reduce the overall production and transportation costs:

built and/or acquired other distributing facilities to increase our profit margin and sales, enhance our brand and minimize the adverse impact of oil price volatility

established regional purchase center to timely collect all information for sales and purchase analysis, to process order making and logistics planning. This allows us to negotiate favorable pricing and volume discounts and maintain an appropriate sale levels

worked closely with the managements of the acquired companies to obtain an in-depth knowledge of local markets and developed a list of suppliers to reduce the purchase cost of certain raw materials.


relocated our production and storage centers to locations closer to our end users which provide us more opportunity to develop an efficient and flexible manufacturing and operational infrastructure and enjoy savings on transportation costs.

In 2011, our overall strategy has been to (i) increase our share of retail sales since such sales had shown to be less price-sensitive than our sales to the distributors, (ii) acquire our own retail facilities to reduce the risk of opportunistic negotiations from our retail customers during periods of volatile oil prices, (iii) build retail points in strategic locations (often close to other, recently acquired locations) to capture a majority of active local markets and (iv) add more products to our current product line to further satisfy customers' diversifying demands.

As the result of expansion of our distribution network and contribution from new products put into markets during the first nine months of 2011, revenues have increased to $ 173.1 million as the result of 11.0% increase in our volume of sales, but our gross margin has dropped to 9.0%, compared with 11.1% in same period of 2010. Our gross margin declined result from increasing raw materials costs, which we couldn't entirely pass on to customers. For the nine months ended September 30, 2011, 43.9% of our sales were to retail customers as compared with 38.3% in the same period of 2010.

We believe that maintaining our retail sales and distribution channels will help stabilize gross margins by offsetting part of the pressure imposed on our profit margin from the surge of raw materials costs. We also believe that higher retail sales and closer ties with our customers as well as broader distribution network are at the core of our strength and business viability going forward.

We intend to (i) control more facilities closer to end markets, through business acquisitions, partner cooperation, building local platform for our products and added-value services, which would enhance the brand awareness of the "Xingyuan" brand and (ii) expand our product line and upgrade our production facilities to explore the markets opportunities and increase our share in the retail market.

Principal Factors Affecting our Financial Performance

We believe that the following factors will continue to affect our financial performance:

Increasing demand for blended marine fuel - The increasing demand for blended marine fuel has a positive impact on our financial position. The strong growth in the blended marine fuel industry since 2002 has been driven by several factors, including, among others, steady population growth in the PRC, improvements in the living standards, national energy conservation efforts.

Expansion of our sources of supply, production capacity and sales network - To meet the increasing demand for our products, we need to expand our sources of supply and production capacity. We plan to make capital improvements in our existing production facilities, which would improve both their efficiency and capacity. In the short-run, we intend to increase our investment in our reliable supply network, personnel training, information technology applications and logistic system upgrades.


Fluctuations in Crude Oil Price - We use oil refinery by-products as raw materials for our production. The recent increase in oil prices had a direct impact on the price we pay for these products. We tried to mitigate this in the short-term by increasing the price of our products and passing as much the increase as possible to our customers. Our efforts to pass on price increase to customers has been complicated by current refined oil pricing mechanism imposed by China authorities.

Results of Operations

Comparison of three months and nine months ended September 30, 2011 and 2010

Revenue

Our revenue increased by US$8.2 million, or 14.3%, from US$57.5 million for the third quarter ended September 30, 2010 to US$65.7 million for third quarter ended September 30, 2011. The increase in our revenues was due to the increased sales volume and higher average crude oil price. The sales volume increase by approximately 4,000 tons, or 5.1%, from 86,000 tons for the third quarter ended September 30, 2010 to 90,000 tons for the third quarter ended September 30, 2011, among which the sales volume of 4# marine fuel has reached to approximately 43,000 tons, accounting for 90% of overall increase in sales volume, thanks to additional capacity contributed by Panjin and Zibo facilities. While the international crude oil price has risen from $78 per barrel in the third quarter of 2010 to $91 per barrel in the third quarter of 2011.

Our revenue increased by US$41.8 million, or 31.8%, from US$131.3 million for the nine months ended September 30, 2010 to US$173.1 million for nine months ended September 30, 2011. The increase in our revenues was the result of increased sales due to the promotion of 1# marine fuel and the expansion of our sales network, increased sales volume and higher average international crude oil price. The portion of retail sales in our total revenues had increased to 43.9% for the nine months of 2011 from 38.3% for the nine months of 2010. During the nine months ended September 30, 2011 the international oil prices stayed around the level of $96 per barrel in comparison to average oil price of $79 per barrel in the nine months of 2010.

Our overall sales volume increased by 11% or 23,000 tons, from 205,000 tons for the nine months period ended September 30, 2010 to approximately 228,000 tons for the nine months period ended September 30, 2011. During the third quarter of 2011, as the sales of 4# marine fuel picked up and the newly built facilities in Shandong and Liaoning provinces brought in more revenues, we had seen higher demand for our fuel products.

