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AMCF > SEC Filings for AMCF > Form 10-Q on 21-Nov-2012All Recent SEC Filings

Show all filings for ANDATEE CHINA MARINE FUEL SERVICES CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for ANDATEE CHINA MARINE FUEL SERVICES CORP


21-Nov-2012

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.

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 subsidiaries, Donggang Xingyuan Marine Bunker Company Ltd., Rongcheng Xinfa Petrol Company Ltd., Rongcheng Mashan Xingyuan Marine Bunker Co. Ltd., Rongcheng Zhuoda Trading Co. Ltd, Suzhou Fusheng Petrol Co. Ltd., Wujiang Xinlang Petrol Co. Ltd, and its previous variable interest entity (VIE), Dalian Xingyuan Marine Bunker Co. Ltd., through which entity we conducted all of our business operations and since we have transferred most of them under the direct control of Dalian Fusheng Petrol Co. Ltd. , and only one subsidiary of the VIE, which is Xiangshan Yongshinanlian 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 Quarterly Report only, excluding Taiwan, Hong Kong and Macau.

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, 2011. 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.

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 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 fuel product 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 Receivables

During the normal course of business, we extend to some of our customers interest-free unsecured credit for an initial term of 30 - 180 days, depending on a customer's credit history, as well as local market practices.

We review our accounts receivables quarterly and determined the amount of allowances, if any, necessary for doubtful accounts. Historically, we have not had any bad debt write-offs. 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.

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 practice. 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 payments.

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 bunker, boiler equipment, laboratory equipment, transportation vehicles and other office equipment, and are depreciated over the estimated useful lives of the assets on a straight-line basis. Intangible assets mainly comprise land use right 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.

Business and Operations Overview

Andatee China Marine Fuel Services Corporation is a Delaware corporation. Our executive offices are located in the City of Shanghai, a key international shipping hub and logistics center in China. Our main offices are located at 800 Baoan Building 23nd Floor, Dongfang Road, Pudong District, Shanghai City, China.

We carry out all of our business through our Hong Kong subsidiary, Goodwill Rich, its wholly-owned Chinese subsidiary, Fusheng, and Fusheng's variable interest entity (VIE), Xingyuan, and Xingyuan's subsidiary (Xingyuan and its subsidiary being collectively referred to as the VIE entities). VIEs are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability. All VIEs with which the Company is involved must be evaluated to determine the primary beneficiary of the risks and rewards of the VIE. The primary beneficiary is required to consolidate the VIE for financial reporting purposes. Through 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 as1#,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.

We sell our products through distributors and 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, Shidao, Tianjin, Wujiang, 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

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 are setting up market developing offices in large cities, such as Shanghai, 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 April 2011, we commenced the construction of Tengda wharf and storage tanks located in Rongcheng City, Shandong Province. The Tengda projects will expand the existing wharf and storage tanks. The capital expenditure for expanding the wharf and tank storage is estimated to be RMB 46 million ($7.4 million). We expect to put it into use by the end of 2012.

In July 2011, we commenced the constructions of new blending facilities in Xinfa in Rongcheng City, Shandong province, which is designed to improve our production capabilities in blending with 20,000 cm tanks on site. The capital expenditure is estimated to be RMB 25 million ($4.0 million). We expect to put it into use by the end of 2012.

Operational Initiatives in 2012

In 2012, 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 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 2012, 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 .

We believe that maintaining our retail sales and distribution channels will lead to stable gross margins which can help offset the pressure imposed on our profit margin by crude oil price downturn. We believe that higher retail sales and closer ties with our customers as well as wider distribution network are at the core of our strength and business viability going forward.

We intend to 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 expand our product line and upgrade our production facilities to explore the markets opportunities and increase our share in retail market.

Principal Factors Affecting our Financial Performance

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

Decreasing demand for blended marine fuel - The decreasing demand for blended marine fuel has a impact on our financial position since the fourth quarter of 2011.

Expansion of our sources of supply, production capacity and sales network -To maintain our market share, 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 oil price volatility had a direct adverse impact on the price we pay for these products.

Results of Operations-Comparison of the three and nine months ended September 30, 2012 and 2011

Revenue

For the three months period, our revenue decreased by $34.2 million, or 52%, from $65.8 million for the third quarter ended September 30, 2011 to $31.5 million for the third quarter ended September 30, 2012.

