XFRA:7LM Quarterly Report 10-Q Filing - 3/12/2012

Effective Date 3/12/2012

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

——————————

FORM 10-Q

 

[X]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED ON JANUARY 31, 2012.

 

OR

 

[  ]   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ________ to ________

 

Commission file number: 000-32505 

 

 

L & L ENERGY, INC.

 (Exact name of Registrant as specified in its charter)

 

 

NEVADA

91-2103949

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

 

 

130 Andover Park East, Suite 200, Seattle, WA

 

98188

(Address of Principal Executive Offices)

 

(Zip Code)

Registrant's telephone number, including area code: (206) 264-8065

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes [X] No [   ] 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [  ]No [  ] 

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [  ]     Accelerated filer [X]    Non-accelerated filer [  ]     Smaller reporting company []

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes [   ] No [X]

 

Indicate the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: As of March 11, 2012 there were 36,300,585 shares of common stock outstanding, with par value of $0.001.

 

1


 

 

                                                                                                 L & L ENERGY, INC.

 

                                                                                            Form 10-Q Quarterly Report

 

 

 

 

Table of Contents

 
     
   

Page

PART I – FINANCIAL INFORMATION

 
     

Item 1.

Condensed Consolidated Financial Statements – Unaudited

 
 

Balance Sheets as of January 31, 2012 and April 30, 2011

3

 

Statements of Income and Other Comprehensive Income for the three and nine months

 
 

ended January 31, 2012 and 2011

4

 

Statements of Cash Flows for the three and nine months ended January 31, 2012 and 2011

5

 

Notes to the Financial Statements

6

 

Condensed Consolidated Financial Statements – Unaudited

 

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

24

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

34

Item 4.

Controls and Procedures

34

     
     

PART II – OTHER INFORMATION

 
     

Item 1.

Legal Proceedings

35

Item 1A.

Risk Factors

36

Item 1B.

Unresolved Staff Comments

46

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

46

Item 3.

Defaults upon Senior Securities

46

Item 4.

Reserved

46

Item 5.

Other Information

46

Item 6.

Exhibits

46

     

Signatures

 

47

Index to Exhibits

47

 

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.

 

This report contains forward-looking statements that involve risks and uncertainties. Please see the sections entitled "Forward-Looking Statements" and "Risk Factors" below for important information to consider when evaluating such statements.

 

 

 

2


 

 

                                                                                      PART I – FINANCIAL INFORMATION

 

Item 1.   Financial Statements

 

L & L ENERGY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

AS OF JANUARY 31,2012 AND APRIL 30,2011

(Unaudited)

     

January 31, 2012

 

April 30, 2011

ASSETS

       
 

CURRENT ASSETS:

       
 

Cash and cash equivalents

$

7,296,153

$

4,914,425

 

Accounts receivables

 

27,963,397

 

24,017,391

 

Prepaid and other current assets

 

23,646,226

 

28,641,462

 

Other receivables

 

789,707

 

2,586,147

 

Inventories

 

10,021,924

 

6,633,019

 

Total current assets

 

69,717,407

 

66,792,444

           
 

Property, plant, equipment, and mine development, net

 

116,469,383

 

96,479,552

 

Construction-in-progress

 

45,388,396

 

44,943,609

 

Intangible assets, net

 

802,893

 

902,555

 

Goodwill

 

3,077,183

 

2,988,175

 

Restricted Cash

 

565,606

 

544,588

 

Long term receivable

 

6,874,968

 

7,272,828

 

Related party notes receivable

 

5,895,978

 

7,428,574

 

Total non-current assets

 

179,074,407

 

160,559,881

     

 

TOTAL ASSETS

$

248,791,814

$

227,352,325

           

LIABILITIES AND EQUITY

       

CURRENT LIABILITIES:

       
 

Accounts payables

$

3,099,413

$

3,439,460

 

Accrued and other liabilities

 

925,320

 

717,298

 

Other payables

 

6,379,766

 

7,546,391

 

Related party payables

 

15,521,963

 

17,264,815

 

Due to officers

 

1,068,800

 

1,070,000

 

Taxes payables

 

20,440,859

 

18,835,276

 

Customer deposits

 

2,114,038

 

4,338,424

 

Shares to be issued

 

271,524

 

-

 

Bank loans

 

4,594,787

 

5,385,030

Total current liabilities

 

54,416,470

 

58,596,694

           

LONG-TERM LIABILITIES

       
 

Long-term payable

 

800,000

 

800,000

 

Asset retirement obligation

 

2,160,091

 

1,978,877

 

Total long-term liabilities

 

2,960,091

 

2,778,877

           
 

Total Liabilities

 

57,376,561

 

61,375,571

           

EQUITY:

       

L&L ENERGY STOCKHOLDERS' EQUITY:

       
 

Preferred stock, no par value, 2,500,000 shares authorized, none issued and outstanding

 

-

 

-

 

Common stock ($0.001 par value, 120,000,000 shares authorized: 32,992,151 and 32,277,579 shares issued and outstanding at January 31, 2012 and April 30, 2011 respectively)

 

32,992

 

32,278

 

Additional paid-in capital

 

54,629,134

 

48,420,321

 

Accumulated other comprehensive income

 

11,336,067

 

6,502,542

 

Retained Earnings

 

91,923,639

 

81,888,339

 

Treasury stock (143,093 shares and 1,259,000 shares at January 31, 2012 and April 30, 2011 respectively)

 

(123,768)

 

(396,859)

Total L & L Energy stockholders' equity

 

157,798,064

 

136,446,621

 

Non-controlling interest

 

33,617,189

 

29,530,133

 

Total equity

 

191,415,253

 

165,976,754

TOTAL LIABILITIES AND EQUITY

$

248,791,814

$

227,352,325

 

                                            The accompanying notes are an integral part of these consolidated financial statements

 

 

 

 

 

3


 

 

L & L ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPRHENSIVE INCOME

FOR THE THREE AND NINE MONTHS ENDED JANUARY 31, 2012 AND 2011

(Unaudited)

 

For The Three Months Periods Ended January 31,

 

For The Nine Months Periods Ended January 31,

   

2012

 

2011*

   

2012

 

2011*

NET REVENUES

$

30,192,688

$

65,894,584

 

$

108,699,834

$

178,642,209

COST OF REVENUES

 

21,421,144

 

44,504,406

   

79,343,401

 

119,374,564

GROSS PROFIT

 

8,771,544

 

21,390,178

   

29,356,433

 

59,267,645

                   

OPERATING COSTS AND EXPENSES:

                 

Salaries & wages-selling, general and administrative

 

1,014,187

 

1,710,726

   

4,559,089

 

4,447,667

Selling, general and administrative expenses, excluding salaries and wages

 

2,356,848

 

3,169,118

   

8,741,739

 

9,295,726

Total operating expenses

 

3,371,035

 

4,879,844

   

13,300,828

 

13,743,393

                   

INCOME FROM OPERATIONS

 

5,400,509

 

16,510,334

   

16,055,605

 

45,524,252

OTHER INCOME (EXPENSE):

                 

Interest income (expense)

 

(45,760)

 

(285,359)

   

260,895

 

(456,827)

Other income (expense)

 

160,387

 

444,341

   

(1,088,447)

 

852,459

Total other income (expense)

 

114,627

 

158,982

   

(827,552)

 

395,632

                   

INCOME BEFORE PROVISON FOR INCOME TAXES

 

5,515,136

 

16,669,316

   

15,228,053

 

45,919,884

LESS PROVISION FOR INCOME TAXES

 

618,140

 

2,147,548

   

1,992,474

 

6,337,053

INCOME BEFORE
NON-CONTROLLING INTEREST

 

4,896,996

 

14,521,768

   

13,235,579

 

39,582,831

                   

Income attributable to non-controlling interests

 

1,037,525

 

1,937,138

   

3,200,280

 

4,998,828

Income attributable to L & L

 

3,859,471

 

12,584,630

   

10,035,299

 

34,584,003

                   

NET INCOME

$

4,896,996

$

14,521,768

 

$

13,235,579

$

39,582,831

                   

OTHER COMPREHENSIVE INCOME:

                 

Foreign currency translation gain

 

347,024

 

1,707,441

   

4,833,525

 

4,367,017

COMPREHENSIVE INCOME

$

5,244,020

$

16,229,209

 

$

18,069,104

$

43,949,848

                   

Comprehensive income attributable to non-controlling interests

$

1,093,359

$

2,098,255

 

$

3,961,242

$

5,351,049

Comprehensive income attributable to L & L

 

4,150,661

 

14,130,954

   

14,107,862

 

38,598,799

                   
                   

INCOME PER COMMON SHARE – basic

$

0.12

$

0.42

 

$

0.31

$

1.17

                   

INCOME PER COMMON SHARE – diluted

$

0.12

$

0.41

 

$

0.30

$

1.15

                   

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING – basic

 

32,723,159

 

30,296,064

   

32,093,512

 

29,490,324

                   

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - diluted

 

33,539,928

 

31,018,298

   

33,004,193

 

30,183,227

 
                         
                                                                                                                   The accompanying notes are an integral part of these consolidated financial statements.

