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HGSH > SEC Filings for HGSH > Form 10-K on 13-Dec-2013All Recent SEC Filings

Show all filings for CHINA HGS REAL ESTATE INC.

Form 10-K for CHINA HGS REAL ESTATE INC.


13-Dec-2013

Annual Report


Item 7. Management's Discussion And Analysis of Financial Conditions And Results Of Operations.

The following discussion and analysis of financial condition and results of operations relates to the operations and financial condition reported in the financial statements of China HGS Real Estate Inc. for the fiscal years ended September 30, 2013 and 2012 and should be read in conjunction with such financial statements and related notes included in this report.

As used in this report, the terms "Company," "we," "our," "us" and "HGS" refer to China HGS Real Estate, Inc. and its subsidiaries.

Preliminary Note Regarding Forward-Looking Statements.

We make forward-looking statements in Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report based on the beliefs and assumptions of our management and on information currently available to us. Forward-looking statements include information about our possible or assumed future results of operations which follow under the headings "Business and Overview," "Liquidity and Capital Resources," and other statements throughout this report preceded by, followed by or that include the words "believes," "expects," "anticipates," "intends," "plans," "estimates" or similar expressions.

Forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed in these forward-looking statements, including the risks and uncertainties described below and other factors we describe from time to time in our periodic filings with the U.S. Securities and Exchange Commission (the "SEC"). We therefore caution you not to rely unduly on any forward-looking statements. The forward-looking statements in this report speak only as of the date of this report, and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise. These forward-looking statements include, among other things, statements relating to:

our ability to sustain our project development

our ability to obtain additional land use rights at favorable prices;

the market for real estate in Tier 3 and 4 cities and counties;

our ability to obtain additional capital in future years to fund our planned expansion; or

economic, political, regulatory, legal and foreign exchange risks associated with our operations.

Our Business Overview

We conduct substantially all of our business through Shaanxi Guangsha Investment and Development Group Co., Ltd, in Hanzhong, Shaanxi Province. Since the initiation of our business, we have been focused on expanding our business in certain Tier 3 and Tier 4 cities and counties in China.

The real estate market in China plodded forward amid increasingly restrictive policies starting in 2011. On March 1, 2013, China's State Council announced five general curbing principles to regulate the real estate market, including new initiatives aimed at streamlining the work responsibility system for property prices, controlling speculative property investments, increasing commodity housing and land supply, stepping up construction of affordable housing, as well as tightening controls of the market. The detailed measures include a 20 percent tax on profits from selling a home, a capital gains tax that is on the books but has not been widely enforced. Additionally, down payments and mortgage rates would be increased for second homes in certain cities. Cities and local governments were instructed to institute "property control targets and detailed implementation plans" by the end of March 2013. The State Council pointed out that China is in the progress of rapid urbanization and housing supply in major cities will not be able to meet demands in the short term. The State Council will maintain its control on speculative property investment and make efforts to meet the demands of home buyers.

The introduction of the cooling measures such as the "National Five" regulations has by far caused a temporary halt in land and property price appreciation. With uncertainties in the PRC government's credit tightening policies, the market for real estate sales in 2013 remained challenging. While the government's broad policy direction is likely to remain unchanged and the restrictive real estate policies have created a "wait-and-see" mentality among real estate buyers, the cumulative downward price adjustment has triggered the partial release of demand, creating a rise in transaction volumes in the 2013. Developers generally have been reducing inventory by adopting more aggressive sales tactics.

For fiscal 2013, our sales volume significantly increased compared to last year. Our total revenue, gross profit and net income for fiscal 2013 were $67,809,073, $26,280,341 and $20,791,565, respectively, representing an approximately 260%, 225% and 302% increase from last year, respectively

In the course of preparing the Company's consolidated financial statements for the year ended September 30, 2013, the Company reviewed its revenue recognition policy with regard to its large high rise residential projects. Upon further research of ASC 360-20-40D "Sale of Condominium Units", the Company concluded to adopt the percentage of completion method to account for real estate sales from these large high rise residential projects with construction periods over 18 -24 months.

