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CHLN > SEC Filings for CHLN > Form 10-Q on 15-May-2014All Recent SEC Filings




Quarterly Report

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

Critical Accounting Policies and Estimates

We prepare our interim condensed consolidated financial statements in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect (i) the reported amounts of our assets and liabilities, (ii) the disclosure of our contingent assets and liabilities at the end of each reporting period and (iii) the reported amounts of revenues and expenses during each reporting period. We continually evaluate these estimates based on our own experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and reasonable assumptions, which together form our basis for making judgments about matters that are inherently uncertain. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

When reading our interim condensed consolidated financial statements, you should consider (i) our selection of critical accounting policies, (ii) the judgment and other uncertainties affecting the application of such policies and (iii) the sensitivity of reported results to changes in conditions and assumptions. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.

The unaudited interim condensed consolidated financial statements are based on accounting principles that are consistent in all material respects with those applied in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. They do not include certain footnote disclosures and financial information normally included in annual consolidated financial statements prepared in accordance with GAAP and, therefore, should be read in conjunction with the audited consolidated financial statements and notes included in the Company's 2013 Annual Report.

Real estate held for development or sale, intangible assets and deposits on land use rights

We evaluate the recoverability of our real estate developments taking into account several factors including, but not limited to, our plans for future operations, prevailing market prices for similar properties and projected cash flows.

We review real estate projects, intangible assets and deposits on land use rights whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. When these events occur, we measure impairment by comparing the carrying value to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. If the total of the expected undiscounted cash flow is less than the carrying amount of the assets, we recognize an impairment loss based on the fair value of the assets.

Our judgments and estimates related to impairment include our determination of whether an event has occurred to warrant an impairment test. If a test is required, we will have to make additional judgments and estimations such as our expectations of future cash flows and the calculation of the fair value of the impaired assets.

When real estate costs are determined to be impaired, they are written down to their estimated net realizable value. The Company evaluates the carrying value for impairment based on the undiscounted future cash flows of the assets. Write-downs of real estate costs deemed impaired are recorded as adjustments to the cost basis.

The following summarizes the components of real estate inventories as of March 31, 2014 and December 31, 2013:

                                                     March 31,       December 31,
                                                       2014              2013
Real estate projects completed and held for sale
Junjing I                                          $   1,777,791     $   1,842,556
Gangwan                                                    9,581             9,839
Junjing III                                            1,024,980         1,284,724
Puhua Phase I                                          6,559,955         7,128,395
Puhua Phase II - West Regionand New Coastal Line       7,423,501         7,643,245
Real estate completed and held for sale               16,795,808        17,908,759

Real estate projects held for development
Puhua Phase II (East Region), III and IV              95,060,927        92,388,308
Park Plaza                                            71,272,453        72,536,513
Golden Bay                                           132,934,038        77,997,482
Jiyuan                                                20,694,309        21,835,276
Other                                                  6,476,460         6,629,575
Construction Materials                                    92,891           178,899
Real estate held for development                     326,531,078       271,566,053

Total real estate held for development or sale     $ 343,326,886     $ 289,474,812

Intangible assets

The intangible assets consisted of the following at March 31, 2014 and December 31, 2013:

                                      March 31,       December 31,
                                        2014              2013
Development right acquired (a)      $  51,949,448     $  53,345,648
Land use right acquired (b)             8,646,539         8,878,924
Construction license acquired (c)       1,211,017         1,243,565
                                       61,807,004        63,468,137
Accumulated amortization              (33,070,073 )     (21,014,664 )
Intangible assets, net              $  28,736,931     $  42,453,473

(a) The Company purchased the exclusive development right (the "Intangible") through the acquisition of New Land in 2007. The cost of the Intangible was $51.8 million (323 million RMB) based on the purchase price allocation determined. This Intangible allows the Company to develop projects within a specified area in the Baqiao District in Xi'an (the "Specified Area") as defined in the Intangible agreement. This Specified Area is sub-divided into different land use rights ("LUR"). Under the Intangible agreement, the Company has preferential right to acquire LURs of land up to 487 acre within this Specified Area from the government. The development right will expire on June 30, 2016. We expect a renewal of the agreement due to the healthy relationship with the government. A substantial portion of the 487 acres are not expected to be fully developed until after the 2016 contract expiration date. The actual purchase price of the LURs to be acquired through the Intangible is also expected to be significantly lower than the fair market value of the LUR when traded in the open market.