 

4


 

 

L & L ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

FOR THE NINE MONTHS ENDED JANUARY 31, 2012 AND 2011

(Unaudited) 

   

For The Nine Months Periods Ended January 31,

   

2012

 

2011

CASH FLOWS FROM OPERATING ACTIVITIES:

       

Net income

$

13,235,579

$

39,582,831

Adjustments to reconcile net income to net cash provided by operating activities:

       
 

Depreciation and amortization

 

4,786,768

 

6,222,658

 

Stock compensation

 

2,913,347

 

4,060,944

 

Accretion of asset retirement obligation

 

181,214

 

-

 

Accounts receivable

 

(3,946,006)

 

(10,856,252)

 

Prepaid and other current assets

 

4,995,236

 

3,936,965

 

Inventories

 

(3,388,905)

 

(915,667)

 

Other receivable

 

766,180

 

(782,360)

 

Accounts payable and other payable

 

(1,704,991)

 

(9,785,424)

 

Customer deposit

 

(2,224,386)

 

982,112

 

Accrued and other liabilities

 

208,022

 

(375,823)

 

Taxes payable

 

1,605,583

 

3,721,722

 

Note receivable

 

1,532,596

 

-

Net cash provided by operating activities

 

18,960,237

 

35,791,706

           

CASH FLOWS FROM INVESTING ACTIVITIES:

       
 

Acquisition of property and equipment

 

(856,378)

 

(10,881,933)

 

Construction-in-progress

 

(19,677,589)

 

(29,249,390)

 

Increase in investments

 

397,860

 

(4,445,402)

 

Cash received from spin-off HSC

 

1,030,260

 

-

Net cash (used in) provided by investing activities

 

(19,105,847)

 

(44,576,725)

           

CASH FLOWS FROM FINANCING ACTIVITIES:

       
 

Payment on bank loans

 

-

 

(1,870,775)

 

Due to officers

 

(1,200)

 

-

 

Proceeds from warrant extension

 

-

 

50,000

 

Proceeds from Treasury stock sold

 

3,840,795

 

2,500,007

 

Payment to previous owner of acquired mine

 

(1,742,852)

 

-

 

Warrants converted to common stock

 

-

 

4,669,750

Net cash provided by financing activities

 

2,096,743

 

5,348,982

           

Effect of exchange rate changes on cash and cash equivalents

 

430,595

 

4,255,310

           

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

2,381,728

 

819,273

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

4,914,425

 

7,327,369

CASH AND CASH EQUIVALENTS, END OF PERIOD

$

7,296,153

$

8,146,642

     

-

   

SUPPLEMENTAL INFORMATION

       

INTEREST PAID

$

344,116

$

446,055

INCOME TAX PAID

$

1,012,634

$

2,615,331

           

NON-CASH INVESTING AND FINANCING ACTIVITY:

       

Stock subscription

$

-

$

1,800,000

 
 

The accompanying notes are an integral part of these consolidated financial statements

                                                               

 

                                                                                                               5


 

                                                                                                                                                              L & L ENERGY, INC.

                                                                                                                          NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                                                                                                                                                                   (Unaudited)

 

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION

 

Description Of Business

 

L & L Energy, Inc. (“L&L” or the “Company”) was incorporated in Nevada, and is headquartered in Seattle, Washington.  Effective on January 4, 2010, the State of Nevada approved the Company’s name change from L&L International Holdings, Inc. to L & L Energy, Inc.  The Company is a coal (energy) company, and started its operations in 1995.  Coal sales are generated entirely in China from coal mining, clean coal washing, coking, and coal wholesale operations.  At the present time, the Company conducts its coal (energy) operations in Yunnan and Guizhou provinces, southwest China.  

 

As of January 31, 2012, the Company has the following subsidiaries or operations in China:

 

·         Kunming Biaoyu Industrial Boiler Co., Ltd (“KMC”), which owns/controls coal wholesale operations, Ping Yi Coal Mine ( “PYC”) and Ping Yi coal washing;

·         L&L Coal Partners (the “2 Mines” or “LLC”), which owns/controls two coal mining operations (DaPuAn Mine and SuTsong Mine) and DaPuAn Mine’s coal washing operations;

·         L&L Yunnan Tianneng Industry Co. Ltd. (“TNI”), which owns/controls ZoneLin Coal Coking Factory (“ZoneLin”);

·         Yunnan L&L Tai Fung (“Tai Fung”), which owns/controls SeZone County Hong Xing Coal Washing Factory (“Hong Xing”) and coal wholesale and distribution operations; and

·         Da Ping Coal Mine (“DaPing”)

 

Basis Of Presentation

 

The consolidated financial statements include the accounts of L & L Energy, Inc. and its affiliates. All intercompany transactions, profits and balances have been eliminated in consolidation.

 
 
                                                                                                                                                    6

 

 

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Accounting Principles

 

These statements reflect all adjustments, consisting of normal recurring adjustments, which, in management’s opinion, are necessary for fair presentation of the information contained herein. These financial statements should be read in conjunction with the Company's financial statements and notes thereto included in the Company's audited financial statements on Form 10-K for the fiscal year ended April 30, 2011 as filed with the Securities and Exchange Commission (“SEC”) on July 29, 2011.

 

Principles of Consolidation

 

The fully consolidated financial statements include the accounts of the Company, and 100% ownership of KMC subsidiary including coal wholesale and PYC coal mine, 80% of operations of LLC “2 Mines” including both coal mining and coal washing, 98% of TNI (coal washing and coking operations), 60% of DaPing, 98% of Tai Fung.  The Company fully consolidates 100% of the assets, liabilities of its subsidiaries and show the non-controlling interests owned by their respective owners as Non-Controlling Interests.  The results of operations of the Company’s subsidiaries less amounts attributable to non-controlling interest owners are net income attributable to the Company.  All significant inter-company accounts and transactions are eliminated.

 

Use of Estimates

 

The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  By their nature, estimates are subject to an inherent degree of uncertainty.  Actual results may differ from management’s estimates.

 

 

7


 

 

New accounting pronouncements

 

In December 2011, the FASB issued guidance on offsetting (netting) assets and liabilities. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The new guidance is effective for annual periods beginning after January 1, 2013.

 

In September 2011, the FASB issued guidance on testing goodwill for impairment. The new guidance provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines that this is the case, it is required to perform the currently prescribed two-step goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit (if any). If an entity determines that the fair value of a reporting unit is no less than its carrying amount, the two-step goodwill impairment test is not required. The new guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted.

 

In June 2011, the FASB issued guidance on presentation of comprehensive income. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. Instead, an entity will be required to present either a continuous statement of net income and other comprehensive income or in two separate but consecutive statements. The new guidance is effective for annual periods beginning after December 15, 2011. In December 2011, the FASB issued a deferral of certain portion of this guidance.

 

In May 2011, the FASB issued guidance to amend the accounting and disclosure requirements on fair value measurements. The new guidance limits the highest-and-best-use measure to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counter party credit risks to be measured at a net basis, and provides guidance on the applicability of premiums and discounts. Additionally, the new guidance expands the disclosures on Level 3 inputs by requiring quantitative disclosure of the unobservable inputs and assumptions, as well as description of the valuation processes and the sensitivity of the fair value to changes in unobservable inputs. The new guidance is effective for annual periods beginning after December 15, 2011.

8


 

 

 

NOTE 3. BUSINESS COMBINATIONS

 

Fiscal year 2011 Acquisitions

 

DaPing Coal Mine

 

On March 25, 2011, the Company entered into an Acquisition Agreement to acquired 60% equity of the DaPing Coal Mine (“DaPing”), with an effective date of March 15, 2011, for a purchase price of 112,080,000 RMB (equivalent to approximately US$17,064,815). An initial installment of 10,000,000 RMB (equivalent to US$1,522,557), which was payable as of April 2011, has been fully paid as of October 31, 2011. The remaining purchase price is payable subject to achieving eight milestone requirements, which consist of licensing, receipt of related certificates, government approvals, transfer of personnel, and transfer of documentation. As of January 31, 2012, none of these milestones have been met, and the remaining balance payable to the prior owners is 102,080,000 RMB (equivalent to US$15,388,508).

 

The following table summarizes the allocation of the purchase price to the fair values of the assets at the date of acquisition:

 

 

 Allocation of purchase price: 

 Current assets

$

528,914

 Property, plant and equipment

 

3,899,314

 Intangible assets*

 

26,673,895

 Fair value of assets

 

31,102,123

 Less: Fair value of liabilities 

 

14,037,308

Net assets acquired 

$

17,064,815

Non-controlling interest 

$

9,626,043

 
*Includes goodwill $2,625,751

Tai Fung Energy Inc. (“Tai Fung”)

On March 8, 2011, the Company entered into an Operating Agreement to invest up to RMB 20,000,000 (equivalent to US$3,063,069) in a newly established entity, Tai Fung, a Chinese company established in SeZone Country, Yunnan Province, PRC on March 8, 2011. Tai Fung is a marketing and distributing company of coal throughout China and had yet to begin operation as of April 30, 2011.

The Company has paid RMB 4,178,718 (equivalent to US$639,985) as of January 31, 2012. The Operation Agreement is subject to renewal after six years from the execution date the agreement.

Pro-forma Information

The following unaudited pro forma condensed combined financial information presents the results of operations of the Company as they may have appeared if the acquisition of DaPing Tai Fung and presented in the aggregate, collectively, had been completed on May 1, 2011 and 2010:

 

 

For the period end

 

January 31, 2012

 

January 31, 2011

Net revenue

$

108,699,834

 

$

179,197,416

Income from operation

 

16,055,605

   

45,648,781

Net income attributable to L&L

$

10,035,299

 

$

34,708,532

Basic proforma earning per share

 

0.31

   

1.18

Diluted proforma earning pershare

 

0.30

   

1.15

 

 

9


 

 

 

NOTE 4. RESTRICTED CASH

 

Long-term restricted cash represents the bank deposits placed as guarantee for the future payments of costs related to land subsidence, restoration, rehabilitation and environment protections required by the local province government authority.

 

 

NOTE 5. PREPAID EXPENSES AND OTHER CURRENT ASSETS

 

Cash advances are made to coal suppliers to guarantee a certain delivery of coal to us at a specified time and price.  Since the demand for coal is high, we set up agreements with these suppliers, with cash deposits, to ensure a constant supply of coal to our washing and coking facilities.  By signing purchase agreements with our suppliers which provide for the payment of deposits over a certain period of time, we ensure that our suppliers will deliver their coal to us in a timely manner.  Certain agreements impose penalties on the suppliers for non-compliance.

 

All of the Company’s Bill receivable is Bank Acceptance from our customers.  Bank’s Acceptance is a promised future payment, or time draft, which is accepted and guaranteed by a bank and drawn on a deposit at the bank by the buyer.  The bank acceptance specifies the amount of money, the date, and the company to which the payment is due.  After acceptance, the draft becomes an unconditional liability of the bank.  But the holder of the draft can sell (exchange) it for cash at a discount to a bank or endorse it to another company instead of cash payment.

 

Additionally, the Company provides advances to employees for them to handle incidentals in our mining operations as well as washing and coking expansion projects as these facilities are far away from our headquarters in Kunming.  There were no advances to officers or directors.