We completed and started delivery of 3 new residential buildings with total GFA of 35,749 square meters, compared to 4 new residential buildings with GFA of 64,141 square meters completed in fiscal 2012. Since the end of fiscal 2012, the Company has been focusing on developing large high rise residential projects, including Mingzhu Garden - Mingzhu Beiyuan project, Oriental Garden project and certain high rise buildings in Yangzhou Pearl Garden project. The individual residential building in these projects are generally over 20 stories. The construction period for these real estate projects are over 18-24 months. As of September 30, 2013, all these large high rise residential projects are still under construction. In the past, the Company's real estate projects were multi-layer apartment buildings and sub-high-rise apartment buildings, which are generally less than 11 stories and the related construction took around 12 months. If the Company continues to applying full accrual method to account for sales from these large high rise real estate projects, the Company's revenue will show significant fluctuation in the next 2-3 years.

Total revenue recognized under the percentage of completion method for fiscal 2013 was $27,535,834 (2012- $Nil), representing 41% of total revenue for fiscal 2013, the related cost of these real estate sales for fiscal 2013 of $17,803,039 (2012-$Nil), representing 48% of total cost of real estate cost in fiscal 2013, the gross margin from the percentage of completion method was $9,732,795(2012-$Nil), representing 35% of total gross profit for fiscal 2013. The adoption of percentage of completion does not have any impact on the Company's historical annual consolidated financial statements, because the Company just started development of these large high rise residential projects at the end of fiscal 2012 and did not report any revenue from these projects.

The housing prices in Tier 3 and Tier 4 cities and counties are stable from last year. While short-term market correction is a process that the property sector is bound to undergo, the fundamental demand for residential housing will remain given the rising per capita income, accelerating urbanization and increasing demand for better living environment. For fiscal 2013, our average selling price
("ASP") for real estate completed projects (excluding sales of parking spaces)
located in Yang County was approximately $441 per square meter, a slight increase from the ASP of $417 per square meter for the year ended September 30, 2012. The ASP of our Hanzhong real estate projects (excluding sales of parking spaces) was approximately $703 per square meter, a slight decrease from the ASP of $754 per square meter for the year ended September 30, 2012 because more residential units were sold in fiscal 2013. The ASP for the completed real estate projects in Hanzhong and Yang County did not have significant fluctuations in fiscal 2013 and 2012.

Market Outlook

Looking ahead to the short to medium term, the overall property market is likely to be more active, but the rebound in property transaction volumes and prices would tend to be more moderate and rational, as the regulators continue to closely monitor the real estate market and make it more controllable. On the other hand, in addition to the cut in sales price during the difficult time in 2012, further squeezing in sector profitability may be expected. The real estate market is likely to undergo further product refinement and diversification, both geographically and in terms of product type.

The Government's tightening policies should continue in 2014, which may make real estate developers face more difficulties in obtaining land use rights and bank loans. These governmental policies will also negatively affect buyers' confidence and consumption psychology. Meanwhile, with affordable housing construction still underway, it takes time for abundant affordable housing to appear in the market. The Company therefore expects the purchase restrictions and price ceiling policies to continue, which however, should have less impact on the Company's products comparing to the real estate market in Tier 1 and Tier 2 cities. Our customers have a constant growth in their disposable income. With lower housing price to family disposable income ratio and increasing urbanization level, there is a growing demand for high quality residential housing. The Company expects to continuously focus on developing real estate properties in prime locations of Tier 3 and Tier 4 cities and counties. In this perspective, the Company is positive about the outlook for the local real estate market, as end-user demand stemming from rising disposable income and ongoing urbanization stays robust.

We intend to remain focused on our existing construction projects in Hanzhong city and Yang County, deepen our institutional sales network, enhance our cost and operational synergies and improve cash flows and strengthen our balance sheet. In this respect, in late of fiscal 2012, we began the construction of the following large high rise residential projects in Hanzhong city and Yang County:

Oriental Pearl Garden

The project is located in downtown of Hanzhong City. It consists of 1 multi-layer residential building and 12 high-rise residential buildings with commercial shops on the first and second floors with an estimated GFA of 278,373 square meters. The Company started construction in the third quarter of fiscal 2012 and expects to complete the whole construction in 1-1.5 years. The pre-sale license was obtained in November 2013.

Mingzhu Beiyuan

The project is located in the south west part of Hanzhong City. It includes 17 high-rise residential buildings with an estimated GFA of 355,321 square meters. The Company started construction in the third quarter of fiscal 2012 and expect to complete the whole construction in 1-1.5 years. The pre-sale license was obtained in April 2013.