The Company amortizes the Intangible when it acquires a LUR within the Specified Area and the amortization of the Intangible is determined by calculating the profit that the specific LUR may generate over the total estimated profit of the Intangible and applying this percentage to the Intangible. The gross margin in this case is just based on the assumption that the land is bought and sold directly, not including any other construction on the land. The Company records the amortized Intangible into real estate held for development or sale as a component of the cost of the related project and allocates it to each building based on the gross floor area ("GFA") of each building. When the units within the project are sold, the related capitalized amortization will be expensed as part of cost of real estate sales. This amortization policy ensures the amortization matches the realization of the economic benefit of the Intangible when the actual LUR is developed into condo projects and related revenue is recognized with the Company percentage of completion method.

The following table summarizes the information and assumptions used by the Company to amortize the Intangible at the time LURs were acquired. The table also includes forward looking information that may be used by the Company for future amortization when future LURs are obtained:

                                                    2007           2009                 2013                2014                2015
                                              Land Sale          Puhua         Golden Bay A        Golden Bay B        Textile City
                              Acre (gross)            31             79                 17.5 (3)            17.1 (3)            29.7 (4)
   Gross Profit* from Intangible Agreement
                 (numerator - in millions)   $      16.5        $  63.7        $        15.2 (3)            14.5 (3)            23.7 (4)

Total Estimated Gross Profit* (Denominator
- in millions) $ 701 (1) $ 701 (1) $ 133.6 (5) $ 133.6 (5) $ 133.6 (5) Percentage 2.4 %(1) 9.3 %(2) 24.96 (5) 23.79 (5) 38.92 (5)

* Gross profit referred to the price difference between the estimated fair market value of the LUR and the estimated preferred acquisition price.

* The Intangible's economic benefits are consumed as the LURs are acquired and the bidding priority and preferred prices are realized. As such, we follow ASC 350-30-35-6 to amortize the Intangible by amortizing the Intangible in a way that considers the identification of the profit on each LUR, which is between the preferred LUR acquisition price and market price of the LUR. The acquisition price and market price of the LURs are the function of the acreage of the LUR acquired, locations and trend of Xian surrounding land use right value. The overall profit from the Puhua project or any other future projects under the Intangible require additional work and conditions such as: construction licenses, goodwill in the real estate industry, planning and actual construction works. However, none of these are directly related to the realization of profit from the Intangible.

1) When the Company entered into the New Land acquisition in March 2007, it was the Company's intention to sell part of the land and retain the remaining portion for our own projects. We estimated the total cost and gross profit based on the then current market conditions and determined that the total estimated profit from utilizing the Intangible would be approximately $168.9 million. As a result of the dedication by the Xi'an government to develop the Baqiao District, the real estate price increased substantially. We were able to sell 31 acre of land at $28 million and realized a gross profit of approximately $16.5 million, representing about 58% gross margin. Based on the high margin that we were able to realize through the LUR sale, we revised our estimated gross profit from $168.9 million to $701 million at the 2007 year end. The gross profit from this land sale was calculated as 2.4% of the total estimated gross profit from the whole 487 acre project. $1.2 million (2.4%) of the Intangible was amortized through the Company's consolidated statement of operations.

2) During 2009, we acquired the LUR of a 79 acre parcel of land for the Puhua project for $46 million and the estimated fair market value was $109 million based on the $30 million invested by Prax for the 25% interest in the Puhua project, although at that time we had only just acquired the LUR. The $63 million gross profit was determined as 9.25% of the total estimated gross profit at the time of Puhua LUR acquisition and $4.6 million (9.25%) of the Intangible was amortized and capitalized into real estate held for development or sale, specifically, the construction in progress ("CIP") of Puhua. As revenue is recognized on the percentage of completion basis, the CIP (including the Amortized Intangible) is expensed through cost of real estate sales based on the same percentage of completion revenue recognition calculation.

