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LLEN > SEC Filings for LLEN > Form 10-K on 30-Jul-2013All Recent SEC Filings

Show all filings for L & L ENERGY, INC.

Form 10-K for L & L ENERGY, INC.


Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of the results of operations and financial condition of the Company should be read in conjunction with the Selected Financial Data, the Company's financial statements, and the notes to those financial statements that are included elsewhere in this Annual Report on Form 10-K. The following discussion includes forward-looking statements that involve numerous risks and uncertainties. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the Risk Factors, Cautionary Notice Regarding Forward-Looking Statements and Business sections in this Annual Report on Form 10-K. We use words such as "anticipate," "estimate," "plan," "project," "continuing," "ongoing," "expect," "believe," "intend," "may," "will," "should," "could," and similar expressions to identify forward-looking statements.

Company Overview

We produce, process, and sell coal in the People's Republic of China ("China" or "PRC "). As of April 30, 2013 our vertically integrated coal operations include five coal mines, two coal washing plants, and three coal wholesale and distribution network in the southwest region of China . For the fiscal year ended April 30, 2013, we produced approximately 763,000 tons in the coal mining operation, washed approximately 470,000 tons of coal in

our coal washing facilities, sold approximately 331,000 tons of coal through our wholesale operation and produced approximately 30,000 tons of coke coal

Currently, substantially all of our coal mining operations are located in the Guizhou and Yunnan provinces. Our operations are located in inland and rural areas of China, which are being developed at a faster rate than the coastal areas that have historically received most of the PRC's government focus. We have funded our business to date primarily through investments from our founder and Chairman, from private placements, from cash flows from operations and from certain debt financings and arrangements.

We conduct our China operations through both wholly- owned subsidiaries and majority interests in other entities.

We derive our revenues from selling coal to customers, State Owned Enterprises (SOE) and private companies in Guangxin, Yunnan and Guizhou Provinces. Our thermal or steam coal is sold to customers that are utilities that generate power, mainly electricity. Our metallurgical and coking coal is sold to customers that make steel, though some steel customers also purchase thermal coal to generate power for their steel factories.

We are a United States company incorporated in Nevada and headquartered in Seattle, WA, Our China headquarters is located in Beijing and we also have China operational centers in Kunming City in Yunnan Province and in Guiyang in Guizhou Province. The majority of our management team and Board of Directors are American citizens, including three of four officers, and many are bilingual. After being a public reporting company since 2001, we commenced trading on the NASDAQ Global Market in February 2010.

Macroeconomic Factors

There were several relevant macro-economic factors directly impacting our operating environment in China during FY 2013, including GDP growth and inflation. In 2012, China's economy expanded 7.8%, down from 9.2% for the previous year. This was largely attributable to a turbulent world economic climate and China's efforts to tame inflation. China's GDP growth fell to 7.7% in the first quarter of 2013 after a 7.9% gain in the fourth quarter of 2012. China's Premier Li Keqiang has lowered expectations to 7.5% for 2013.

At the start of the Company's fiscal year in May 2012, inflation in China was 3.0%, and moved down to a low of 1.8 % in July 2012. After the PRC tightened their fiscal policies, which included letting interest rates rise and capping prices of certain domestically-produced commodities like coal not to exceed last year's prices, inflation fell to 2.4% at the end of the Company's fiscal year in April 2013. As a result, China began our fiscal year with slightly higher demand for coal to fuel GDP growth. At the same time, oversupply of coal from increased cheaper imported coal decreased the unit price of coal during the year.

Coal prices in the United States in 2012 declined due to lower demand caused by heavy competition from an increased supply of shale natural gas, , a large surplus inventory of coal, and the current government's anti-coal policies. Combined with a sluggish market for coal in Europe due to slow economic growth, coal exporters have taken advantage of the arbitrage opportunities between Chinese domestic coal prices and international coal prices. This created a temporary oversupply of coal. As a result, the coal price has decreased for Chinese market in FY 2013. However, we have seen the price of coal stabilize over the winter in 2012. Since June 2013 we have begun to see usual seasonal reduction in coal process during the summer.