Yangzhou Pearl Garden

The Company is currently constructing 5 high-rise residential buildings and 1 multi-layer residential building with total GFA of 64,854 square meters in Yangzhou Pearl Garden located in Yang County. The related pre-sales licenses were obtained in February 2013. The construction is expected to be completed in 1-1.5 years.

Yangzhou Palace

The Company is currently constructing 9 high-rise residential buildings and 16 sub-high-rise residential and multi-layer residential buildings with total GFA of 285,244 square meters in Yangzhou Palace located in Yang County. The construction started in the fourth quarter of fiscal 2013. The related pre-sales license is expected to be obtained in later half of fiscal 2014. The construction is expected to be completed in 2-3 years.

Road Construction

In addition to the above residential projects, the Company was approved by Hanzhong local government to construct two municipal roads with a total length of 1,064.09 meters. The budget for these two municipal roads was approximately $3 million and was approved by Hanzhong Ministry of Finance. The related construction was substantially completed as of September 30, 2013. A further extension on these road construction projects was under discussion between the Company and the Hanzhong local government, and therefore, these two roads have not been delivered to the local government as of September 30, 2013. For these construction projects, the Company recognizes the fee as other revenue using the full accrual method when the project is completed.

We expect these initiatives will help us cope with this difficult period and better position us to capitalize on opportunities from a future market upturn.

Summary of real estate projects completion status

                                       Actual ( estimated)
                                        Completion time of        Estimated time to sell of
                                           construction                 the property

Development completed
Hanzhong City Mingzhu Garden             Majority was completed
(Mingzhu Nanyuan & Mingzhu                           during the
Beiyuan)                           third quarter of fiscal 2012                   2014-2015
                                    Phase one completed in 2010
Hanzhong City Nan Dajie (Mingzhu                            and
Xinju)                              Phase two completed in 2011                        2014
Yang County Yangzhou Pearl           Majority completed in 2011
Garden                                                 and 2012                   2014-2015
Hanzhong City Central Plaza             Completed prior to 2010                        2014



Under development:                        Estimated Completion time of construction
Hanzhong City Oriental Pearl Garden                  To be completed in 1-1.5 years
Hanzhong City Mingzhu Garden
(Mingzhu Nanyuan & Mingzhu Beiyuan)                  To be completed in 1-1.5 years
Yang County Yangzhou Pearl Garden                    To be completed in 1-1.5 years
Yang County Yangzhou Palace                             To be completed in 2-3 year
Shijin Project                                                 Under planning stage
                                               To be completed and delivered during
Hanzhong City Mingzhu Road West                                         fiscal 2014
                                               To be completed and delivered during
Hanzhong City Liuhou Road                                               fiscal 2014

RESULTS OF OPERATIONS

Revenues

The following is a breakdown of revenue for the years ended September 30, 2013
and 2012:

                                                              For the year ended September 30,
                                                                 2013                 2012
Revenue recognized under full accrual method               $      40,273,239    $      18,856,978
Revenue recognized under percentage of completion method   $      27,535,834    $               -
Total                                                      $      67,809,073    $      18,856,978

Adoption of percentage of completion revenue recognition method

Since the end of fiscal 2012, the Company has been focusing on developing large high rise residential projects, including Mingzhu Garden - Mingzhu Beiyuan project, Oriental Garden project and certain high rise buildings in Yangzhou Pearl Garden project. The individual residential buildings in these projects are generally over 20 stories. The construction period for these real estate projects are over 18-24 months. As of September 30, 2013, all these large high rise residential projects were still under construction. In the past, the Company's real estate projects were multi-layer apartment buildings and sub-high-rise apartment buildings, which are generally less than 11 stories and the related construction takes around 12 months. If the Company continues to applying full accrual method to account for sales from these large high rise real estate projects, the Company's revenue will show significant fluctuation in the next 2-3 years.

In the course of preparing the Company's consolidated financial statements for the year ended September 30, 2013, the Company reviewed its revenue recognition policy with regard to these large high rise residential projects. Upon further research of ASC 360-20-40D "Sale of Condominium Units", the Company concluded to adopt the percentage of completion method to account for real estate sales from these large high rise residential projects with construction periods over 18 -24 months.