 

Prepaid expenses and other current assets consisted of the following:

 

Description

January 31, 2012

April 30, 2011

Advances to suppliers

$20,205,468

$14,389,107

Bill receivable

918,957

12,345,103

Advanced to employees

2,369,656

1,518,454

Other

152,145

388,798

Total

$23,646,226

$28,641,462

 

10


 

 

NOTE 6. OTHER RECEIVABLES

 

Other receivables consisted of the following:

 

Description

January 31, 2012

April 30, 2011

Short term loans to business associates

$288,018

$927,736

HSC receivable

228,891

1,259,151

Other

272,798

399,260

Total

$789,707

$2,586,147

 

The Company made short term loans to business associates in order to develop a long term business relationship.  Such loans are considered consistent with accepted business practices in China.  These business associates are suppliers to our Company and we believe that these loans result in securing adequate supplies for the expansion of production capacity in our mines.

 

 

NOTE 7. INVENTORIES

 

Inventories are primarily related to coal located at KMC, 2 Mines, PYC,Tai Fung and TNI. Inventories consisted of the following:

 

Description

January 31, 2012

April 30, 2011

Raw Coal

$ 2,127,540

$ 2,952,157

Coke Coal

493,891

537,072

Fine Coal

7,400,493

3,143,790

Total 

$ 10,021,924

$ 6,633,019

 

 

NOTE 8. PROPERTY, PLANT, EQUIPMENT AND MINE DEVELOPMENT

 

Property, plant, equipment and mine development consisted of the following:

 

Description

 

January 31, 2012

 

April 30, 2011

Mine development

$

47,055,719

$

27,241,647

Mineral rights

 

46,655,871

 

45,306,336

Building and improvements

 

11,168,796

 

9,736,380

Machinery and equipment

 

26,729,580

 

24,329,509

 

 

131,609,966

 

106,613,872

Accumulated depreciation 

 

(15,140,583)

 

(10,134,320)

Property, Plant and Equipment, net

$

116,469,383

$

96,479,552

 

Mineral rights represent the exclusive right, granted by the Chinese government, to operate the 2 Mine, as well as PYC and   DaPing.  The rights were acquired in the first quarter of 2008 as a result of the acquisition of these mines, which occurred on May 1, 2008, November 1, 2009and March 15, 2011, respectively.  The Company has elected to use unit-of-production method to depreciate its mineral rights.

 

Depreciation expense was $1,189,496 and $1,490,128 for the three months ended January 31, 2012 and January 31, 2011, respectively. 

 

Depreciation expense was $4, 644, 380 and $5, 880, 800 for the nine months ended January 31, 2012 and January 31, 2011, respectively. 

 

11


 

 

NOTE 9.  CONSTRUCTION IN PROGRESS

 

Construction in progress includes mine development, ventilation and electrical system improvements, building of staff quarters, and beginning construction of a sewage treatment system and road expansion for the washing facilities.  Construction in progress was $45,388,396  and $44,943,609 as of January 31, 2012 and April 30, 2011, respectively. Capitalized interest costs included in construction in progress were approximately $74,903 and $177,781 for the nine months ended January 31, 2012 and 2011, respectively.

 

 

NOTE 10.  INTANGIBLE ASSETS

 

Customer relationship and technology assets are being amortized over a period of 7 years.  Amortization expense for these assets was $124,837 and $107,018 for the nine months ended January 31, 2012 and January 31, 2011, respectively.  Amortization expense of Asset Retirement Cost was $37,795 and $161,504 for the three and nine months ended January 31, 2012.

 

Intangible assets consisted of the following:

 

Description

 

January 31,2012

 

April 30, 2011

Technology

$

281,362

$

273,224

Customer relationship

 

899,731

 

873,706

 

 

1,181,093

 

1,146,930

Accumulated amortization

 

(378,200)

 

(244,375)

 

$

802,893

$

902,555

 

We have reclassified Mineral Rights to Property, Plant, Equipment and Mine Development. Mineral Rights were disclosed as Intangible Assets in prior financial statements

 

As of January 31, 2012, estimated future amortization expenses related to intangible assets were as follows (in thousands):

 

Remainder of Fiscal 2012

$

42

Fiscal 2013

 

166

Fiscal 2014

 

166

Fiscal 2015

 

166

Fiscal 2016

 

166

Thereafter

$

97

 

 

NOTE 11.  LONG TERM RECEIVABLE

 

As of January 31, 2012, the Company entered into several agreements with Colorado-based Bowie Resources, LLC and have loaned a total of approximately $6.5 million.  The loan originally carried a variable interest rate of approximately nine (9) percent to approximately eleven (11) percent.  The loan is co-senior with another lender.  The total balance was $6,874,968 including interest of $325,955 for the period end of January 31, 2012 and $7,272,828 including interest of $230,815 for the period ended April 30, 2011.

 

12


 
 

NOTE 12.  RELATED PARTY TRANSACTIONS

 

Related Party Notes Receivable

 

The Company loaned money to various entities that have non-controlling interests with the Company.  Those loans are reflected in the consolidated balance sheets as related party notes receivables, and are secured by assets and machinery of the various mines or businesses, as indicated below.  Because these borrowers have business in which the Company has an interest, the Company considers these borrowers as related parties. The business purpose of these related party transactions relates to the maintenance of long-term business relationships.

 

There was no impact to the statements of income and other comprehensive income for the nine months ended January 31, 2012 and year ended April 30, 2011 as a result of these loans. For the nine months ended January 31, 2012, the total amount of loan repayments was approximate 5.9 million.

 

Related party notes receivable consisted of the following as of January 31, 2012:

 

Borrowers

Relationship

USD

Maturity

Collateralized by

Associates to TianRi Coal Mine

Shareholder & non-controlling interest holder

$1,606,591

1-May-15

Mining equipment

Associates to SuTsong

Shareholder & non-controlling interest holder

2,854,372

1-May-15

Mine Assets

Associates to DuPuAn

Shareholder & non-controlling interest holder

1,126,620

1-May-15

Mine Assets

Yunnan Tinnan Co. Ltd.

Non-controlling interest holder

171,476

1-May-15

Machinery

Others

Shareholder & non-controlling interest holder

136,919

Various dates

 
   

$5,895,978

   

 

 

Related party notes receivable consisted of the following as of April 30, 2011:

 

Borrowers

Relationship

USD

Maturity

Collateralized by

Associates to TianRi Coal Mine

Shareholder & non-controlling interest holder

$1,549,961

1-May-15

Mining equipment

Associates to SuTsong

Shareholder & non-controlling interest holder

2,771,809

1-May-15

Mine Assets

Associates to DuPuAn

Shareholder & non-controlling interest holder

2,761,248

1-May-15

Mine Assets

Yunnan Tinnan Co. Ltd.

Non-controlling interest holder

191,698

1-May-15

Machinery

Others

Shareholder & non-controlling interest holder

153,858

Various dates

 
   

$7,428,574

   
 

Related Party Payable

Related party payable consisted of the following:

 

 

 

January 31,2012

 

April 30, 2011

Payable to previous owners of ZoneLin (current)

$

200,000

$

200,000

Payable to previous owners of DaPing Coal Mine

 

15,321,963

 

17,064,815

Total related party payable - current

 

15,521,963

 

17,264,815

Payable to previous owners of ZoneLin (non-current)

 

800,000

 

800,000

Total related party payable

$

16,321,963

$

18,064,815

Related party payables do not bear interest and are un-collateralized. These related party payable have no impact on the statements of income and other comprehensive income for the nine months ended January 31, 2012 and year ended April 30, 2011.

13


 

 

Due to Officers

 

Due to officers consisted of the following:

 

                 

Due to officer

 

January 31, 2012

 

April 30, 2011

Dickson Lee

$

233,334

$

420,000

Robert Lee

 

670,000

 

650,000

Shirley Kiang

 

60,000

 

-

Clayton Fong

 

105,466

 

-

Total due to officer

 

1,068,800

 

1,070,000

                                                                                                 

 

NOTE 13.  ASSET RETIREMENT OBLIGATION

 

With respect to the DaPuAn and SuTsong mines, the Company estimates the asset retirement obligation at a rate of 3 RMB per ton based on total reserves at the end of the useful lives of the mines. The Company expects to extract approximately 10 million tons of coal over the expected useful lives (29 and 17 years for DaPuAn and SuTsong Mine respectively).  The interest rate used in the net present value calculation is 7%.

 

As for the Ping Yi Mine, the Company estimates the asset retirement obligation at a rate of 2 RMB per ton based on total reserves at the end of the useful lives of the mines. The Company expects to extract approximately 4.4 million tons of coal over the expected useful life of twelve years. The interest rate used in the net present value calculation is 7%.

 

The DaPing Mine was acquired by the Company in March 2011. According to the mine reservation report, management expects to extract approximately 15 million tons of coal over the remaining 26 years. DaPing Mine is located in Guizhou Province and the management estimates the asset retirement obligation at a rate of 2 RMB per ton based on total reserves at the end of the useful lives of the mines. The interest rate used in the net present value calculation is 7%.

 

During the quarter ended October 31, 2010, the Company revised the forecasted cash flows used for the net present value calculations for the DaPuAn, SuTsong and PingYi mines. The revisions to estimated cash flows pertain to revisions in the estimated amount and timing of required reclamation activities throughout the lives of the respective mines and reflect changes in estimates of closure volumes, disturbed acreages and third-party unit costs as of October 31, 2010. We based these estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from management’s estimates. We evaluated the forecasted cash flows as of January 31, 2012, and no revision was deemed necessary.

 

The following is a summary of the change in the carrying amount of the asset retirement obligation during the quarter ended January 31, 2012 and year ended April 30, 2011.