While the coastal metropolises have great demand for coal, growth is slow in these large cities. However, growth, and therefore demand, is still high in the secondary cities in non-coastal China (like Kunming in Yunnan Province and Guiyang in Guizhou Province, both where we operate). Due to China's relatively underdeveloped rail system and the government's emphasis on developing passenger rail vs. freight rail, coal-fired electrical power plants in coastal cities have seen an excess of coal supply. This creates an environment where pricing in coastal cities see larger price swings than their non-costal counterparts.

Looking forward, coal will continue to be a key component of the PRC's energy policy. According to the U.S. Energy Information Administration, coal makes up 70% of China's total primary energy consumption and China is both the largest consumer and producer of coal in the world. In 2012, China accounted for over 49.4% of the world's coal consumption. It is estimated that demand for coal in China will continue to increase for several decades, thus producing a favorable business environment for coal producers and wholesalers. Although China has substantial natural coal resources, the coal mining industry in China is fragmented and inefficient, and includes many small companies who lack the economies of scale and resources needed to maximize production capacity. Historically, mining companies in China have been unable to produce enough coal to meet China's growing coal demands. As a result the PRC has allowed China to become a net importer of coal and has implemented a national policy of consolidation to increase production capacity, improve efficiency and safety in coal mines in China. Beginning with the 11th 5 year plan, the policy of government-mandated consolidation has continued with the current 12th 5 year plan, which expands and accelerates the consolidation to new provinces including Guizhou.

General Discussion and Analysis of FY 2013 Results

We began our first quarter in FY 2013 with increased production compared with the results from FY 2012. In FY 2012, we experienced a challenging operating environment due to temporary government-mandated idling of some of our mines as a result of nearby fatal accidents in non-L&L mines. For FY 2013, we continued our momentum from the fourth quarter of FY 2012 by continuing to ramp up production in all of our mines, especially in DaPuAn and WeiShe Mines where production increased substantially. At the same time, our acquisitions of LaShu and LuoZhou Mines helped to accelerate our coal production output as they were able to ramp up their production ahead of schedule. As a result, our mine production went from approximately 336,000 tons in FY 2012 to approximately 763,000 tons in FY 2013.

DaPuAn and SuTsong Mines produced coal at an increasing pace form a combined production of 225,000 tons in FY 2012 to 360,000 tons in FY 2013. DaPing produced 94,000 tons in FY 2013 as compared with 66,000 tons in FY 2012. Ping Yi was spun off in FY 2012 and did not contributed to L&L's mining production in FY 2013 . WeiShe produced in FY 2012 at an annual rate of 12,000 tons and was organically expanded to 143,000 tons in FY 2013. Although we only acquired LaShu and LuoZhou mines on November 18, 2013, both mines were able to ramp up production ahead of schedule and produced a total of 167,000 tons during the months we owned them in FY 2013.

Our coal washing segment revenues increased slightly as we increased production from 434,000 tons in FY 2012 to 474,000 tons in FY 2013. The smaller increase in total tons washed was primarily due to the disposal of the Ping Yi washing facility at the end of FY 2012. Additionally we disposed of our coking segment on November 18, 2012 as part of our acquisition of the Lashu and Louzhou Mines, as a result, our coking segment also had experienced a decrease in production from 93,000 tons in FY 2012 to 35,000 tons in FY 2013. Our wholesale and distribution segment continued to increase substantially from 93,000 tons in FY 2012 to 238,000 tons in FY 2013 due to our increased production, increase in number of contracts with large end users, and availability of coal in the region.

On September 5, 2012, we acquired the existing operations of GuangYeh Coal Sales Company based in Yunan to expand our sales and distribution networks and have access to more customers. On October 2012, we signed an contract to sell 360,000 tons of coal to Datang International Power Co. On May 15, 2013, the amount of coal to be sold under this contract was increased to one million tons per year.

The third quarter of FY 2013, we made two strategic acquisitions of two new coal mines, LaShu and Luozhou in Guizhou Province. As part of the payment for the acquisition, we sold DaPing Mine and ZoneLin Coking Plant. The production ramp up of both LaShu and LuoZhou were ahead of the schedule and thus contributed to our increased coal production. As a result, our overall production for this quarter was increased by 100% as compared with the same period last year.

