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CHLN > SEC Filings for CHLN > Form 10-Q on 14-Nov-2012All Recent SEC Filings




Quarterly Report

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


Some of the statements contained in this Form 10-Q are not historical facts and are forward-looking statements, which can be identified by the use of terminology such as estimates, projects, plans, believes, expects, anticipates, intends, or the negative or other variations, or by discussions of strategy that involve risks and uncertainties. We urge you to be cautious of the forward-looking statements, that such statements, which are contained in this Form 10-Q reflect our current beliefs with respect to future events and involve known and unknown risks, uncertainties, and other factors affecting our operations, market growth, services, products, and licenses. No assurances can be given regarding the achievement of future results, as actual results may differ materially as a result of the risks we face, and actual events and conditions that may differ from the assumptions underlying the statements that have been made regarding anticipated events. Factors that may cause actual results, our performance or achievements, or industry results, to differ materially from those contemplated by such forward-looking statements include without limitation: our ability to attract and retain management to integrate and maintain technical information and management information systems; our ability to raise capital when needed and on acceptable terms and conditions; the intensity of competition; and general economic conditions.

All written and oral forward-looking statements made in connection with this Form 10-Q that are attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Given the uncertainties that surround such statements, you are cautioned not to place undue reliance on such forward-looking statements.

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, 2011("2011Annual Report"). 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 2011Annual Report.

Warrants and derivative liability

As of September 30, 2012, the Company has nil of warrants liability and nil of fair value of embedded derivatives on the balance sheet, representing approximately 0.00% and 0.00% of total liabilities, respectively.

We have utilized the Cox-Rubinstein-Ross ("CRR") Binomial Lattice Model to estimate the fair values of warrants liability and embedded derivatives. The CRR model depends on the following assumptions: the Company's common stock price underlying the warrants; strike price; conversion price; expected life; expected volatility; risk free interest rate; and dividend rate. We have used the CRR Binomial Lattice Model for the past 3 years and we do not expect any significant changes to the assumptions used except for adjustment to the common share price and the expected volatility.

We estimate the fair value of warrants liability and embedded derivatives every quarter and recognize the change of fair value as gain or loss on our current quarter consolidated statement of income. The fair values of warrants liability and embedded derivatives have changed during the past few years according to the valuation models and the fair values are positively related to the market share price movement and the volatility.

Prior to June 10, 2010, the date of the amendment to the convertible debt (the "Amendment"), the Company used the CRR Binomial Lattice Model to assess the fair value of warrants and embedded derivatives at each reporting period. After the Amendment, since the investor could exercise the warrants on a cashless basis and receive one common share for every two warrants held, if the investor converts at least 55% of face amount of convertible debt held, in addition to the CRR Binomial Lattice Model, the Company also uses an alternative valuation method (the "Alternative Model") to assess the fair value of the warrants. The Alternative Model is based on the share price of the Company at the valuation date and the number of common shares that could result from the two for one cashless exercise. The Company records the warrant liability based on the higher valuation resulting from either CRR Binomial Lattice Model or Alternative Model at the valuation date.

Several investors converted a total of $9,763,000 face value of convertible debt and exercised the related warrants with using the 2-to-1 cashless exercise feature added as part of the Amendment. Subsequently, the Company was able to charge $8,073,512 to convertible debt carrying and the fair value of the conversion features into shareholders' equity. The fair value of $1,624,159 of the warrants on the day of exercise was also charged to shareholders' equity.

After the conversion of the convertible debt and exercise of the warrants as described above and 5 days after the effectiveness of the registration statement, the 2-to-1 cashless warrants conversion feature expired for those investors who did not exercise their warrants. Therefore, use of the Alternative Model has been terminated.

During the three months ended September 30, 2012, our common stock price experienced fluctuations with the price decrease from $2.00 on July 2, 2012 to $1.39 on September 28, 2012. The decrease in stock price caused an decrease in fair value for warrants liability and embedded derivatives. As a result, we recognized a change in fair value of warrants of approximately $976 and a change in fair value of embedded derivatives of approximately $109,344, both of which are non-cash gains.

The following table summarizes the fair value of warrant liability and embedded derivative as of September 30, 2012 and December 31, 2011.

                                          September 30,       December 31,
                                              2012                2011

  Fair value of warrants liability       $             -     $        4,162
  Fair value of embedded derivatives     $             -     $      330,629

The following tables summarize all the warrants and conversion options outstanding and the assumptions used for their valuations as of September 30, 2012 and December 31, 2011.