 

   

31-Jan-12

 

30-Apr-11

         

Beginning balance

$

1,978,877

 $ 

            507,279

Liabilities incurred during the period

 

-

   

614,071

Liabilities settled during the period

 

-

   

                         -

Accretion of interest

 

181,214

 

              98,165

Revisions in estimated cash flows

 

-

 

                     759,362

Ending balance

$

2,160,091

$

1,978,877

14


 

 

NOTE 14.  OTHER PAYABLES

 

Other Payables consisted of the following:

 

Description

 

31-Jan-12

 

30-Apr-11

Payable to business associates

$

2,101,110

$

4,747,155

Others

 

4,278,656

 

2,799,236

Total other payables

$

6,379,766

$

7,546,391

 

Total Other Payables was $6.4 million as of January 31, 2012. None of these payables are collateralized by any assets of the Company. $2 million was a temporary interest free loan from a business partner. The other $4.3 million is for salary payable, notes payable, miscellaneous payment of fees related to maintenance, safety, employee training for security and environmental matters.

 

 

NOTE 15.  TAX PAYABLES

 

Taxes payable consisted of the following:

 

Description

 

31-Jan-12

 

30-Apr-11

VAT Payable

$

4,939,152

$

5,546,296

Income Tax Payable

 

11,602,061

 

10,622,221

Other Taxes Payable

 

3,899,646

 

2,666,759

Total Tax Payable

$

20,440,859

$

18,835,276

 
* Other Taxes Payables mainly include resources tax payable and business tax payable

15


 

 

NOTE 16.  BANK LOANS

 

During the third quarter of 2010, as part of the acquisitions of TNI and PYC, the Company assumed two loan agreements with banks in China.  The first loan with TNI was for RMB 14,300,000 or approximately $1,951,000.  This loan carried an interest rate of 5.4% per annum and matures on December 23, 2010, which was paid off. The second loan with PYC was for RMB 15,000,000 or approximately $2,376,614.  The loan carries an interest rate of 9.7% per annum and matures on February 26, 2011, but has since been extended by mutual agreement to February 26, 2012.  During the fourth quarter of 2011, as part of acquisition of DaPing, the Company assumed RMB 20 million bank loan or approximately $3,168,819 with interest rate of 9.18% per annum and matured on October 29, 2011, and has since been extended to November 30, 2012. All loans are unsecured.

 

 

NOTE 17.  INCOME TAXES

 

Our effective tax rates were approximately 13.1% and 13.8% for the nine months ended January 31, 2012 and 2011, respectively. Our effective tax rate was lower than the U.S. federal statutory rate due to the fact that our operations are carried out in foreign jurisdictions, which are subject to lower income tax rates, and the Company has net operating loss carry-forwards available to offset current and future taxable income.

 

 

NOTE 18.  STOCKHOLDERS’ EQUITY

 

Stock Issued for Compensation

 

For the three months ended January 31, 2012, the Company issued 120,156 shares of common stock with the share value of $342,841 for employees.

 

For the three months ended January 31, 2012, the Company issued 19,010 shares of common stock with the share value of $53,250 for the Board of Directors.

 

For the three months ended January 31, 2012, the company issued 25,000 shares of common stock with the share value of $67,975 for advisors.

 

For the three months ended January 31, 2012, the company issued 65,000 shares of common stock with the share value of $188,200 for consulting fees.

 

During the second quarter, no stock options or warrants were issued for compensation

 

Treasury Stock

 

The Company sold 110,000 shares of treasury stock with the share value of $125,990  to investors. In accordance with US generally accepted accounting principles, the Company recorded an increase to additional paid-in-capital of $125,990, respectively, as a result of the sold and transferred treasury shares. At January 31, 2012, the Company owned a total of 143,093 of its own shares. 

 

Stock issued for Warrant Exercise 

 

For the three months ended January 31, 2012, 36,000 warrants were exercised and 36,000 shares common stocks with the cash value of $29,880 were issued to investor.

 

The following table summarizes common stock and treasury shares activity for the three months ended January 31, 2012:

 

 

 

For the three month period ended January 31, 2012

 

 

Shares

 

Amounts

Shares for compensation

130,732

$

380,742

Treasury stock for investors

110,000

 

225,000

Shares for warrants Exercised

36,000

 

29,880

Total

 

276,732

$

635,622

 

16


 

 

NOTE 19.  WARRANTS

 

Warrants Issued for Compensation

 

The Company has authorized 1,100,000 Class D warrants to be issued to executives and 4,000,000 Class E warrants to be issued to Directors. 

 

During the year ended April 30, 2011, the Company issued 1,000 Class E warrants to a Director.  The warrants were fully vested as of April 30, 2011 and expire five years after issuance.  The grant date fair value was $8.92.  The Company issued 1,000 warrants to a non-employee. The warrants were fully vested as of April 30, 2011 and expire five years after issuance. The grant date fair value was $9.82.

 

The fair value was estimated on the date of the grant using the Black-Scholes option-pricing model. The following table displays the weighted average assumptions that have been applied to estimate the fair value of warrants on the date of grant for the three months ended January 31, 2012:

 

 

 

 

January 31, 2012

Expected life (years)

 

5.0

Risk-free interest rate

 

1.95%

Expected volatility

 

178%

Expected dividend yield

 

0%

 

(1)   Expected Life: The expected life was determined based on the option’s contractual term and employees’ expected early exercise and post-vesting employment termination behavior.

 

(2)  Risk Free Rate: The risk-free interest rate was based on U.S. Treasury yields with a remaining term that corresponds to the expected term of the option calculated on the granted date.

 

(3)  Expected Volatility: Expected volatility is computed based on the standard deviation of the continuously compounded rate of return of days when the stock price changed over the historical period of the expected life of the options.

 

(4)   Dividend Yield: The expected dividend yield is zero. The Company has not paid a dividend and does not anticipate paying dividends in the foreseeable future.

 

For the three months ended as January 31, 2012, no warrant was issued or exercised for compensation.

 

           

17


 

 

   Following is a summary of the status of warrants outstanding at January 31, 2012:

 

Type of Warrants

Range of Exercise Prices

 

Total Warrants Outstanding

 

Weighted Average Remaining Life (Years)

 

Weighted Average Exercise Price

Executives-Class D

$                  2.25

 

                10,000

 

1.08

 

$                2.25

Directors - Class E

$            3.00 - $9.34

 

               210,916

 

2.79

 

$                3.03

Non-employee

$ 11.22

 

1,000

 

3.38

 

$ 11.22

Total

   

                221,916

 

2.72

 

$                3.03

 

As of January 31, 2012, all warrants outstanding for compensation were exercisable. The weighted-average grant-date fair value of warrants granted during the three months ended January 31, 2012 was $ 9.37.

 

Warrants Issued to Investors

 

Effective October 28, 2011, the Company issued promissory notes (unsecured) to certain accredited investors and employees of the Company in the principal amount of $384,872 of which $210,000 has been loaned to the company and $174,872 is considered irrevocable commitment contribution.  The proceeds of the notes were used primarily for general business purposes in the U.S.  The notes mature on the 330th day from the dates of receipt of cash contribution from the holders of the notes and the Company may prepay all or any portion of the notes without penalty.  Interest is payable on the unpaid balance of the notes at an annual rate of 10%. The interest payable on the promissory notes accrued in the amount of $11,082 as of January 31, 2012.   As further consideration for providing this financing, the holders of the notes have also received warrants to purchase an aggregate of 96,218 shares of the Company’s common stock at an exercise price of $4.00 per share.  The warrants expire at the end of the four-year period following the maturity dates of the corresponding promissory notes.  The issuance and sale of the warrants was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.

 

For the three months ended January 31, 2012, the company issued 36,000 warrants to prior investor and the warrants were completely exercised, respectively.

 

The table below is a summary of all warrants activity as of January 31, 2012:

 

Warrants Roll-forward Summary

 

 

 

     

Weighted

 

Weighted

     

Average

 

Average

     

Exercise

 

Remaining

 

Units

 

Price

 

Life (in Years)

Outstanding at April 30, 2011

1,024,474

 

$4.38

 

2.68

 

Issued

-

 

-

 

-

 

Exercised

-

 

-

 

-

 

Cancelled

-

 

-

 

-

 

Expired

-

 

-

 

-

 

Outstanding at July 31, 2011

1,024,474

 

$4.38

 

2.43

 

Exercisable at July 31, 2011

1,024,474

 

$4.38

 

2.43

 

Issued

96,218

 

$4.00

 

5.52

Exercised

-

 

-

 

-

Cancelled

-

 

-

 

-

Expired

-

 

-

 

-

Outstanding at October 31, 2011

1,120,692

 

$4.35

 

3.2

Exercisable at October 31, 2011

1,120,692

 

$4.35

 

3.2

Issued

36,000

 

$0.83

 

5

Exercised

(36,000)

 

$0.83

 

-

Cancelled

-

 

-

 

-

Expired

-

 

-

 

-

Outstanding at January 31, 2012

1,120,692

 

$4.35

 

2.94

Exercisable at January 31, 2012

1,120,692

 

$4.35

 

2.94

                         

18


 

 

NOTE 20.  NON-CONTROLLING INTEREST

 

As described in Note 1, to the consolidated financial statements, the Company has the majority controlling interest of L&L Coal Partners, TNI, Tai Fung and DaPing.  During the fiscal year 2010, the Company increased its ownership interest in L&L Coal Partners to 80% from 60% on April 30, 2009.  The equity related to non-controlling interest as of January 31, 2012 represents 20% third party interest in L&L Coal Partners, 2% third party interest in TNI, 2% third party interest in Tai Fung and  40% third party interest in DaPing.

 

Below is a schedule of changes in ownerships interest as of January 31, 2012 and April 30, 2011:

 

   

January 31, 2012

 

April 30,2011

Beginning balance

$

29,530,133

$

12,594,293

Non-controlling interest related to acquisitions

 

-

 

10,391,810

Translation

 

886,776

 

923,351

Net income related to non-controlling interest

 

3,200,280

 

5,620,679

Ending balance

 

33,617,189

 

29,530,133

 

 

NOTE 21.  EARNINGS PER SHARE

 

The Company only had common shares, warrants and stock options issued and outstanding as of January 31, 2012.  Under the treasury stock method of earnings per share, the Company computed the diluted earnings per share as if all issued warrants were converted to common stock and cash proceeds were used to buy back common stock.