The adoption of percentage of completion method does not have any impact on the Company's historical annual consolidated financial statements, because the Company just started development of these large high rise residential projects at the end of fiscal 2012 and did not report any revenue from these projects in the past.

Percentage of Completion method

Real estate sales for our long term real estate projects are recognized under percentage completion method in accordance with the provisions of ASC 360-20-40D "Sale of Condominium Units". Revenue and profit from the sales of long term development properties is recognized by the percentage of completion method on the sale of individual units when all the following criteria are met:

a. Construction is beyond a preliminary stage.
b. The buyer is committed to the extent of being unable to require a refund except for non-delivery of the unit or interest.
c. Sufficient units have already been sold to assure that the entire property will not revert to rental property.
d. Sales prices are collectible.
e. Aggregate sales proceeds and costs can be reasonably estimated.

If any of the above criteria is not met, proceeds shall be accounted for as deposits until the criteria are met.

Under the percentage of completion method, revenues from condominium units sold and related costs are recognized over the course of the construction period, based on the completion progress of a project. In relation to any project, revenue is determined by calculating the ratio of incurred costs, including land use rights costs and construction costs, to total estimated costs and applying that ratio to the contracted sales amounts. Cost of sales is recognized by determining the ratio of contracted sales during the period to total estimated sales value, and applying that ratio to the incurred costs. Current period amounts are calculated based on the difference between the life-to-date project totals and the previously recognized amounts.

Revenue recognized to date in excess of amounts received from customers is classified as current assets under cost and earnings in excess of billings, whose balance is $2,178,270 as of September 30, 2013 ( 2012- $Nil). Amounts received from customers in excess of revenue recognized to date are classified as current liabilities under billings in excess of cost and earnings, whose balance is $5,109,758 as of September 30, 2013 ( 2012-$Nil).

Any changes in significant judgments and/or estimates used in determining construction and development revenue could significantly change the timing or amount of construction and development revenue recognized. Changes in total estimated project costs or losses, if any, are recognized in the period in which they are determined.

Full accrual method

Revenue from the sales of short term development properties, where the construction period is expected to be 18 months or less is recognized by the full accrual method at the time of the closing of an individual unit sale. This occurs when title to or possession of the property is transferred to the buyer. A sale is not considered consummated until (a) the parties are bound by the terms of a contract, (b) all consideration has been exchanged, (c) any permanent financing for which the seller is responsible has been arranged, (d) all conditions precedent to closing have been performed, (e) the seller does not have substantial continuing involvement with the property, and (f) the usual risks and rewards of ownership have been transferred to the buyer. Further, the buyer's initial and continuing investment is adequate to demonstrate a commitment to pay for the property.

The Company provides "mortgage loan guarantees" only with respect to buyers who make down-payments of 30%-50% of the total purchase price of the property. The period of the mortgage loan guarantee begins on the date the bank approves the buyer's mortgage and we receive the loan proceeds in our bank account and ends on the date the "Certificate of Ownership" evidencing that title to the property has been transferred to the buyer. The procedures to obtain the Certificate of Ownership take six to twelve months (the "Mortgage Loan Guarantee Period"). If, after investigation of the buyer's income and other relevant factors, the bank decides not to grant the mortgage loan, our mortgage-loan based sales contract terminates and there will be no guarantee obligation. If, during the Mortgage Loan Guarantee Period, the buyer defaults on his or her monthly mortgage payment for three consecutive months, we are required to refund the loan proceeds back to the bank, although we have the right to keep the customer's deposit and resell the property to a third party. Once the Certificate of Property has been issued by the relevant government authority, our loan guarantee terminates. If the buyer then defaults on his or her mortgage loan, the bank has the right to take the property back and sell it and use the proceeds to pay off the loan. The Company is not liable for any shortfall that the bank may incur in this event. To date, no buyer has defaulted on his or her mortgage payments during the Mortgage Loan Guarantee Period and the Company has not had to refund any loan proceeds pursuant to its mortgage loan guarantees.

For municipal road construction projects, fees are generally recognized by the full accrual method at the time of the projects are completed.