For the nine months ended September 30, 2011, 1# marine fuel represented 14.0% of our sales, 2# marine fuel represented 7.7% of our sales, 3# marine fuel represented 8.6% of our sales, 4# marine fuel represented 52.4% of our sales, 180CST represented 9.8% of our sales and 120CST represented 7.5% of our sales. For the nine months ended September 30, 2010, 1# marine fuel represented 13.0% of our sales, 2# marine fuel represented 7.2% of our sales, 3# marine fuel represented 7.1% of our sales, 4# marine fuel represented 56.7% of our sales, 180CST represented 10.5% of our sales and 120CST represented 5.4% of our sales.


Cost of Revenue

Our cost of revenues increased by US$7.7 million, or 14.9%, from US$51.7 million for the third quarter ended September 30, 2010 to US$59.4 million for the third quarter ended September 30, 2011 due to higher sales.

Our cost of revenues increased by US$40.7 million, or 34.9%, from US$116.7 million for the nine months ended September 30, 2010 to US$157.4 million for the nine months ended September 30, 2011 due to higher sales.

However, as a percentage of revenues, the cost of revenues decreased slightly from 90.1% for the nine months ended September 30, 2010 to 88.8% for the nine months ended September 30, 2011.

Gross Profit

As a result of the efforts discussed above, our gross profit increased by US$0.5 million, or 9.0%, to US$6.2 million for the third quarter of 2011 as compared to US$5.7 million in the third quarter of 2010. As a percentage of revenues, our gross profit margin decreased from 10.0% for the third quarter of 2010 to 9.5% for the third quarter of 2011.

Our gross profit increased by US$1.1 million, or 7.4%, to US$15.7 million for the nine months of 2011 as compared to US$14.6 million in 2010. Our gross profit margin decreased from 11.1% for the nine months of 2010 to 9.1% for the same period of 2011.The decrease in our gross profit percentage resulted primarily from an increase in the sale of products with lower gross profit margin, such as 1# marine fuel, generally, the unit price of 1# is higher by $90 per ton than 4# while the gross profit margins of the other two products are usually the same, in which case results in lower gross profit margin from 1# than 4#, by approximately 1.2%.

Selling Expenses

Selling expenses increase by US$0.7 million, or 60.7%, from US$1.2 million for the third quarter of 2010 to US$1.9 million in the third quarter of 2011. The increase was primarily due to the increase in sales employees' compensation as a result of increased sales and an increase in promotional expense to market our products produced by the facilities in the area of Panjin and Zibo, where our newly completed facilities are located. As a percentage of revenues, selling expenses increased from 2.1% for the third quarter of 2010 to 2.9% for 2011.

Selling expenses increased by US$0.8 million, or 29.1%, from US$2.7 million for the nine months of 2010 to US$3.5 million in 2011. The increase was primarily due to the increase in sales employees' compensation and other promotional expenses in marketing products produced by newly completed facilities in Panjin and Zibo areas. As a percentage of revenues, selling expenses decreased from 2.04% for the nine months of 2010 to 2.00% for 2011.


General and Administrative Expenses

General and administrative expenses increased by US$0.1 million, or 19.9%, from US$0.7 million for the third quarter of 2010 to US$0.8 million for the third quarter of 2011. The increase was primarily due to increased professional and other various expenses associated with maintaining the public company status in the United States. As a percentage of revenues, general and administrative expenses increased from 1.2% for the third quarter of 2010 to 1.3% for 2011.

General and administrative expenses increased by US$0.6 million, or 28.7%, from US$2.0 million for the nine months of 2010 to US$2.6 million for the nine months of 2011. The increase was primarily due to increased professional and other various expenses associated with maintaining the public company status in the United States. As a percentage of revenues, general and administrative expenses decreased from 1.5% for the nine months 2010 to 1.4% for the same period of 2011.

Operating Income

As a result of the factors discussed above, our operating income decreased by US$0.3 million, or 9.3%, from US$3.8 million for the third quarter of 2010 to US$3.5 million for the third quarter of 2011. As a percentage of revenues, our operating income decreased from 6.7% for the third quarter of 2010 to 5.3% for 2011.

Our operating income decreased by US$0.3 million, or 2.7%, from US$9.9 million for the nine months of 2010 to US$9.6 million for the nine months of 2011. As a percentage of revenues, our operating income decreased from 7.5% for the nine months of 2010 to 5.6% for the nine months of 2011.

Interest Expense

Interest expense increased by US$73,538, or 22.9%, from US$330,813 for the third quarter of 2010 to US$404,351 for the third quarter of 2011. The increase in interest expense was the result of increase in the level of our loan financing.

Interest expense increased by US$1.1 million or 186.2%, from US$0.6 million for the nine months of 2010 to US$1.7 million for the nine months of 2011. The increase in interest expense was the result of increase in the level of our loan financing.

Provision for Income Taxes

Provision for income taxes increased US$0.2 million, or 29.9%, from US$0.7 million for the third quarter of 2010 to US$0.9 million for the third quarter of 2011.

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