 

   

For the Three Months Ended January 31

   

For the Nine Months Ended January 31

   

2012

2011

   

2012

2011

               

Net income attributable to L&L

$

3,859,471

12,584,630

 

$

10,035,299

34,584,003

Number of Shares

 

32,723,159

30,296,064

   

32,093,512

29,490,324

Per Share - Basic

$

0.12

0.42

 

$

0.31

1.17

               

Effect of dilutive shares

$

816,768

722,235

 

$

910,680

692,904

Number of dilutive shares

 

33,539,928

31,018,298

   

33,004,193

30,183,227

Per Share - Diluted

$

0.12

0.41

 

$

0.30

1.15

 

 

19


 

NOTE 22.  COMMITMENTS AND CONTINGENCIES

Operating Lease Commitments

 

The Company has three operating leases:  the Seattle office, Guizhou office and Beijing office.  All are non-cancelable leases, expiring in July 2012, February 2012 and June 2012, respectively. The non-cancelable operating lease agreement requires that the Company pays certain operating expenses, including management fees to the leased premises. The future minimum rental payment in less than a year is $85,533 and there is no future payment in greater than a year.

 

Legal Matters

 

On August 26, 2011, a federal securities law class action complaint was filed against the Company, certain officers and directors (i.e., Dickson V. Lee and Ian G. Robinson) and a former officer (i.e., Jung Mei (Rosemary) Wang) in the United States District Court, Western District of Washington at Seattle on behalf of a class consisting of all persons who purchased the common stock of the Company during the period August 13, 2009 through August 2, 2011, inclusive, and who were damaged thereby (the “Securities Class Action”).  It alleges that the Company filed false and misleading reports with the SEC from August 13, 2009 to August 2, 2011, primarily based upon an amendment the Company filed to its 2010 Annual Report on Form 10-K on July 28, 2010 and a report published by the Glaucus Research Group on August 2, 2011.   On December 15, 2011, the court appointed Gregg Irvin as lead plaintiff, and he filed an amended complaint and second amended complaint on February 8 and March 2, 2012, respectively, naming four other current and former directors as defendants (i.e., Shirley Kiang, Robert Lee, Dennis Bracy and Robert Okun).

 

On November 4, 2011, a complaint was filed by Larew P. Stouffer, an individual, in a derivative suit against the Company as nominal defendant, and against certain existing officers/employees and/or directors (i.e., Dickson V. Lee, Norman Mineta, Ian G. Robinson, Robert W. Lee, Shirley Kiang, Dennis Bracy, Syd S. Peng) and certain former officers and/or directors (i.e., Edward L. Dowd, Andrew M. Leitch, Robert Okun, Joseph J. Borich, Jung Mei Wang and David Lin) in the First Judicial District Court of the State of Nevada for Carson City (the “Stouffer Derivative Suit”).  It mainly alleges that the defendants breached fiduciary duties to the Company and its shareholders, wasted corporate assets by paying certain officers and directors who breached their fiduciary duties, were unjustly enriched by accepting compensation while breaching fiduciary duties, and committed wrongful acts in concerted action. 

 

On November 15, 2011, a complaint was filed by Russell L. Bush, an individual, in a derivative suit against the Company as nominal defendant, and against all existing directors (i.e., Dickson V. Lee, Norman Mineta, Ian G. Robinson, Robert W. Lee, Shirley Kiang, Dennis Bracy, Syd S. Peng) in the United States District Court, Western District of Washington at Seattle (the “Bush Derivative Suit”, with the Stouffer Derivative Suit, the “Derivative Suits”).  It mainly alleges that the defendants breached fiduciary duties by failing to install proper internal control and overseeing system, and were unjustly enriched by accepting compensation while breaching fiduciary duties. 

 

Foreign Currency

 

The majority of the Company sales, purchases and expense transactions are denominated in RMB and most of the Company’s assets and liabilities are also denominated in RMB.  The RMB is not freely convertible into foreign currencies under the current law.  In China, foreign exchange transactions are required by law to be transacted only by authorized financial institutions.  Remittances in currencies other than RMB may require certain supporting documentation in order to affect the remittance.

 

Environmental Remediation

 

The PRC adopted extensive environmental laws and regulations that affect the operations of the coal mining industry.  The outcome of environmental liabilities under proposed or future environmental legislation cannot be reasonably estimated at present, and could be material.  Under existing legislation, however, Company management believes that there are no probable liabilities that will have a material adverse effect on the financial position of the Company.

 

Chinese Government

 

The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America.  These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange.  The Company’s results may be adversely affected by changes in the governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversions and remittance abroad, and rates and methods of taxation, among other things.

 

Concentrations

 

For the nine months ended January 31, 2012, we had three major customers who purchased 42% of the Company’s total sales, and represented $14,240,757of AR balance in total as at January 31, 2012. In addition, we had two major suppliers who provided 26% of our total purchases, and received a net advance of $1,066,333 from the Company as at January 31, 2012

 

Acquisition of Weishe Coal Mine

 

On January 28, 2012, the Company entered into the Weishe Coal Mine Equity Ownership Transfer Agreement (the “Agreement”) with Guizhou Union Energy, Inc., a Chinese corporation (“Union”), Guizhou Union Capital Investment Holding Co., Ltd., a Chinese corporation (“Union Capital”), and Mr. Guo Xu Zhang, a Chinese citizen (“Mr. Zhang”), to purchase 51% of the equity ownership interest of Weishe Coal Mine.

 

Under the Agreement, the purchase price for 51% of the ownership interest in Weishe Mine is about US$7.9 million, which will be paid in full by issuing 3,000,000 shares of common stock of the Company (“LLEN Stock”).  The 3,000,000 shares of LLEN Stock will be paid to Union or a designee of Union.

 

The company has determined that control had not been obtained as of January 31, 2012 and has therefore not consolidated the accounts as of period end.

 

20


 

 

NOTE 23.  STOCK INCENTIVE PLAN

 

On September 9, 2010, our Board of Directors adopted the 2010 Stock Incentive Plan (the “2010 Plan”), which was approved by our shareholders at our annual meeting of the shareholders held on the same date. On February 17, 2011, the company filed S-8 Registration Statement. The Stock Incentive Plan authorizes the Board of Directors or one or more of its members to grant options to eligible individuals to purchase shares of common stock our Company to eligible individuals.  Eligible individuals may be employees, non-employee members of the Board or the board of directors of any Parent or Subsidiary, and consultants who provide valuable service to us or our Parent or Subsidiary. Options to purchase Common Stock may be incentive stock options, stock units, stock appreciation rights or non-statutory stock options as determined by the Board of Directors or its delegate. 4,200,000 shares of Common Stock were reserved for issuance.

 

Each option agreement specifies the term as to when the option is to become exercisable. Standard options vest at a rate of at least 20% of the underlying shares per year over five years and have a maximum term of 10 years. However, in no event shall an incentive stock option granted to a 10% or greater stockholder be granted at an exercise price less than 110%  of the fair market value of the stock on the date of grant.

 

As of January 31, 2012, no stock option has been granted or vested. No stock option has been exercised.

 

The following table displays the weighted average assumptions that have been applied to estimate the fair value of stock option awards on the date of grant for the three months ended January 31, 2012:

 

   

2012

Dividend yield

 

-

Risk-free interest rate

 

2.17%

Expected volatility

 

156.61%

Expected lives

 

5 years

 

(1)     Expected Life: The expected life was determined based on the option’s contractual term and employees’ expected early exercise and post-vesting employment termination behavior

 

(2)     Risk Free Rate: The risk-free interest rate was based on U.S. Treasury yields with a remaining term that corresponds to the expected term of the option calculated on the granted date.

 

(3)     Expected Volatility: Expected volatility is computed based on the standard deviation of the continuously compounded rate of return of days when the stock price changed over the historical period of the expected life of the options.

 

(4)     Dividend Yield: The expected dividend yield is zero.  The Company has not paid a dividend and does not anticipate paying dividends in the foreseeable future.

 

Stock compensation expense was recognized based on awards expected to vest. FASB ASC Topic 718 requires forfeiture to be estimated at the time of grant and revised in subsequent periods, if necessary, if actual forfeitures differ from those estimates.

 

The following summarizes pricing and term information for options outstanding as of January 31, 2012:

 

   

Options Outstanding

Range of

 

Total Options Outstanding

 

Weighted Average Remaining Life (Years)

 

Weighted Average Exercise Price

Exercise Prices

 

 

 

     

 

$

7.65

   

40,000

 

4.09

 

$

7.65

                   

 

As of January 31, 2012, all stock options outstanding for compensation were exercisable. The weighted-average grant-date fair value of options granted during the year ended April 30, 2011 was $7.06.  

21


 

 

The following table is a summary of stock option activity under the Stock Incentive Plan as of January 31, 2012 and changes for the year then ended:

 

 

 

Incentive Stock Options

 

Weighted Average Exercise Price Per Share

 

Weighted Average Remaining Life (Years)

 

 

 

 

 

 

 

Outstanding at May 1, 2010

 

-

 

$

-

 

-

Granted

 

40,000

 

$

7.65

 

-

Exercised

 

-

 

$

-

 

-

Canceled

 

-

 

$

-

 

-

Outstanding at January 31, 2012

 

40,000

 

$

7.65

 

4.09

 

 

 

 

 

 

 

 

Exercisable at January 31, 2012

 

40,000

 

$

7.65

 

4.09

 

 

 

 

22

 


 

 

NOTE 24.  SEGMENT INFORMATION

The Company reports its operations primarily through the following reportable operating segments: coal mining, coal wholesaling, coking coal washing revenue. The Company’s chief operating decision maker uses operating income as the primary measure of segment profit and loss.