Revenue recognized under full accrual method

The following table summarizes revenue recognized under full accrual method from sales of completed real estate projects for the years ended September 30, 2013 and 2012, respectively:

                                                    For the Years Ended September 30,
                                    2013                          2012                                 Variance
                             Revenue          %            Revenue          %           Variance          %
Projects
Yangzhou Pearl Garden     $  19,896,650        49.4 %   $  15,067,820        79.9 %   $   4,828,830         32.0 %
Mingzhu Xinju                 5,832,713        14.5 %         704,150         3.7 %       5,128,563        728.3 %
Mingzhu Garden (Nanyuan
and Beiyuan)                 14,543,876        36.1 %       3,063,875        16.3 %      11,480,001        374.7 %
Central Plaza                         -           -            21,133         0.1 %        (21,133)        (100) %
Total Revenue             $  40,273,239         100 %      18,856,978   $     100 %   $  21,416,261        113.6 %
Sales Tax                   (2,483,235)                   (1,180,437)                   (1,302,798)        110.4 %
Revenue net of sales
tax                       $  37,790,004                 $  17,676,541                    20,113,463        113.8 %

The revenues are derived from the sale of the completed residential buildings, commercial front-stores and parking spaces in projects. Revenues before sales tax increased by 113.6% to approximately $40.3 million for the year ended September 30, 2013 from approximately $18.9 million in the last year. The total GFA sold and delivered during fiscal 2013 was 72,811 square meters, representing an increase of 80.2% from 40,397 square meters completed and sold for fiscal 2012. The ASP for fiscal 2013 approximately amounted to $553 per square meter, increasing by 18.4% from the ASP of $467 per square meter in fiscal 2012 due to more commercial units being sold in fiscal 2013.

A significant portion of revenue for fiscal 2013 was from the sales of commercial units in NanDajie Project (Mingzhu Xinju) project. On October 23, 2012, the Company entered into a sales agreement to sell the remaining commercial units in Nan Dajie (Mingzhu Xinju) project with a total GFA of 4,545.88 square meters located in Hanzhong City for a total contract amount of $5,441,450 (RMB33,911,426). The purchaser is related to one of the Company's concrete suppliers for our Hanzhong City Oriental Pearl Garden project and Mingzhu Beiyuan project. The purchaser's payments are guaranteed by third parties. The ownership certificate of the related property was issued to the purchaser on November 22, 2012.

Sales taxes for the years ended September 30, 2013 and 2012 consisted of a business tax, 5% of the revenue, an urban construction tax, 7% of business tax, an education surcharge tax, 3% of business tax, and land appreciation tax. Land appreciation tax for the years ended September 30, 2013 and 2012 was assessed at the rate of 0.5% of the customer deposits in Yang County and 1% of the customer deposits in Hanzhong. The sales taxes for fiscal 2013 increased by 110.4% from last year, primarily as a result of the increase in our revenue.

Revenue recognized under percentage completion method

                                                              For the year ended September 30, 2013
                                                                                                      Accumulated
                                                                                      Revenue           Revenue
                                                                                    Recognized        recognized
                                                   Average          Qualified          under             under
                                                Percentage of        Contract      Percentage of     Percentage of
                                   Total GFA    Completion(1)        Sales(2)       Completion        completion
Real estate properties under
development located in Hanzhong
Mingzhu Garden - Mingzhu Beiyuan      355,321              59 %   $ 40,650,179   $    23,671,745   $    23,617,745
Real estate properties under
development located in Yang
County
Yangzhou Pearl Garden                  64,854              57 %   $  6,784,363   $     3,864,089         3,864,089
Total                                 420,175                       47,434,542        27,535,834        27,535,834

(1) Percentage of Completion is calculated by dividing total costs incurred by total estimated costs for the relevant buildings in the each real estate building , estimated as of the time of preparation of our financial statements as of and for the year indicated.

(2) Qualified contract sales only include all contract sales with customer deposits balance as of September 30, 2013 equal or greater than 30% of contract sales amount and related individual of buildings were sold over 20%.

For Mingzhu Garden Mingzhu Beiyua real estate property under development, the total contract sales as of September 30, 2013 was $57,487,864. Total GFA sold under the contract sales was 103,309 square meters. The average unit price was $ 557 per square meters. For the purpose of percentage of completion calculation, the qualified contract sales amount was $40,650,179 for the year ended September 30, 2013 (2012- $Nil).

For Yangzhou Pearl Garden real estate property under development, the total contract sales as of September 30, 2013 was $7,059,729. Total GFA sold under the contract sales was 16,636 square meters. The average unit price was $424 per . . .

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