                      September 30,      December 31,
Investor Warrants:        2012               2011
Strike price                    6.07              6.07
Market price                    1.39              1.00
Valuation date             9/30/2012        12/31/2011
Expiry date                2/28/2013         2/28/2013
Volatility                        50 %           85.00 %
Risk free rate                  0.13 %            0.14 %
Option value                 0.00000           0.01918

Number of warrants           161,715           161,715

Value                              -             3,102

                               September 30,      December 31,
Investor Warrants: 5-7-2007        2012               2011
Strike price                              N/A              4.50
Market price                              N/A              1.00
Valuation date                            N/A        12/31/2011
Expiry date                               N/A          5/9/2012
Volatility                                N/A             85.00 %
Risk free rate                            N/A              0.04 %
Option value                              N/A           0.00042

Number of warrants                          -         2,539,416

Value                                       -             1,060

                                 September 30,      December 31,
Conversion Option Valuation:         2012               2011
Strike price                               5.57              5.57
Market price                               1.39              1.00
Valuation date                        9/30/2012        12/31/2011
Expiry date                           1/28/2013         1/28/2013
Volatility                                   51 %           85.00 %
Risk free rate                             0.11 %            0.13 %
Option value                            0.00000           0.01896

Host Value - principal                8,999,500         8,999,500
Host Value - interest                         -                 -

Shares issuable on conversion         1,615,709         1,615,709

Option value - principal                      -            30,628

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. There has been no impairment on real estate inventories and no impairment loss has been recorded for the three and nine months ended September 30, 2012 and 2011.

The following summarizes the components of real estate inventories as at September 30, 2012 and December 31, 2011:

                                                   September 30,      December 31,
                                                        2012              2011
Real estate projects completed and held for sale
JunJing I project                                  $    3,360,868     $   3,381,448
JunJing II project                                        144,418         1,321,972
Tsining 24G project                                        44,975            44,910
Gangwan project                                            18,951            37,847
Tsining Home IN project                                    60,412            60,325
Real estate completed and held for sale                 3,629,624         4,846,502

Real estate projects held for development
Puhua project                                         121,444,608       115,798,346
Tangdu project                                          4,717,563         4,710,742
JunJing III project                                     1,953,477         9,299,511
Park Plaza project                                     63,904,813         8,471,800
JiYuan project                                         14,375,377        13,151,101
Golden Bay project                                     11,556,901         5,657,731
Other projects                                          5,424,936         1,356,331
Construction materials                                    260,483           190,252
Real estate held for development                      223,638,158       158,635,814

Total real estate held for development or sale     $  227,267,782     $ 163,482,316

The Company's Tangdu project is essentially a land use right plus miscellaneous pre-construction costs. The Company still owns the legal title to this land use right; however, the government is negotiating with the Company regarding a potential transfer back to the government. If the land use right is transferred back to the government, the Company believes the government will refund all the associated costs incurred by the Company.

Intangible asset

The intangible assets consisted of the following at September 30, 2012 and December 31, 2011:

                                     September 30,      December 31,
                                         2012               2011
Development right acquired (a)      $    51,384,061     $  51,309,767
Land use rights acquired (b)              8,552,435         8,540,070
Construction license acquired (c)         1,197,837         1,196,106
                                         61,134,333        61,045,943
Accumulated amortization                 (7,071,446 )      (6,896,990 )
Intangible assets, net              $    54,062,887     $  54,148,953

(a) The development right for 487 acres of land in Baqiao Park obtained from the acquisition of New Land in fiscal 2007. The intangible asset has a finite life. In accordance with accounting standard, "Goodwill and Other Intangible Assets", the intangible asset is subject to amortization over its estimated useful life. This method is intended to match the pattern of amortization with the income-generating capacity of the asset. The development right was originally set to expire on June 30, 2011. On November 25, 2010, the Company was able to extend the right to June 30, 2016.

(b) The land use rights were acquired in the acquisition of Suodi. The land use rights certificate will expire in November of 2048. The Company amortizes the land use rights over 39 years.

(c) The construction license was acquired through 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 the Company will be able to continuously renew the license in the future. The license was subject to renewal on March 10, 2011. The Company successfully renewed the license until December 31, 2015.

Deposits on land use rights

                               September 30,      December 31,
                                    2012              2011
Deposits on land use rights        42,375,958        65,286,137

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.

Material trends and uncertainties that may impact continuing operations

Changes in national and regional economic conditions, as well as in areas where we conduct our operations and where prospective purchasers of our homes live, may result in more caution on the part of homebuyers resulting in 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 fiscal quarter ended September 30, 2012. The average sale price increased to 7,530 RMB per square meter (approximately US$1,198 per square meter) from 7,431 RMB (approximately US$1,174 per square meter) in the second quarter of 2012, representing an increase of 1 percent quarter-over-quarter. Xi'an city's real estate transaction volume (in terms of sq. meter signed) increased about 8.4% in the third quarter of 2012 compared to the same period of 2011. During the third quarter of 2012, our sales of properties decreased approximately 9.7% over same period of 2011, which was mainly due to the decreased sales of projects in Tsining.