 

For the three months ended January 31,

 

For the nine months ended January 31,

                       

Total Revenues (including intersegment sales)

2012

 

2011

 

2012

 

2011

Coal mining revenue

$

9,253,214

 

$

20,659,192

 

$

29,378,795

 

$

57,896,500

Coal wholesale revenue

 

5,282,647

   

11,158,461

   

14,597,277

   

21,728,398

Coking revenue

 

4,468,356

   

7,370,934

   

18,502,143

   

22,138,270

Coal washing revenue

 

13,787,124

   

33,772,936

   

51,508,199

   

94,928,894

 

$

32,791,341

 

$

72,961,523

 

$

113,986,414

 

$

196,692,062

                       
                       

Intersegment revenues

2012 *

 

2011 *

 

2012

 

2011

Coal mining revenue

$

-

 

$

-

 

$

-

 

$

-

Coal wholesale revenue

 

-

   

-

   

-

   

-

Coking revenue

 

-

   

-

   

-

   

-

Coal washing revenue

 

2,598,653

   

7,066,939

   

5,286,580

   

18,049,853

 

$

2,598,653

 

$

7,066,939

 

$

5,286,580

 

$

18,049,853

                       
                       

Net revenues

2012

 

2011

 

2012

 

2011

Coal mining revenue

$

9,253,214

 

$

20,659,192

 

$

29,378,795

 

$

57,896,500

Coal wholesale revenue

 

5,282,647

   

11,158,461

   

14,597,277

   

21,728,398

Coking revenue

 

4,468,356

   

7,370,934

   

18,502,143

   

22,138,270

Coal washing revenue

 

13,787,124

   

33,772,936

   

51,508,199

   

94,928,894

Less intersegment revenues

 

(2,598,653)

   

(7,066,939)

   

(5,286,580)

   

(18,049,853)

 

$

30,192,688

 

$

65,894,584

 

$

108,699,834

 

$

178,642,209

                       
                       

Net income attributable to L&L

2012

 

2011

 

2012

 

2011

Coal mining

$

3,114,807

 

$

10,714,862

 

$

10,084,786

 

$

29,355,763

Coal wholesale

 

313,765

   

630,008

   

1,064,802

   

1,495,816

Coking

 

748,443

   

849,776

   

2,241,891

   

2,671,069

Coal washing

 

1,549,880

   

3,093,659

   

5,387,423

   

8,673,779

Parent Company

 

(1,867,424)

   

(2,703,675)

   

(8,743,603)

   

(7,612,424)

 

$

3,859,471

 

$

12,584,630

 

$

10,035,299

 

$

34,584,003

                       
                       

Depreciation expense

2012

 

2011

 

2012

 

2011

Coal mining

$

720,235

 

$

898,849

 

$

3,247,189

 

$

3,619,170

Coal wholesale

 

14,935

   

135,674

   

45,309

   

363,817

Coking

 

85,670

   

75,937

   

240,387

   

714,085

Coal washing

 

294,289

   

270,925

   

901,498

   

768,185

Parent Company

 

74,367

   

108,743

   

209,997

   

415,543

 

$

1,189,496

 

$

1,490,128

 

$

4,644,380

 

$

5,880,800

                       
                       

Total assets

2012

 

2011

 

2012

 

2011

Coal mining

$

162,098,819

 

$

107,342,023

 

$

162,098,819

 

$

107,342,023

Coal wholesale

 

17,923,098

   

16,202,458

   

17,923,098

   

16,202,458

Coal coking

 

11,154,846

   

9,068,552

   

11,154,846

   

9,068,552

Coal washing

 

47,748,196

   

32,354,311

   

47,748,196

   

32,354,311

Parent Company (intercompany)

 

9,866,855

   

11,166,018

   

9,866,855

   

11,166,018

 

$

248,791,814

 

$

176,133,362

 

$

248,791,814

 

$

176,133,362

 

*Reclassification

23


 

 

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 the Company. 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.

 

 

 

 

24


 

 

Overview

 

We produce, process, and sell coal in the People’s Republic of China (“PRC”) and also have a financial interest in the Bowie Mine, a U.S. thermal coal mine located in Paonia, Colorado.  Our vertically integrated coal operations include five mines, three coal washing plants, one coking facility, and several coal wholesale and distribution facilities in the southwest region of China.  Our operations are located in inland China (Yunnan and Guizhou Provinces), which is being developed at a faster rate than the coastal areas which have historically received most of the government’s focus.

 

We sell the coal we produce, or acquire through wholesalers, who sell to end users in China and to other wholesalers. We were initially founded in 1995 by Dickson Lee, an American citizen and current Chairman and CEO, 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 located in China, which interest we disposed of 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 are incorporated in Nevada and headquartered in Seattle, WA 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, including three of our officers, and many are bilingual. After being a public reporting company since 2001, we commenced trading on the NASDAQ Global Market in February 2010.

 

There are several relevant macro-economic factors directly impacting our operating environment in China, including GDP growth and inflation. While the Chinese government targeted GDP growth for 2011 at 8%, according to the World Bank, China’s GDP growth was projected to expand 9.1 percent in 2011.  On March 5, 2012, Chinese premier Wen Jiabao set the GDP growth target at 7.5% for 2012.  Coupled with projected inflation of 5.3 percent, the PRC has tightened their fiscal policies including letting interest rates rise and capping prices of certain domestically-produced commodities like coal. The result has been higher demand for coal for power and steel production to fuel GDP growth and coal shortages due to the capping of coal prices.

 

Coal will continue to be a key component of the PRC’s energy policy. According to the U.S. Energy Information Administration, coal makes up 70% of China’s total primary energy consumption and China is both the largest consumer and producer of coal in the world.  In 2010, China accounted for over 48% 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 that lack the economies of scale and resources needed to maximize production capacity. Mining companies in China have been unable to produce enough coal to meet China’s growing coal demands, and as a result the PRC has allowed China to become a net importer of coal and has implemented a national policy of consolidation to increase production capacity and improve efficiency and safety at coal mines in China. Begun during the 11th five-year plan, the policy of government-mandated consolidation has continued with the current 12th five-year plan, which expands and accelerates the consolidation to new provinces including Guizhou.

 

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 to 300,000 tons per year per mine, 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 fewer. 

·         Second, safety standards and safety enforcement activity will continue to rise .  For example, a mine accident in a county will often result in a temporary idling or slowdown 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. 

 

Soon after the distribution of Guizhou Province’s policy, Liupanshui City Government, which is the local government of Pan County where our Ping Yi and DaPing Mines operate, issued their implementation policy.  In addition to Guizhou Province, we also anticipate and are prepared for the consolidation policy  eventually to be implemented and accelerated in Yunnan Province. 

25


 

 

Because the coal consolidation plan is government-mandated, and given the lessons learned from other provincial coal consolidations, we believe our relationship with the provincial and local governments will be a key competitive advantage for the Company. After meetings between the Company and the Vice Governor of Guizhou Province with responsibility for natural resources and the Guizhou Energy Bureau Chief, Vice Governor Sun GuoQuiang provided written and oral encouragement and support to the Company to become a leader in Guizhou’s consolidation efforts. In order to support our Guizhou operations, we established a new branch office in Guiyang City, which is the capital of Guizhou province, in July, 2011.  On October 13, 2011, the Company also received a letter from the local Pan County government (Pan Shan) in Guizhou Province supporting our participation in the five-year coal consolidation plan.  On February 16, 2012, Company executives met with Guizhou Provincial Governor Zhao KeZhi, who commended the Company’s leadership and participation in the Guizhou coal consolidation process.  Among the Guizhou government officials who participated were the Director of the Guizhou Department of Commerce X.Q Shen, Deputy Director of the Guizhou Department of Commerce Sun Dengfeng, Vice Secretary General of the Guizhou Provincial People’s Government Gang Li, and the Director General of Office of Foreign Affairs Yao Shoulun and his Deputy Director G.D. Chen.

 

We believe that the accelerated government-mandated consolidation of the coal industry in Guizhou Province is an attractive opportunity for the Company. Coal consolidators will be limited to those now participating in Guizhou, which creates a proprietary opportunity for the Company. And as safety standards and enforcement increase, the Company believes that its dedication to safety through training, improving technology, transferring U.S. mine safety knowledge, and expending adequate capital will be a competitive advantage. We believe that being publicly traded gives the Company access to additional sources of capital not available to most competitors.  Finally, we believe that being publicly traded on NASDAQ may attract some potential strategic partners who may help to accelerate the Company’s acquisition and organic growth efforts. 

 

As a result of increasing individual mine production standards and the accelerating consolidation policy, our coal operations have grown significantly in the last six years, primarily through acquisitions, and more recently from expanding production capacity at existing mines.  In 2006 we acquired a coal consolidator and wholesaler, KMC Wholesale and Distribution, with over ten years experience in coal operations.  In 2008, we acquired an interest in L&L Coal Partners, which owns and operates two operating coal mines -- the DaPuAn mine and SuTsong mine -- in Yunnan Province.  In May 2009, L&L Coal Partners completed the construction of a coal washing plant located at the DaPuAn mining facility, also in Yunnan Province.  In January 2010, we acquired our third coal mine -- the Ping Yi mine -- and in June 2010 completed the construction of a coal washing plant located near our Ping Yi mine, both in Guizhou Province.  In February 2010, we acquired the ZoneLin coking operation in Yunnan Province.   In February 2011, we entered into an exclusive agreement to market coal from U.S. supplier Bowie Resources in Colorado to certain countries in Asia, and in March 2011, we acquired a 60% interest in another coal mine, the DaPing mine in Guizhou Province.  In January 2012, we entered into an agreement acquiring 51% controlling interest of the Weishe mine in Guizhou Province, which will have an initial capacity of 150,000 tons per year and is expected eventually to expand to 400,000-450,000 tons per year.  Coupled with the completion of expansion plans for all of the Company’s other mines, we expect eventually to produce a total of 1,650,000 tons per year in both Yunnan and Guizhou Provinces. The acquisition has not been completed as of January 31, 2012.

 

Unlike the Company, many small mine operators who are uncertain of their future under the Guizhou accelerated consolidation and the Yunnan consolidation, have tried to maximize their gain in the short term by pushing their production beyond their capacity while reducing expenditures for safety.  This has resulted in increasing the number of mining accidents, sometimes with high numbers of fatalities.  In turn, the provincial and local governments have responded by ordering temporary idling or slowdowns of mines in the region for safety inspections or safety briefings.  Some choose to operate illegally during the idling or slowdown periods.  Others when allowed to produce again push even harder to make up for lost production.  This behavior coupled with the complicated geology of the Yunnan and Guizhou regions contributes to a higher risk for mining accidents.  In Yunnan Province alone, there were over 40 mining accidents in 2011, a 33% increase from 2010.  This cycle is consistent with the earlier consolidation in other provinces.  Therefore, we believe that the Company will continue to experience periodic to frequent idling or production slowdowns until the consolidation process reaches critical mass and closes down small or high risk mines that have not been acquired by a consolidator.  Together with disruptions from increasing regulatory and safety compliance and making frequent safety improvements, these actions may have a corresponding negative impact on production volumes and revenues.