In the fourth quarter of FY 2013, our Beijing headquarters became fully operational and the company's subsidiary was accepted as member of the China National Coal Association. In April 2013, the Company also engaged KPMG (Taiwan) to review and audit the Company's financial statements for the past two years in order to assist the Company to explore the potential of Taiwan Depositary Receipt ("TDR"). Except during the Chinese New Year holiday which fell in this quarter, all of the five mines were operating at or near full capacity for a total of 197,000 tons, a substantial increase from 108,000 tons in the same period last year. The unit price for our coal was also stabilized for three consecutive quarters. During this quarter, our wholesale business increased to 70,000 tons from 22,000 tons during during the same period last year as we started to ship to Datang International Power Group, although our unit price decreased significantly from previous quarters due to competition and excessive supply of coal.

Plan of Operations

The Company is a vertically integrated coal operator participating in the business of consolidation of a fragmented coal industry in Yunnan and Guizhou Provinces of southwest China. As of April 22, 2013, the Company opened an office in China's capital city of Beijing, and subsequently relocated its headquarters to Beijing. We are in the process of looking into further expansion into North China. We plan to expand our coal business two ways: first, through expansion of existing operations in accordance with the growth policy, and second, through continued acquisitions of operations that lack the capital and management skills to expand to meet the minimum capacity required by the government. The growth policy includes portfolio improvements to reduce mining risks and to improve
(coal) energy to reduce emissions. Additional plans for expanding our coal business includes expanding our coal wholesale operations, pursuing strategic partnerships, exploring viable options for raising capital with an emphasis on debt and other non-dilutive instruments, and strengthening our management and technical team. L&L will also look to develop strategic partnerships with energy (coal) busyers and develop possible new energy projects, where L&L can leverage US technology and resources.

Organic Growth.

All five of our mines are producing coal at or close to full capacity. We expect to further expand our production as the five mines are continuing to expand each of their production capacities.

The WeiShe mine was acquired in February of 2012 and was able to ramp up near its approved capacity of 150,000 tons per year, producing 142,915 tons during FY 2013. The Company has begun Weishe's expansion to 400,000 tons of annual capacity. LaShu and Luozhou were acquired in November 2012 and have ramped up at a faster pace. LuoZhou produced 93,379 tons of coal during last six months of FY 2013 against its approved capacity of 150,000 tons per year. LaShu produced 73,201 tons of coal during the last six months of FY 2013 against its approved capacity of 300,000 tons annually. We expect to expand all three of these Guizhou mines (WeiShe, LaShu and LuoZhou) to produce over 1.2 million tons in the next few years (Luozhou 450,000, Lashu 300,000 and Weishe 450,000), well ahead of the 2015 deadline for consolidation in the province. We plan to expand the production capacity for each of the two mines DaPuAn and SuTsong in Yunan to 300,000 tons. This would bring our total targeted production to 1.8 million tons.

We acquired producing mines that lack capital and/or management expertise to expand to meet the minimum government-mandated production requirement, and we are able to provide the resources to expand production capacity and improve safety. Most coal mines in Southwest China, including our mines before upgrading, use the conventional/traditional mining method. Since the acquisition of our mines, the Company has invested substantially in mine infrastructure, which allows us to increase the productivity and safety of our mines. The Company had invested in tunnel construction, shafts, transportation system and roads, pumps, ventilation system, walls, storage facilities, dorms and other types of infrastructure. The investment in tunnel construction and shaft allow the Company to dig coal from new areas in a safer environment to increase the production capacity. The investment in transportation systems allows the Company to get coal from ground with shorter turnaround time and at a larger capacity. We have also installed additional shafts in some of our mines to increase safety, operational efficiency, and improve the working environment. Two of our mines continue to use timber to reinforce mine shafts. We have improved safety by using steel and hydraulic braces to reinforce the support the roof of the mine. Our newest mines use roof bolts which are safer and will allow greater mechanization in the future. We have also invested in monitoring equipment for hazardous gases like methane, better electrical equipment, communication systems, GPS locators for each underground miner, and blowers and better ventilation systems to ensure safe air quality. The Company also seeks to acquire larger mines, as mines designed with larger production capacities have become available on the market recently due to consolidation policy requirement that all mines join under a holding company that controls 800,000 to 2,000,000 tons of annual production.