For the nine months period, our revenue decreased by $33.3 million, or 19%, from $173.2 million for the nine months ended September 30, 2011 to $139.9 million for nine months ended September 30, 2012.

The decrease in our revenues was mainly due to the decreased sales volume. Our overall sales volume decrease by 50,601 tons, or 56%, from 90,134 tons for the third quarter ended September 30, 2011 to 39,533 tons for the third quarter ended September 30, 2012. For the nine months period, our overall sales volume decreased by 25% or 56,588 tons, from 228,529 tons for the nine months period ended September 30, 2011 to 171,941 tons for the nine months period ended September 30, 2012.

The decrease in our revenue was due to the following reasons:

(1) The reduction in our sales volume was primarily due to the overall slow-down of the Chinese economy which had an adverse impact on the demand for fishing and cargo vessel fuel. In addition, during the third quarter of 2012, we did not initiate any sales promotion due to our failed privatization plan. In addition, we had to reduce the selling price of our #3 fuel from RMB 5,072 per ton in the third quarter of 2011 to RMB 4,286 per ton in the third quarter of 2012 due to strong competition from other fueling companies. Furthermore, the seasonal factor impacted our sales revenue to certain extent for our third quarter operating result. The Chinese government prohibits fishing vessels from fishing from June 15th to September 15th of each year, the breeding season for many varieties of fish, in order to protect marine resources and prevent overfishing. As a result, the demand for the blended fuel drops, which, in turn, has an adverse effect on our operations in the 3rd fiscal quarter of each calendar year. The decreased market demand for fishing boat fuel in 2012 further exacerbated this seasonality impact on our revenue for the third quarter of 2012.

(2) Starting late 2011, the CEO of the Company proposed a "going private" transaction due to, among other reasons, adverse market environment affecting all China-based listed company, in which sales promotion was reduced even during the second quarter sales peak. The "going private" effort was abandoned by the CEO of the Company, as previously disclosed.

(3) In addition, due to the global crude oil price fluctuation which impacted the Company's pricing policy, the Company's products such as #2 marine fuel for fishing boat and 120CST fuel for cargo vessels lost their competitive price edge to a certain extent, which led to some customers switching to other competitors. Total fishing boat customers decreased approximately 15% and cargo vessel customers lost 10% as compared to the same period of 2011. Sales from our major geographic market Donggang, Shangdong and Zhejiang decreased about 27%, 83% and 21% respectively.

(4) Under a competitive environment, we reduced the averaging selling price of #2 and #3 fuel product in order to stimulate customer purchase, with the average selling price of #2 fuel decreasing from RMB 6,037 per metric ton in the nine months ended September 30, 2011 to only RMB 3,270 per metric ton in the nine months ended September 30, 2012, while average selling price of #3 fuel decreased from RMB 5,213 per metric ton in the nine months ended September 30, 2011 to only RMB 4,416 per metric ton in the nine months ended September 30, 2012 . The decrease in average selling price also led to decreased sales.

For the nine months ended September 30, 2012, #1 marine fuel represented 16.1% of our sales, #2 marine fuel represented 12.4% of our sales, #3 marine fuel represented 8.6% of our sales, #4 marine fuel represented 51.7% of our sales, 180CST represented 9.3% of our sales and 120CST represented 1.9% of our sales.

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.

Cost of Revenue

Our cost of revenues decreased by $29.0 million, or 48%, from $60.4 million for the third quarter ended September 30, 2011 to $31.5 million for the third quarter ended September 30, 2012 primarily due to decreased sales volume from 90,134 metric ton in third quarter of 2011 to only 39,533 metric tons in third quarter of 2012. For the nine months period, our cost of revenues decreased by $26.0 million, or 16%, from $160.0 million for the nine months ended September 30, 2011 to $134.0 million for the nine months ended September 30, 2012 due to decreased sales volume 228,529 metric ton in 2011 to only 171,941 metric tons in 2012.

