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LLEN > SEC Filings for LLEN > Form 10-Q on 13-Dec-2013All Recent SEC Filings

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


13-Dec-2013

Quarterly Report


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

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements. All forward-looking statements are inherently uncertain as they are based on current expectations and assumptions concerning future events or future performance of theCompany. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. Forward-looking statements usually contain the words "estimate," "anticipate," "believe," "expect," or similar expressions, and are subject to numerous known and unknown risks and uncertainties. In evaluating such statements, prospective investors should carefully review various risks and uncertainties identified in this Report, including the matters set forth under the captions "Risk Factors" and in the Company's other filings with the U.S. Securities and Exchange Commission ("SEC"). These risks and uncertainties could cause the Company's actual results to differ materially from those indicated in the forward-looking statements. The Company undertakes no obligation to update or publicly announce revisions to any forward-looking statements to reflect future events or developments.

Although forward-looking statements in this Quarterly Report on Form 10-Q 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. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the heading "Risk Factors" in Item 1A, as well as those discussed elsewhere in this Quarterly Report. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report. We file reports with the SEC. You can read and copy any materials we file with the SEC at the SEC's Public Reference Room, 100 F. Street, NE, Washington, D.C. 20549 on official business days during the hours of 10 a.m. to 3 p.m. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including the Company.

We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Quarterly Report. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this Quarterly Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

When we use the terms "we," "us," "our," "L & L," and "the Company," we mean L & L ENERGY, INC. a Nevada corporation, and its subsidiaries.


Overview

We produce, process, and sell coal in the People's Republic of China ("China" or "PRC"). As of October 31, 2013 our vertically integrated coal operations include five coal mines two coal washing plants, and coal wholesale and distribution networks in the southwest region of China. Hong Xing Coal Washing Factory, one of our two coal washing plants, is currently idled pending the renovation of its coal washing equipment. 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 sell the coal we produce, or acquire through wholesalers; both though direct sales to end users in China and through other wholesalers.

We were initially founded in 1995 by an American citizen and current Chairman and CEO Dickson Lee and originally focused on consulting services. In 2001 we became a public reporting company and in 2004 acquired a majority interest in a coal related air compressor equipment company ("LEK") located in China, we disposed of LEK in 2009 in order to focus on growing our coal businesses. In 2006 we commenced our coal operations which now constitute our principal operating business. 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 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 Yunnan, Guizhou and Guangxi Provinces. Most of our thermal or steam coal is sold to SOEs utilities companies that generate power, mainly electricity. Most of our metallurgical coal and coking coal is sold to SOEs that make steel, though some steelmaker customers also purchase thermal coal to generate power for the steel factories.

We are a United States company incorporated in Nevada and headquartered in Seattle, WA. We have our China headquarter in Beijing and have China operations 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 and many are bilingual. As 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 fiscal year 2013, including GDP growth and inflation. In 2012, China's GDP growth was 7.8%, down from 9.2% and 10.4% in 2011 and 2010 respectively. This was largely attributable to a turbulent world economic climate and China's efforts to tame inflation.

In the middle of November 2012, China completed its 18th National Congress for its once a decade leadership transition. The new leaders have conveyed plans to boost the economic growth in an orderly manner for the coming years.

At the start of the Company's prior fiscal year in May 2012, inflation in China was 3.0%, down from a recent high of 6.5% in July 2011. After the PRC tightened its fiscal policies, which included letting interest rates rise and capping prices of certain domestically-produced commodities like coal, inflation fell to 2.7% at the end of the Company's first quarter ended July 31, 2013.Since then the rate has increased up to 3.2 in October 2013.

Coal prices in China declined in the summer of 2012 primarily due to lower priced coal throughout the US and Europe. Prices have stabilized and risen modestly in China this winter. Coal prices in the United States declined because there is lower demand for coal due to increased competition from ample and low price natural gas, one of the warmest winters in recorded history and certain government policies. Combined with a sluggish market for coal in Europe, coal exporters took advantage of the arbitrage opportunities between Chinese domestic coal prices and international coal prices. This created a temporary oversupply of coal summer 2012. Prices over the fall and winter rose modestly. During the summer of 2013, prices have adjusted downward as typically happens for the season.