In addition to infrastructure improvement, we also improve our production and safety through introducing basic management practices such as expanding from single shift to multiple shift operating teams, and including production incentives and bonuses in our team's compensation package. Our mine operations have instituted regular safety training for both mine management and workers, regular sharing of safety information, and individual shift safety briefings and debriefings at the start and end of each shift. Because slogans are effective in impacting Chinese behavior, safety banners are posted for easy viewing. We comply with and try to exceed all the safety standards and cooperate fully with local, provincial, and national government safety regulators and safety supervision teams. There have been no fatal accidents in any of our mines.

This has resulted in the successful integration and safe expansion of the five mines we have acquired and continued expansion of production capacity to meet the current government-mandated minimum annual production requirement.

The Company continues to expand the capacity and improve the safety of our mines. According to Chinese government regulation, a coal mine can produce up to the production capacity set forth in the mining production permit. However, depending on the market demand for coal, especially during the high demand season in the winter, the local government does allow coal mines to produce more than the production capacity that year or use the unused capacity from previous years without giving specific written approval. It has become a common practice that the actual production can vary from the authorized production limit. A new permit must be obtained if the total mine production exceed the total approved tonnage for the life of the mine.

The Company constructed the DaPuAn coal washing plant to enhance the value of the coal mined at DaPuAn mine. In addition, the Company expanded the capacity of our coal washing facilities, in particular Hong Xing, which washes other mines' coal. L&L is exploring partnerships to jointly develop coal washing facilities including prepaid coal washing services for the Company, which will ensure additional washing capacity for the Company's coal preparation facilities in South China.

Acquisitive Growth.

In addition to a rapid organic growth in the next several years, we expect continued opportunities to acquire mines and other operations. We believe that the current government-mandated consolidation policy in China will continue and thus create more acquisition opportunities for us. Strategically, the Company aims to accelerate the rate of acquisition and increase the size of acquiring mines in North China.

Our acquisition and inspection team consists of business, operational, financial, and renowned coal experts. Two of the members are Dr. Syd Peng and Mr. Jingcai Yang, independent directors of the Company. Dr. Peng is a distinguished professor of mining engineering at the West Virginia University (WVU), specializing in underground mining technologies. After earning his PhD in Mining Engineering from Stanford University in 1970, Dr. Peng spent his entire career in mining including work for the U.S. Bureau of Mines and the faculty of WVU where he served as Chairman of the Department of Mining Engineering. He is a member of the National Academy of Engineering and is the recipient of numerous professional awards. Mr. Yang is a well-known leader in the coal industry of China. He has over 30 years of experience, 16 of those spent with Shenhua, the largest coal company in the world. Mr. Yang was formerly the Chief Engineer of Shenhua before being promoted to Chairman & CEO of Shandong Coal Corporation, the largest and most profitable Shenhua subsidiary, where he held full P&L responsibility.

Originally, our standard criteria include existing mines in production with good infrastructure and sufficient reserves but lacking the capital and management to expand to or beyond the current minimum of 300,000 tons per year. Because the consolidation policy requires that all mines must be consolidated into a holding company that have a total coal production capacity of between 800,000 tons and 2,000,000 tons, depending on the county in Guizhou province where the mines are located, we have begun targeting larger mines with production near 300,000 tons or more, better geology, and strong management teams for acquisition. Mines with these characteristics are on the market more frequently than in the past due to the government consolidation policy.

We acquired three mines from Union Energy that met those criteria, Weishe, LaShu and Luozhou mines. Their production capacity is currently approximately 150,000, 300,000 and 150,000 tons per year, respectively and will be expanding to over 1.2 million tons collectively. We expect other opportunities will arise in Guizhou as the deadline approaches. We will also look at opportunities to buy mines in North China which have already undergone consolidation and are running at the capacity of approximately one million tons or more per year.