The decrease in cost of revenue was primarily due to the following reasons:

(1) Decreased sales activities affected by seasonality, reduced sales promotion, reduced number of customers, decreased market demand for our products affected by the general economy slow-down as described above, and

(2) Our main business is to purchase raw materials and crude oil from upstream suppliers and then blend, manufacture and sell to customers. The purchase price for raw materials and crude oil was largely affected by the global and local crude oil price fluctuation. For the nine months ended September 30, 2012, the global crude oil trading prices reached a high of $109 per barrel in March 2012, and then decreased to $100 per barrel in May, further decreasing to about $80 in the June and July period, and then increased to about $90 per barrel by the end of September 30, 2012. Due to the crude oil price fluctuation, our raw material costs and production costs also fluctuated. Consequently, average unit cost for our products sold was RMB 5,036 per ton for the three months ended September 30, 2012 as compared to RMB 4,301 per ton for the same period of 2011. For the nine months period, our average unit cost per ton was RMB 4,931 for the nine months ended September 30, 2012 as compared to only RMB 4,541 for the same period of 2011. Although the overall cost of sales decreased was affected by the decreased sales, we note that the percent of decrease in our cost of sales was less than the percent of decrease in our revenue, due to increased unit cost of product affected by the global crude price volatility.

Gross Profit

Our gross profit and gross profit margin was affected by several factors, including (1) the gross profit margin of our six major products are different. Fuel #3 and fuel #4 has a higher gross profit margin than other products, and fuel 120CST and fuel 180CST has the lowest margin. Therefore, the sales of different product mix in different reporting period impacted our gross profit
(2) we retail our products to end user and also wholesale side to distributors as well. Gross profit from the retail side is normally higher than the wholesale because we can set the selling price higher and can control the operating costs more easily. Accordingly, an increase or decrease in the retail sales will impact our gross profit to a certain extent. (3) The increase and decrease in the average selling price and average unit cost will also impact our gross margin.

As a result of the increased average unit cost from RMB 4,301 per ton in third quarter of 2011 to RMB 5,036 per ton in third quarter of 2012, and decrease in sales of our high gross margin product, such as fuel #4 within our product mix and decrease in sales from the retail side, our gross profit decreased by $5.2 million, or 99%, to $0.08 million for the third quarter of 2012 as compared to $5.3 million in the third quarter of 2011. As a percentage of revenues, our gross profit margin was 0.02% and 8.1% for the third quarter of 2012 and 2011, respectively.

As a result of the increased average unit cost from RMB 4,541per ton in the nine months ended September 30, 2011 to RMB 4,931 per ton in the same period of 2012, and a decrease in sales of high gross margin products, such as fuel #1 and fuel #4 within our product mix and a decrease in sales from the retail side, our gross profit decreased by $7.3 million, or 55%, from $13.2 million for the nine months ended September 30, 2011 to $5. 9 million for the nine months ended September 30, 2012. As a percentage of revenues, our gross profit margin dropped to 4.2% for the nine months ended September 30, 2012 compared to 7.6% for the nine months ended September 30, 2011.

In summary, the decrease in our gross profit margin during the three and nine months ended September 30, 2012 as compared to the same period of 2011 was primarily due to (i) a decrease in revenue; (ii) increased costs of revenue which were mainly caused by increased raw material cost, (iii) and competition in the market. As a result, our gross profit margin was lower than the level we normally would expect. With the completion of the Company's distribution network setup in Shandong, Jiangsu and Zhejiang, we intend to increase our sales in these regions in the coming quarters to improve our gross profit margin, and we expect to have a margin recovery as the new market gains sales momentum and recovery of macroeconomic conditions in the energy industry. Moreover, we are working on research and development of better formula for blended fuel products to decrease our costs to increase our gross profit margin.

Selling Expenses

Selling expenses decreased by $0.7 million, or 67%, from $1.0 million for the third quarter of 2011 to $0.3 million in the third quarter of 2012. This decrease is mainly due to reduced sales promotion expenses and lease expenses. As a percentage of revenues, selling expenses decreased from 1.5% for the third quarter of 2011 to 1.1% for 2012.

Our selling expenses increased by $0.3 million, or 30%, from $1.0 million for the nine months ended September 30, 2011 to $1.3 million for the nine months ended September 30, 2012. As a percentage of revenues, selling expenses increased from 0.6% for the nine months ended September 30, 2011 to 0.9% for 2012.

General and Administrative Expenses

General and administrative expenses increased by $0.6 million, or 70.0%, from $0.8 million for the third quarter of 2011 to $1.4 million for the third quarter . . .

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