 

We derive our revenues from selling coal to customers, mainly State Owned Enterprises (SOE) in Yunnan and Guizhou Provinces.  Our thermal or steam coal is sold to SOEs that are utilities that generate electricity.  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 factory.  Our coal is also sold to cement makers, who use coal to heat the kilns necessary to produce cement.  

26


 

 

Plan of Operations

 

The Company is a vertically integrated coal operator participating in the business of consolidation of a fragmented coal industry in Yunnan and Guizhou Provinces of southwest China. We plan to expand our coal business two ways: first, through expansion of existing operations in accordance with the consolidation policy, and second, through continued acquisitions of operations that lack the capital and management skills to expand to meet the minimum capacity required by the government.  Additional plans for operations for expanding our coal business includes expanding our coal wholesale operations into Guizhou, pursuing strategic partnerships, exploring viable options for raising capital with an emphasis on debt and other non-dilutive instruments, and strengthening our team.

 

Organic Growth.  We acquire producing mines that lack the capital and management expertise to expand to meet the minimum government-mandated production requirement, and then we provide the management expertise and fund the needed capital expenditures for each acquisition to expand their production capacity and improve safety. Most coal mines in Southwest China, including our mines, use the conventional/traditional mining method, under which the coal seam is broken up by explosives and then the coal is gathered and loaded on to shuttle cars, which are winched to the surface loading area by a cable and rail system.  In lieu of shuttle cars, the Company uses conveyer systems, which are much more efficient and safer than shuttle cars.  We also drill additional shafts in some of our mines to increase safety, operational efficiency, and improve the working environment.  While our mines continue to use timber to reinforce mine shafts, the Company has improved safety by using steel and hydraulic braces to reinforce the support the roof of the mine.  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.

 

In addition to simple infrastructure improvements, we improve our production and safety by introducing basic management practices like increasing the working hours by expanding the operation from one shift to multiple shifts and work teams, and using production incentives and bonuses as part of our team’s compensation package.  Our mine operations have instituted regular safety training for our 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 our five mines, all of which are producing more than when we acquired them and are on their way to meeting the current 300,000 tons a year government-mandated minimum annual production requirement. For example, for the two mines which the Company has owned the longest, and have had the most time to work on our expansion plans, DaPuAn mine’s production increased from 121,159 tons in FY2009 to 245,545 tons per year in FY2011 and SuTsong mine’s production increased from 83,852 tons in FY2009 to 122,081 tons in FY2011. 

 

The value and revenue of some of our mined coal is increased by coal washing.  The Company is expanding the capacity of our coal washing facilities, in particular Ping Yi and Hong Xing, both of which wash other mines’ coal.  We are also planning on expanding the capacity of our ZoneLin coking factory, which processes other mines’ coal.

 

Given the increasing frequency of the government-ordered idling or slowdown of mines in the areas the Company operates in, we have been fully compliant with provincial and local government authorities.  During these periods, the Company continues to expand the capacity of our mines and improve the safety of our mines.   When approved for production, we have been producing to a capacity that avoids the risk of any accidents, generally to the capacity of our approved mining permit instead of near the capacity of our mining permit application to increase the specific number of tons of coal that can be extracted from our mines each year.  In the past, the government has allowed the Company to produce more than the existing permit allows but less than the amount applied for in the application.

 

Acquisitive Growth.  We believe that the current consolidation policy in China will continue and thus create more acquisition opportunities for us.  The Company will also need to accelerate the rate of acquisitions and increasing consideration of acquiring larger mines in order to comply with the government-mandated consolidation targets for holding companies.  Our focus in the short term will be taking advantage of unique opportunities to acquire mines due to the accelerated government-mandated consolidation policy in Guizhou Province. The process includes negotiating and signing memorandums of understanding and letters of intent with mines that meet our criteria. Our preferred criteria includes 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 or mines and therefore must now join a holding company that controls coal production between 800,000 tons and 2,000,000 tons depending on where in Guizhou they operate. We then send in a team to inspect the mine, evaluate the management, and perform extensive due diligence. Based on the analysis of our inspection team, we target and negotiate to acquire the best mines. Thus far, our acquisition team has attained signed letters of intent with 14 producing mines in Guizhou Province and will continue to evaluate and target further mines for acquisition.  We may not acquire all the mines that we have signed letters of intent for.

27


 

Our inspection team is led by Dr. Syd Peng and was in China at the end of our second fiscal quarter and the start of our fourth fiscal quarter to inspect, assess, and supervise the acquisitions.  Dr. Peng and the inspection team have physically inspected a significant number of potential mines for acquisition and have recommended the Company pursue the acquisition of several of mines.  Our teams are currently focused on extensive due diligence of these potential acquisitions in preparation for upcoming negotiations.  In addition to mines that meet our preferred criteria, we have been inspecting larger mines with production near 300,000 tons or more, have considerable proven coal reserves, better geology, and strong management teams already in place.  When further development is well executed, larger mines require less capital expenditure to expand capacity.  Better geology, especially thicker coal seams, promotes greater efficiency.  Strong management teams are integral to better safety and allow for scaling up operations more quickly.  Mines with these characteristics are on the market more frequently than in the past because the government implementation of the Guizhou consolidation plan announced in the spring of 2011 has started to change the local market.  As a result, the Company will put a higher priority on larger mines while continuing to explore existing mines that meet our preferred criteria.

 

Other.  In addition to acquiring mines, the Company established a new coal wholesale operation DaXing L&L Coal Company.  With approval from the government, DaXing has begun developing additional coal storage space and growing its distribution network.  Our subsidiary is expected to generate revenue early in 2012 and through its sourcing of coal, introduce potential mine acquisitions to the Company in a similar manner as KMC.  DaXing recently entered into a joint sales agreement with two strategic partners. The first is China Chengtong Metal Tianjin Company, a wholly owned subsidiary of CCMC, a large China state owned enterprise specializing in coal and metal trading throughout northern China and Inner Mongolia.  The second is Tianjin Fuhao Industrial Co. Ltd. Both companies agree to source and sell one million tons of coal each with the Company in calendar 2012.

 

In addition, the Company is also exploring strategic partnerships that can accelerate our ability to grow organically and acquisitively and has signed a memorandum of understanding with Tianjin Fuhao Industrial Co. Ltd to explore strategic opportunities to expand and enhance the value of both companies. Tianjin Fuhao is a major coal wholesaler and logistics company in Northern China and is a wholly owned subsidiary of Tianjin Materials and Equipment Co., which ranks 57th among China’s top 500 enterprises with recent revenues of over $16 billion.

 

We may need to raise additional capital to acquire additional profit making operations.  To assist the government-mandated consolidation of the coal industry, the provincial government has made debt financing available for up to 70% of the purchase price of each mine acquisition through commercial banks for government-supported consolidators.  On September 26, 2011, the Company received a letter of endorsement from the Industrial and Commercial Bank of China stating that the Corporate Banking Department of the Guizhou Province Branch is willing to support our plan of consolidation.  The bank has indicated that it will provide up to 50% financing for acquisitions for a period of time no greater than five years subject to due diligence on each acquisition. 

 

The Company will continue to recruit talented professionals to strengthen our team at the board, officer, and management levels.  Our board is composed mostly of independent directors who are predominately U.S. citizens.  Their experience ranges from a leader in clean energy to a former member of Congress and cabinet secretary of the U.S. Department of Commerce and the U.S. Department of Transportation.  We recently recruited a world renowned expert in coal mining who had chaired the Department of Mine Engineering at West Virginia University.  Officers include the founder of the Company, a Chief Financial Officer who was a partner with Ernst &Young, two former senior White House staffers, one of whom is also the former Director of the United States Mint.  We have recruited key managers to augment our legal, accounting, and operations departments in both the United States and China. 

 

The Company’s immediate mission is to become a leading coal energy company in the coal-rich Yunnan and Guizhou Provinces. By meeting the government-mandated production targets for each holding company in Guizhou, we believe that the Company’s production capacity will increase from the current goal of 600,000 tons per year to 2,000,000 tons per year by end of 2013.

28


 

Results of Operations

 

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

 

   

Three Months Ended January 31,

 

Nine Months Ended January 31,

   

2012

 

2011

 

2012

 

2011

 

  

Amount

% of Revenue

  

Amount

% of Revenue

  

Amount

% of Revenue

  

Amount

% of Revenue

Revenues

$

30,192,688

100%

$

65,894,584

100%

$

108,699,834

100%

$

178,642,209

100%

Cost of revenue

  

21,421,144

71%

  

44,504,406

68%

  

79,343,401

73%

  

119,374,564

67%

Gross profit

 

8,771,544

29%

 

21,390,178

32%

 

29,356,433

27%

 

59,267,645

33%

Selling general & administrative

  

3,371,035

11%

  

4,879,844

7%

  

13,300,828

12%

  

13,743,393

8%

Interest expense (income)

45,760

0%

 

285,359

0%

 

(260,895)

0%

 

456,827

0%

Other expense (income)

  

(160,387)

-1%

  

(444,341)

-1%

  

1,088,447

1%

  

(852,459)

0%

Provision for income taxes

  

618,140

2%

  

2,147,548

3%

  

1,992,474

2%

  

6,337,053

4%

Net Income Attributable to Non-controlling interest

 

1,037,525

3%

 

1,937,138

3%

 

3,200,280

3%

 

4,998,828

3%

Net income

$

3,859,471

13%

$

12,584,630

19%

$

10,035,299

9%

$

34,584,003

19%

 

Revenue

The following table presents revenues by operating segment:

 

 

Three Months Ended

 

Increase (Decrease)

 

January 31,

 

to Revenues

 

2012

2011

 

$

%

                 

Coal Mining

$

9,253,214

$

20,659,192

 

$

(11,405,978)

-55%

Coal Wholesale

 

5,282,647

 

11,158,461

   

(5,875,814)

-53%

Coal Washing

 

11,188,471

 

26,705,997

   

(15,517,526)

-58%

Coal Coking

 

4,468,356

7,370,934

 

(2,902,578)

-39%

Total Revenues

$

30,192,688

$

65,894,584

 

$

(35,701,896)

-54%

                 
 

Nine Months Ended

 

Increase (Decrease)

 

January 31,

 

to Revenues

 

2012

2011

 

$

%

                 

Coal Mining

$

29,378,795

$

57,896,500

 

$

(28,517,705)

-49%

Coal Wholesale

 

14,597,277

 

21,728,398

   

(7,131,121)

-33%

Coal Washing

 

18,502,143

 

22,138,270

   

(3,636,127)

-16%

Coal Coking

46,221,619

76,879,041

 

(30,657,422)

-40%

Total Revenues

$

108,699,834

$

178,642,209

 

$

(69,942,375)

-39%

*Reclassification

29


 

In the first quarter of FY2012, regional slowdowns and idling of mines by the Chinese government in both Guizhou and Yunnan provinces significantly reduced our revenues and earnings.  In the second quarter of FY2012, the Company made considerable progress improving production in Yunnan Province but a major accident in a mine near our Ping Yi and DaPing mines in Guizhou Province prolonged our efforts to establish normal production.  Even with the continued setback in Guizhou, our mining production increased from approximately 69,000 tons in Q1 to 91,000 tons in Q2.