In each of years 2010 through 2013, the Amortized Intangible that was included in the cost of real estate sales are as follows:

2010 - $461,819 (or 3.12 million RMB)

2011 - $547,876 (or 3.54 million RMB)

2012 - $645,264 (or 4.07 million RMB)

2013 - $602,581 (or 3.70 million RMB)

2014Q1 - $39,089 (or 0.24 million RMB)

3) In December 2013 and March 2014, the Company acquired the land of Golden Bay A and Golden Bay B projects, which were 17.5 and 17.1 acres, respectively. According to the market condition around this project, the gross profit margin, which is defined as the estimated profit divided by the fair value of the LUR, of the land of Golden Bay was determined as 30%.The gross profit of Golden Bay A and Golden Bay B was estimated to be $15.2 million and $14.5 million, respectively.

4) In December 2010, we signed a preliminary contract with the government disclosing our intention to acquire an additional 29.7 acre tract of land of Textile City. We estimate that we may obtain the land use right for this piece of land during the second half of 2015. The estimated bidding price should be 10 percent higher than the price of Golden Bay because of the increase of market selling price. The gross profit margin of Textile City was determined as 20 percent because it is not located in a prime location like the Golden Bay project.

5) After the acquisition of the land of Golden Bay and Textile City, there are still 313 acres available for the Company to develop in the Baqiao area. But since we don't have specific plan on when this land will be available for purchase, we determined to amortize the remaining intangible asset to the Golden Bay and Textile City projects. The amortization schedule will be updated when any new project in this area arises. According to the gross profit margin of the Golden Bay and Textile City, the total gross profit of these two projects was determined to be $53 million. The total gross profit of the five pieces of land will be $133.6 million. The Company acquired Golden Bay B's land use right and recorded amortization of $12,553,872 during the first quarter of 2014 and capitalized this amount in the real estate held for development or sale. The $12,553,872 amortization recorded was calculated by multiplying the $33,092,754 remaining carrying value of the development right immediately before this amortization by 37.94%, the percentage of profit expected to be realized from acquiring the land use right through the utilization of the development right over the total expected profit from acquiring land use rights through the utilization of the development right.

Because the government has issued various policies to slow down the sale of land, we currently do not have specific development plans for the remaining 313 acre of land under the Intangible agreement. We will continue the discussion with the local government to locate potential projects. As part of our periodic reporting procedures, we review and update our estimates of total gross profit depending on the market conditions. Once we are able to secure a new project under the Intangible agreement, we will adjust the amortization table accordingly. The Company also assesses impairment and has determined that the expected future profit from the exclusive right is still well above the carrying value and has concluded that no impairment has occurred.

(b) The land use right was acquired through the acquisition of Suodi. The land use right certificate will expire in November 2048. The Company amortizes the land use right over 39 years starting from the date of acquisition. For the three months ended March 31, 2014 and 2013, the Company has recorded $56,468 and $55,367, respectively, amortization expense on land use right. The amortization was included in selling, general and administrative expenses. For the next five years, the Company will amortize approximately $220,000 annually on the land use right.

(c) The construction license was acquired through the acquisition of Xinxing Construction. The construction license, which is subject to renewal every 5 years, is not amortized and has an indefinite estimated useful life because management believes it will be able to continuously renew the license in future years. The license is subject to renewal on January 1, 2016.

The Company evaluates its intangible asset for impairment whenever events or changes in circumstances indicate the carrying value may not be recoverable. Based on the discounted estimated future cash flows, the Company will record a write-down for impairments if the discounted cash flows are over the carrying value of the intangible asset. No impairment write-down was recognized for March 31, 2014 and 2013.

Deposits on land use rights

                               March 31,       December 31,
                                  2014             2013
Deposits on land use rights     27,507,078        59,155,165

Deposits on land use right as at March 31, 2014 mainly includes the $11.3 million (RMB 70 million) deposit for the land of the head office building and $16.1 million (RMB 100 million) deposit for the land of Textile City project.