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. China is both the largest consumer and producer of coal in the world. In 2009, China accounted for over 46% 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. The past few years, 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. A national policy of consolidation to increase production capacity, improve efficiency and safety in coal mines in China was announced years ago and continues today. Beginning with the 11th 5 year plan in 2006, the policy of government-mandated consolidation has continued with the current 12th 5 year plan from 2011-2015, which expands and accelerates the consolidation to new provinces including Guizhou.

In summary, China began fiscal year ending April 30, 2013 with excessive supply of cheaper coal imported resulting in pricing pressure for the entire coal industry. This pricing pressure was evidence in Q1 and Q2 of our fiscal year 2013 as our average selling price per ton decreased 7.7% and 5.0% respectively from previous quarter but the price started to stabilize in Q3 2013 with average selling price per ton increased 6.4% from previous quarter.


The Twelfth Five-Year Plan Impact on the Chinese Coal Industry

The National People's Congress ratified the 12th Five-Year Plan in March 2011 for the period 2011-2015. Three sectors received major boost: health care, technology, and energy. With its emphasis on "inclusive growth," the Chinese government is encouraging foreign business participation in these Strategic Emerging Industries. In the energy sector, the PRC announced guidelines for a government-mandated consolidation of the fragmented and inefficient coal industry in Guizhou Province, similar to earlier consolidation efforts in northern China.

On April 15, 2011, the General Office of the Government of Guizhou Province issued Document (2011) Number 47 notifying the Guizhou Province Energy Department of guidelines related to accelerating the pace of consolidation through 2013. There are three main components to the guidelines: production, safety, and efficiency.

First, in addition to increasing individual mine production, the provincial government is mandating that individual mines be consolidated into coal holding companies responsible for a minimum production between 800,000 and 2,000,000 tons per year, thus reducing the number of coal holding companies from over 1,600 to 200 or less.

Second, safety standards will continue to rise as well as increased safety enforcement activity. For example, a mine accident in a county will often result in a temporary shutdown of all mines operating in that county so that safety inspectors can review the safety of each mine.

Third, to improve efficiency, the level of mechanization will increase significantly, both in shaft drilling and coal production.

Overall Strategy and Plan of Operations

In the past, the Company has been a vertically integrated coal operator participating in the consolidation of the fragmented coal industry in the Yunnan and Guizhou Provinces of southwest China. In January 2013, the Company's Board of Directors decided to instruct the management to a) focus on targeting operations in North of China for acquisition where larger scale of mines are available and to upgrade our mining portfolio. b) As the Company gains in presence in China, management was also advised to focus on thermal coal and move away from coking coal, due to it being a more price sensitive/volatile as it is strategic material used in the steel making process. Moving forward, we plan to expand our coal business in three ways: first, through expansion of existing wholesale and distribution operations in Guizhou, gradually building up our logistic network. Second, to acquire a large over 1 million tons of coal mine(s) in North of China. Third, by continuing to expand production at our current coal mines we own and operate. We are diligently pursuing on the TDR (Taiwan Deposit Receipt) in Taiwan to raise substantial capital and to explore other options for raising capital, to ensure the company may grow and achieve the above objectives. On October 28, 2013, the company signed a strategic marketing agreement with Guizhou Zheshang Coal Group ("Zheshang"). Zheshang is a privately held company located in Guizhou with 10 mines that produce approximately 2 million tons per year. Zheshang is currently expanding their targeted annual production to 5 million tons. Under the agreement, L&L will utilize its extensive customer network to market coal produced by Zheshang. L&L will be responsible for customer relationships, transportation and logistics, while Zheshang will be responsible for mining production, and mine safety. The partners are targeting sales of approximately 1.2 million tons of coal per year.


Organic Growth

All five of our mines are producing at full capacity. We had a strong quarter of 211,000 tons of coal production. We expect to double that number once all five mines have been fully expanded.