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. Additional government policies were implemented by the local government in February 2011to curb speculation in the real estate market. These new policies included capping year-over-year housing unit average selling price increases to 15%, restricting third-time home purchases for local residents and second-time home purchases for non-local residents. These new policies could result in buying hesitation amongst potential new customers, and could impact our revenues.

The real estate development industry is capital intensive, requiring 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 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 would seek additional capital in the form of debt or equity financing from a variety of potential sources, including bank financing and/or securities offerings. The availability of borrowed funds, to be utilized for land acquisition, development and construction, may be greatly reduced, and the lending community may require larger amounts of equity to be invested by borrowers in a project 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 force 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 impact 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 government agencies to grant the necessary licenses, permits and approvals could have an adverse effect on our operations.

As of September 30, 2012, we had $9,945,932 of cash and cash equivalent, compared to $22,014,953 as of December 31, 2011, a decrease of $12,069,021.The Company believes that the combination of present capital resources and internally generated funds are more than adequate to meet cash requirements for the year 2012. We intend to meet our liquidity requirements, including capital expenditures related to the purchase of land for the development of future projects, through cash provided by operations and additional funds raised by future financings including borrowing from related parties and private fund companies. 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 the loans needed. We believe that adequate cash will be available to fund our operations.


Our Company

We are a leading residential real estate 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, that, we believe, will benefit from China's rapid gross domestic product ("GDP") growth and the middle classes' corresponding increase in purchasing power.

We commenced operations in Xi'an in 1999 and have been considered to be one of the industry leaders and one of the largest private residential developers in the region. We have experienced significant growth in the past 12 years and have completed over 1.3 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 architectural firms from the United States, Canada and Europe. These firms 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 have sizes in the range of 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 the recommendations of our existing customers.

We acquire our land reserves and development sites through primary land development with the local government, open-market auctions and acquisition of old factories from the government and distressed assets from commercial banks. We do not depend on a single land acquisition method and this facilitates our acquisition of the land at a reasonable cost, which in turn results in us typically receiving higher returns on our investments 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, and sale and management of residential real estate properties in order to capitalize on the rising demand for real estate from China's emerging middle class. We strive 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. As such, we have identified certain cities that possess attractive replication dynamics.

Continue to Focus on the Middle Market.

Since the middle class has growing purchasing power and, as a result of prevailing Chinese culture and values, a strong desire to own homes, we believe the demands for residential real estate from the emerging middle class will offer attractive opportunities to grow our Company. Thus, we plan to leverage our brand name, experience and design capabilities to meet these demands from the middle class.

Our Competitive Strengths

We believe we have the following competitive strengths that will enable us to compete effectively and to capitalize on the growth opportunities in our market:

Leading position in our market and industry

We are one of the largest private residential real estate developers in Western China. We believe that we have strong design and sales capabilities as well as a well-regarded brand name in the region. Due to strong local project experience and long-term relationships with the central and local governments, we have been able to acquire significant land assets at reasonable costs, thereby providing a strong pipeline of potential future business and revenues over the next three to five years.

Attractive market opportunity

The real estate market in western China has grown slower than that of eastern China. We believe the real estate market in the region is well positioned to grow at faster rates for the next few years due to social, and economic factors. Our business model has proven to be efficient and we plan to expand into other Tier II and Tier III cities in western China. Our growth strategy is focused on western China, and we believe we will significantly benefit from the Chinese government's "Go West" policy, which encourages economic development and population movement to western China.

Unique and proven business model

Due to strong local project experience and long term working relationships with the central and local governments, we have been able to acquire land assets at more reasonable costs than our competitors. We are primarily focused on capitalizing on rising demand for properties from China's emerging middle class, which has significant purchasing power and a strong demand for residential housing. In order to leverage our brand to appeal to the middle class, we use various advertising media to market our property developments and to reach our target demographic, including newspapers, magazines, television, radio, e-marketing and outdoor billboards. We believe that our brand is widely recognized in our market and known for high quality products at cost-effective prices.

Our Property Projects

We provide three fundamental types of real estate developments:

l High-rise apartment buildings, typically 19 to 33 stories, usually constructed of steel-reinforced concrete, that are completed within approximately 24 months of securing all required permits.

l Mid-rise apartment buildings, typically 7 to 18 stories, usually constructed of steel-reinforced concrete, that are completed within approximately 12 to 18 months of securing all required permits. . . .

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