The Company conducts regular reviews of the deposits on land use rights. After review and assessment, the Company concluded that there was no impairment to the carrying value of the deposits and therefore no write-down was required.

Property, Plant and equipment Assets held for sale

The total rental income (cash inflow) from leasing the Tsining JunJing I commercial retail property was $0.2 million (RMB 1.3 million) during first quarter of 2014 compared with $0.2 million (RMB 1.2 million) during the same period of 2013. Based on the $0.2 million (RMB 1.3 million) of net cash receipts in the first quarter of 2014, it will take the Company approximately 12 years to recover the $9.97 million (RMB 62 million) carrying value of the asset. There was no cash outflow in connection with the maintenance and repair of the property. The annual amortization of this property is RMB 3 million (non-cash item) per year over 30 years.

We do not believe the property cannot be sold with reasonable effort. Many potential customers have shown their interest in buying this property. However, we have signed lease agreements with several parties and the longest term amongst these agreements does not expire until year 2022. We may not be able to sell the property before the expiration date of the lease agreements. In addition, the Company currently uses this property as a collateral for loans outstanding and due to the nature of our operation, we will likely use this property as a collateral again in the future.

We assess whenever events or changes in circumstances indicate that the carrying amount of this property may not be recoverable. When these events occur, we measure impairment by comparing the carrying value to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. If the total of the expected undiscounted cash flow is less than the carrying amount of the assets, we recognize an impairment loss based on the fair value of the assets. Our judgments and estimates related to impairment include our determination of whether an event has occurred to warrant an impairment test. If a test is required, we will have to make additional judgments and estimations such as our expectations of future cash flows and the calculation of the fair value of the impaired assets.

During the fourth quarter of 2012, we sold 7,367 square meters of JunJing I commercial property for $14.9 million (RMB 94.3 million). The carrying value of the sold property was only $8.5 million (RMB 52.8 million). Therefore, we believe there is no impairment for the commercial property. The remaining commercial property has a GFA of 5,371 square meters, with a carrying value of $6.4 million (RMB 38.5 million). The market selling price of properties like Tsining JunJing I commercial retail property was much higher than its cost when we reclassified it from inventory to fixed assets. Thus, our assessment does not show any impairment to the carrying value of the property.

We are also generating income from other income producing properties.

Material trends and uncertainties that may impact continuing operations

Changes in national and regional economic conditions, as well as local economic conditions where we conduct our operations and where prospective purchasers of our homes live, may result in more caution on the part of homebuyers and consequently fewer home purchases. According to E House (China) Real Estate Research Institute the average residential sale price in Xi'an city was stable in the quarter ended March 31, 2014. The average sale price decreased to 7,333 RMB per square meter (approximately US$ 1,202 per square meter) from 7,418 RMB in the same period of 2013, representing about 1.1% year-to-year decrease.

Most purchasers of our homes finance their acquisitions through lenders providing mortgage financing. A substantial increase in mortgage interest rates or unavailability of mortgage financing would adversely affect the ability of prospective homebuyers to obtain the financing they need in order to purchase our homes, as well as the ability of prospective move-up homebuyers to sell their current homes. For example, if mortgage financing became less available, demand for our homes could decline. A reduction in demand could also have an adverse effect on the pricing of our homes because we (and our competitors) may reduce prices in an effort to compete for home buyers. A reduction in pricing could result in a decline in revenues and margins.

The real estate development industry is capital intensive and development requires significant up-front expenditures to acquire land and begin development. Accordingly, we incur substantial indebtedness to finance our homebuilding and land development activities. Although we believe that internally generated funds and our current borrowing capacity will be sufficient to fund our capital and other expenditures (including land acquisition, development and construction activities), the amounts available from such sources may not be adequate to meet our needs. If such sources are not sufficient, we may seek additional capital in the form of debt or equity financing from a variety of potential sources, including bank financings, third parties and related party financings. The availability of borrowed funds to be utilized for land acquisition, development and construction may be greatly reduced, and the lending community may require increased amounts of equity to be invested in a project by borrowers in connection with new loans. Failure to obtain sufficient capital to fund planned capital and other expenditures could have a material adverse effect on our business.