WeiShe mine was acquired in February of 2012 and took 8 months to ramp up to its approved capacity of 150,000 tons per year. We have already begun expansion to 400,000 tons of annual capacity. Luozhou and Lashu were acquired in November 2012 and have ramped up much faster. They are already running near approved capacities of 200,000 and 150,000 tons respectively. We expect to expand all three of these Guizhou mines to over 1.2 million tons in the next few years, well ahead of the 2015 deadline for consolidation in the province. In Yunnan, we have 2 mines DaPuAn and SuTsong which we expect to expand to 300,000 tons.

We acquired producing mines that lack capital and/or management expertise to expand to meet the minimum government-mandated production requirement, and then we provide the resources to expand production capacity and improve safety. Most coal mines in Southwest China, including our mines, 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 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 conveyor belts allows the Company to get coal from ground with shorter turnaround time and bigger capacity. We also drill 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 and 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 to scale up to large production have become available on the market recently because the consolidation policy requires that all mines come under a holding company that controls one to two million tons of production per year.

In addition to simple infrastructure improvement, we improve our production and safety through introducing basic management practices by 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 expansion of production capacity to meet the current government-mandated minimum annual production requirement of 300,000 tons a year.

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 quote 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. The situation may change from month to month or year to year. A new permit must be obtained if the total mine production exceed the total approved tonnage for the life of the mine.

Acquisitive Growth

There is no acquisitive growth in the second quarter of FY 2014 which ended on October 31,2013.

We have built an acquisition team to facilitate our growth in the future, which consists of business, operational, financial, and renowned coal experts. Two of the members are Dr. Syd Peng and Mr. Jingcai Yang who are both 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, 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 included 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. Mr. JingCai Yang suggested that, due to business strategy considerations and improving safety production, the company should look for larger coal mine(s) in North China. Because the consolidation policy requires that all mines must also join a holding company that controls coal production between 800,000 to 2,000,000 tons. We are now targeting larger mines with production near 300,000 tons or more, and have considerable proven coal reserves, better geology, and strong management teams already in place. When these well-designed mines are executed effectively, they require less capital expenditure to expand capacity. Strong management teams are integral to better safety and allow for scaling up operations more quickly. Mines with these characteristics are now on the market more frequently than in the past because of the government consolidation policy.

We acquired 3 mines from Union Energy that met those criteria, Weishe, Luozhou and Lashu mines. They are currently operating at 150,000, 150,000 and 200,000 tons per year respectively and will be expanding to over 1.2 million collectively. We expect other opportunities will arise in Guizhou as the deadline nears. We will also look at opportunities to buy mines in Shanxi and Inner Mongolia which have already undergone consolidation and are running at the capacity of one million tons per year.


Other

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 Dr. Syd Peng 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 ShenHua Coal Mine Group Mr. Jingcai Yang. James Schaeffer, the Executive Director who has over three decades of mining experience in participated projects throughout Asia in the energy and resource sectors. He is member of the International Society of Mining, Metallurgy and Exploration. Joseph Borich has extensive knowledge in developing business relation in China and Taiwan throughout his career. Officers include the founder of the Company, a Chief Financial Officer who was a partner with Ernst & Young and an Executive Vice President who was a former senior White House staffer. 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.

General Discussion and Analysis of Second Quarter Fiscal Year of 2014 Results

The coal sold by our mines was 211,000 tons, an increase of 18.5% from 178,000 tons same period last year. This was primarily due to the organic expansion of our existing operations and the acquisitions of new mines. Our net earnings attributable to L&L shareholders were $1.4 million (see below), down 81.5% from second quarter $7.7 million of fiscal year 2013. Earning per diluted share was $0.03 for the second quarter of fiscal year 2014, down 85.7% compare to $0.21 per diluted share of the second quarter of fiscal year 2013. Our net earnings and EPS dropped dramatically as a result of the Company settling a debt liability with Ironridge for a onetime non-operation loss of $6,101,488.