In addition to acquiring mines, the Company established a new coal wholesale operation DaXing L&L Coal Company. With approval from the government, DaXing has begun developing additional coal storage space and growing its distribution network. Our DaXing subsidiary had handled over 90,000 tons of raw coal sales during FY 2013. Through its sourcing of coal, it introduces potential mine acquisitions to the Company in a similar manner as KMC did for the Company in Yunnan. DaXing is actively looking for and entering into a joint sales agreement with strategic partners.

The Company will continue to recruit talented professionals to strengthen our team at the board, officer, and management level. Our board is composed mostly of independent directors who are predominately U.S. citizens. We successfully recruited a world renowned expert in coal mining who had chaired the Department of Mine Engineering at West Virginia University and a former senior executive with the largest coal company in the world. Officers include the founder of the Company, a Chief Financial Officer who was a partner with Ernst &Young, two former senior White House staffers. One of whom is also the former Director of the United States Mint. We have recruited key managers to augment our legal, accounting, and operations departments in both the United States and China, of whom many were trained in the United States and have advanced degrees in business.

The Company's immediate mission is to become a leading coal energy company in coal-rich Yunnan and Guizhou Provinces. To meet the government-mandated production targets for each holding company in Guizhou, we believe that the Company's production capacity will be increased to between 1,000,000 and 2,000,000 tons per year by the end of 2013. Production could be much higher with additional acquisitions.

Discussion of Critical Accounting Policies and Estimates

Our financial statements are prepared in accordance with accounting principles that are generally accepted in the United States of America ("U.S. GAAP"). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities. Management evaluates its estimates on an on-going basis. Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable under the circumstances. Actual results may differ from the estimates used. Our actual results have generally not differed materially from our estimates. However, we monitor such differences and, in the event that actual results are significantly different from those estimated, we disclose any related impact on our results of operations, financial position and cash flows. Note [2] to our audited consolidated financial statements included in Item 15 of this Annual Report on Form 10-K provides a description of our significant accounting policies. We believe that of these significant accounting policies, the following involve a higher degree of judgment or complexity:

Use of Estimates - The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base these estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from management's estimates.

Estimate of recoverable coal reserves. The Company capitalizes its mineral rights at fair value when acquired, including amounts associated with any value beyond reserves, and amortized to operations as depletion expense using the units-of-production method over the estimated recoverable coal. The recoverable reserves are based on estimates prepared using Chinese government standards and reflect the amount the Company is permitted to recover as per production permits and not necessarily the amount that is recoverable from the mine in general.

Estimate of Impairment of Long-Lived Assets - The Company applies the provisions of ASC Topic 360, "Property, Plant, and Equipment," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The Company evaluates the recoverability of its long-lived assets if circumstances indicate impairment may have occurred. This analysis is performed by comparing the respective carrying values of the assets to the current and expected future cash flows, on an undiscounted basis, to be generated from such assets. ASC 360 requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts. In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair value of the long-lived assets. Loss on long-lived assets to be disposed of is determined in a similar manner, except that fair values are reduced for the cost of disposal. Based on its review, the Company believes that as of April 30, 2013 and 2012, there was no impairment of its long-lived assets.

Estimate of Impairment of Intangibles - The Company applies Accounting Standards Codification ("ASC") Topic 350, Intangibles - Goodwill and Other Intangible Assets, to record goodwill and intangible assets. In accordance with ASC 350, certain intangible assets are to be assessed periodically for impairment using fair value measurement techniques. Goodwill is tested for impairment on an annual basis as of the end of the Company's fiscal year, or more frequently when impairment indicators arise. The Company evaluates the recoverability of intangible assets periodically and takes into account events and circumstances which indicate that impairment exists. The Company believes that as of April 30, 2013 and 2012, there was no impairment of its goodwill.

Estimate of Fair Value Measurements - For certain of the Company's financial instruments, including cash and cash equivalents, accounts receivable, other receivable, accounts payable and other payables, the carrying amounts approximate their fair values due to their short maturities. In addition, the Company has long-term debt with financial institutions. The carrying amounts of the line of credit and other long-term liabilities approximate their fair values based on current rates of interest for instruments with similar characteristics.

ASC Topic 820, "Fair Value Measurements and Disclosures," requires disclosure of . . .

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