In addition, regulatory requirements could cause us to incur significant liabilities and operating expenses and could restrict our business activities. We are subject to statutes and rules regulating, among other things, certain developmental matters, building and site design, and matters concerning the protection of health and the environment. Our operating expenses may be increased by governmental regulations such as building permit allocation ordinances and other fees and taxes, which may be imposed to defray the cost of providing certain governmental services and improvements. Any delay or refusal from governmental agencies to grant us necessary licenses, permits and approvals could have an adverse effect on our operations.

As of March 31, 2014, we had $14,935,316 of cash, compared to $21,320,071 as of December 31, 2013, a decrease of $6,384,755.

The Company believes that the combination of present capital resources, internally generated funds, and unused financing sources are more than adequate to meet cash requirements. We intend to meet our liquidity requirements, including capital expenditures related to the purchase of land for the development of our future projects, through cash flow provided by operations and additional funds raised by future financings. Upon acquiring land for future development, we intend to raise funds to develop our projects by obtaining mortgage financing mainly from local banking institutions with which we have done business in the past. We believe that our relationships with these banks are in good standing and that our real estate will secure any loans that are needed. We believe that adequate cash flow will be available to fund our operations.


Our Company

We are a leading residential developer with a focus on fast growing Tier II and Tier III cities in western China. We are dedicated to providing quality, and affordable housing to middle class families. The majority of our customers are first time home buyers and first time up-graders, who, we believe, will benefit from China's rapid gross domestic product ("GDP") growth and the middle classes' corresponding increase in purchasing power.

We commenced our operations in Xi'an in 1999 and have been considered one of the industry leaders and one of the largest private residential developers in the region. We have experienced significant growth in the past 14 years and have developed over 1.5 million square meters of residential projects. Through the utilization of modern design and technology, as well as a strict cost control system, we are able to offer our customers high quality, cost-effective products. Most of our projects are designed by world-class architecture firms from the United States, Canada and Europe that have introduced advanced "eco" and "green" technologies into our projects.

As we are focusing primarily on the demand from first time home buyers and first time up-graders in western China, the majority of our apartments range in size from 70 square meters to 120 square meters; with such sizes considered to be a stable market section of the residential real estate market in western China. Our typical residential project is approximately 100,000 square meters in size and consists of multiple high-rise, middle-rise and low-rise buildings as well as a community center, commercial units, educational facilities (such as kindergartens) and other auxiliary facilities. In addition, we provide property management services to our developments and have exclusive membership systems for our customers. We typically generate a large portion of our sales through referrals from our existing customers.

We acquire our land reserves and development sites primarily from the local government, open-market auctions, acquisitions of old factories from the government and acquisitions of distressed assets from commercial banks. We do not depend on a single method of land acquisition, which enables us to acquire land at reasonable costs and, generally enables us to generate higher returns from our developments. We intend to continue our expansion into other strategically selected cities in western China by leveraging our brand name and scalable business model.

Our Strategies

We are primarily focused on the development, construction, management and sale of residential real estate properties to capitalize on the rising demand for real estate from China's emerging middle class. We seek to become the market leader in western China and plan to implement the following specific strategies to achieve our goal:

Consolidate through Acquisition and Partnership. Currently, the residential real estate market in western China is fragmented with many small players. We believe that this market fragmentation will provide us with opportunities for acquisitions or partnerships. We believe acquisitions will provide us better leverage in negotiations and better economies of scale.

Expand into Other Tier II and Tier III Cities. We believe our proven business model and expertise can be replicated in other Tier II and Tier III cities, especially in western China. For example, in 2011, we entered into the Ankang city market for a residential project. Furthermore, we have identified certain other cities that possess attractive replication dynamics. The Ankang project started pre-sales during the fourth quarter of 2012. However, we did not recognize its revenue until certain criteria are met in 2013. As of March 31, 2014, contract sales for the Ankang project totaled $37.7 million.

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