Our overall revenue, gross profit and Net income Attributable to L & L for the quarter ending October 31, 2013 compared to the same period in October 31, 2012 was as follows:

October 31, 2013 October 31, 2012
* Revenue $42.9 m $45.5 m
* Gross Profit $17.2 m $11.9 m
* Net Income attributable to L&L $1.4 m $7.7 m

The net income of $2.3 m at October 31, 2013 included a one time non-operation loss of $6,101,488.

Results of Operations

The following table presents our operating results as a percentage of our revenues for the periods indicated:


Results of Operations



                                                              Three Months Ended October 31,                         Six Months Ended October 31,
                                                              2013                       2012                       2013                       2012
                                                      Amount    % of Revenue     Amount    % of Revenue     Amount    % of Revenue     Amount    % of Revenue
Revenues                                            $42,966,509      100.00%   $45,504,279      100.00%   $94,147,879      100.00%   $84,952,377      100.00%
Cost of revenue                                      25,723,806       59.87%    33,625,414       73.90%    57,850,369       61.45%    63,173,428       74.36%
Gross profit                                         17,242,703       40.13%    11,878,865       26.10%    36,297,510       38.55%    21,778,949       25.64%
Selling general & administrative                      7,964,864       18.54%     4,161,219        9.14%    12,353,143       13.12%     7,796,888        9.18%
Interest income                                           4,884        0.01%     (117,069)      (0.26%)        10,016        0.01%     (224,335)      (0.26%)
Other income (expense)                                (493,454)      (1.15%)     (562,188)      (1.24%)     (494,790)      (0.53%)     (890,414)      (1.05%)
Loss on debt settlement                             (6,101,488)     (14.20%)                              (6,101,488)      (6.48%)                      0.00%
Derivative gain                                       3,184,062        7.41%             -                  3,633,186        3.86%             -
Provision for income taxes                            1,694,850        3.94%       805,527        1.77%     3,387,301        3.60%     1,497,967        1.76%
Net Income Attributable to Non-controlling interest   2,746,456        6.39%     1,949,832        4.28%     5,437,688        5.78%     3,327,195        3.92%
Income from Discontinued Operations, Net of Tax               -        0.00%     2,101,397        4.62%             -                  3,657,762        4.31%
Net income Attributable to L&L                       $1,430,537        3.33%    $7,742,941       17.02%   $12,166,302       12.92%   $13,929,410       16.40%

Revenue

The Revenue under this section is the total revenue of the Company and its subsidiaries including intercompany sales which are eliminated during the consolidation process. The following table presents revenues by operating segment:

For Continued Operations (Excluding DaPing Coal Mine and Zonelin Coking Plant)

On November 18, 2012, the Company finalized the acquisition of the LuoZhou Coal Mine and LaShu Coal Mine. This transaction involved the transfer of the Company's interests in its ZoneLin Coking Plant (98%) and the DaPing Mine (60%) to satisfy majority of the payment for acquisition of Luozhou and Lashu. According to the FASB ASC 360 Rule, since the intention to swap DaPing and Zonelin for LuoZhou and LaShu were known during the second quarter ending October 31, 2012, the presentation of DaPing and ZoneLin for balance sheet was classified as "asset/liabilities of discontinued operation", and "discontinued operation" in Profit and Loss and Cash Flow Statements were reported on the second quarter for the period ending October 31, 2012.

For continued operations, in this quarter, our net revenue decreased to $42.9 million during the three months ended October 31, 2013 from $45.5 million during the three months ended October 31, 2012, representing approximately a 5.6% decrease year over year. The decrease was primarily due to our coal washing revenue segment. One of our coal washing facilities is temporarily idling for management evaluation and equipment improvements.

Our net revenue increased 11% from $94.1 million during the six months ended October 31, 2013 compared to $84.9 million during the six months ended October 31, 2012. This was due to the net increases in mining and wholesale segments after taking into account decreases in the washing segment.


The tables below provide the breakdown the contributions from continuing operations and discontinued operations for three and six month periods on a year over year basis.

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