 

In this third quarter of FY2012, our mines produced 67,000 tons.  This reduction was mostly the result of two temporary setbacks which the Company does not anticipate will affect Q4 of FY2012.  First, as reported prior, a major accident in early Q3 very near our DaPuAn mine caused our mine’s production to drop over 50% in Q3.  However, the Chinese government notified the Company that DaPuAn mine passed its safety inspection in early Q4 and was approved to ramp up production.  Secondly, the Chinese New Year holiday traditionally results in a two week idling of nearly all businesses throughout China, and impacted the Company’s quarterly revenues approximately 15%.  Because the majority of Chinese New Year had occurred in Q3, the holiday will have a minimal impact on Q4.

 

Therefore our net revenues decreased from $65.9 million during the three months ended January 31 2011 to $30.2 million during the three months ended January 31, 2012, representing approximately a 54% decrease. The decrease was primarily due to the government’s temporary slowdown and idling of all mines in our region, including our mines, and the Chinese New Year holiday.  This reduced the sources and volume of coal available for our coal washing, coking, and wholesale and distribution segments and decreased our production in our mines.    Second quarter to the third quarter revenues decreased 27.8% from $41.8 million to $30.2 million The revenue decline was partially slowed because the shortage of coal in the regions we operate due to mine slowdowns and idling resulted in an increase in the price customers paid per ton of coal.  By January 2012, DaPuAn, Su Tsong, and DaPing mines were ramping up production to the capacity of our approved mining permit rather than near the capacity of our mining permit application to increase the specific number of tons of coal that can be extracted from our mines each year.  Only Ping Yi mine remains uncertain.  Barring unforeseen accidents at nearby mines that may result in slowdowns or idling in the regions we operate in, the current organic production forecast for Q4 anticipates a strengthening quarter in FY2012 and that FY2013 will likely exceed FY2012.

   

Coal Mining. During the three months ended January 31, 2012, our coal mining net revenues decreased by $11,405,978 approximately a 55% decrease compared to the three months ended January 31, 2011. Similar to the fourth quarter of the fiscal year 2011 and first and second quarters of fiscal year 2012, this sales decrease was due to the lack of coal inventory caused mainly by the government mandated temporary slowdown and idling of all the mines in the regions we operate in.  During the fiscal year of 2012, Yunnan and Guizhou Provinces experienced an increase in the number of mining accidents.  For example, from May to September, there were 40 fatal accidents in Yunnan Province (10 more than the same period of last year), which led the provincial and local governments to order the slow down the production or temporary idle our mines frequently. Of note, there was a gas explosion that killed 10 miners at Guohekou mine in Pan County in Guizhou Province on August 14, 2011, which is located 10 miles from our Ping Yi mine.  Also, at least 34 miners were killed a gas explosion at Sizhuang Coal Mine in Sezone County in Yunnan Province on November 10, 2011, which is located two miles from our DaPuAn mine.  Sizhuang mine was operating illegally and was ordered by the provincial coal safety supervision bureau to stop production in April of 2011. Even though our coal mines had no accidents, the disruptions caused by government safety inspections have had a significant impact on our production and thus our revenue. 

 

DaPuAn mine was open marginally more in Q2 than in Q1 and was able to increase production by 16% from Q1 to Q2 before being ordered by the government to slowdown production in November due to the Sizhuang mine accident. As a result, DaPuAn mine’s production decreased 46% from November to December.  However, DaPuAn mine’s production increased 26% from December to January.  Further, DaPuAn mine passed the government safety inspection mid-February and was approved to begin ramping up production.

 

SuTsong mine produced 8% less in Q3 than in in Q2 due to frequent government ordered slowdowns due to nearby mine accidents and is currently in production.

 

Da Ping mine was approved for trial production in August and produced approximately 8,500 tons before being idled by the government order in September due to the nearby Guohekou mine accident.  Aside from the August trial production in Q2, Da Ping produced a small amount of coal as a byproduct of upgrading and expanding its production capacity and the development of a second shaft. Beginning in November 2012, Da Ping has progressed from idled to slowdown status, resulting in increasing production 51% from Q2 to Q3, which is the highest quarterly production since the Company acquired the mine.

 

Ping Yi mine opened briefly in August after being granted temporary permission to trial produce and was able to produce 13,000 tons during the August trial period, before being idled again because of a fatal accident at nearby Guohekou mine.  Ping Yi continues to be idled and produces a moderate amount of coal as a byproduct of expanding its production capacity during the idling. In addition, the dismissal of some local government officials has complicated the resumption of normal production.

 

 

30


 

Wholesale revenues decreased by 53% during the three months ended January 31, 2012 compared to the three month ended January 31, 2011.  This was due to the volume of sales dropping because of decreased supplies of raw coal and fine coal resulting from the government mandated temporary slowdowns and idling of coal mines in the regions we operate.  The Chinese New Year holiday also negatively impacted this segment due to closures of one to two weeks during the end of Q3..

 

Coal washing revenue decreased by 58% during the three months ended January 31, 2012 compared to the three month ended January 31, 2011 because government mandated temporary slowdowns and idling of coal mines in the regions we operate led to decreased supply of raw coal to our washing facilities. The Chinese New Year holiday also negatively impacted this segment due to closures of one to two weeks during the end of Q3.

 

Coal Coking revenue decreased by 39% due to the government mandated temporary slowdowns and idling of coal mines in the county our coking facility operates, which resulted in limited supply of fine coal to our coking facility.  The Chinese New Year holiday also negatively impacted this segment due to closures of one to two weeks during the end of Q3.

 

Gross Profit

 

Our gross profit percentage in this quarter decreased to 29% from 32% of the same quarter last fiscal year mainly as a result of the government-mandated temporary coal-mine slowdowns and idling that have significantly reduced our revenue from the coal mining segment, which has historically been the Company’s most profitable business segment.  The corresponding change in product/segment mix and the relatively stagnant fixed costs accordingly have reduced the gross profit of the current period.

 

Selling general & administrative

 

Total selling, general, and administrative expense were increased from 7% to 11% during the three months ended January 31, 2012 compare to the same period in 2011. This result is mostly due to the continuing investment on expanding the operation capacity of DaPing Coal Mine and Ping Yi Mine during the idling and slowdown periods.

 

Provision for income taxes

 

 

Three Months Ended January 31,

 

Nine Months Ended January 31,

   

2012

 

2011

   

2012

 

2011

Net income before income taxes

$

5,515,136

$

16,669,316

 

$

15,228,053

$

45,919,884

Provision for income taxes

618,140

 

2,147,548

   

1,992,474

 

6,337,053

Effective tax rate

 

11.21%

 

12.88%

   

13.08%

 

13.80%

 

 

Our provision for income taxes decreased from the three months ended January 31, 2011 to the three months ended January 31, 2012, primarily as a result of decreased in net income.

 

Our effective tax rate remains at around 13% relative to net income before income taxes during the nine months ended January 31, 2012 compared to the same period in 2011.

 

 

31


 

 

Net Income Attributable to Common Stockholders

 

The following table presents net income attributable to common stockholders:

 

   

Three Months Ended January 31,

 

 Increase (Decrease) to Income

   

2012

2011

 

 $

 %

Net income from continued operations (before non-controlling int.)

$

4,896,996

14,521,768

 

(9,624,772)

-66.28%

Less: Net income attributable to non-controlling interests

1,037,525

1,937,138

 

(899,613)

-46.44%

Net income attributable to Common shareholders

$

3,859,471

12,584,630

 

(8,725,159)

-69.33%

             
   

Nine Months Ended January 31,

 

 Increase (Decrease) to Income

   

2012

2011

 

 $

 %

Net income from continued operations (before non-controlling int.)

$

13,235,579

39,582,831

 

(26,347,252)

-66.56%

Less: Net income attributable to non-controlling interests

3,200,280

4,998,828

 

(1,798,548)

-35.98%

Net income attributable to Common shareholders

$

10,035,299

34,584,003

 

(24,548,704)

-70.98%

 

The decrease of our net income from continued operations before non-controlling interests was due to government-mandated temporary coal-mine slowdowns and idling, Regarding the net income attributable to non-controlling interests, we acquired DaPing coal mine on April, 2011 and obtained 60% of its ownership, and this acquisition has diluted our percentage of the total net income attributable to common shareholders.  During the three months ended January 31, DaPing coal mine had accounted for  25% of our net income from continued operations before non-controlling interests, which increased the percentage of net income attributable to non-controlling interests to net income from continued operations before non-controlling interest and led to a lower net income attributable to common shareholders.

32


 

 

Liquidity and Capital Resources

 

The following factors affected the Company’s liquidity and capital resources:

 

Net cash provided by operating activities was $18,960,237 for the nine months ended January 31, 2012.  For the nine months ended January 31, 2011, net cash flow provided by operating activities was $35,791,706.  The decrease in cash inflow during the current quarter is due to decrease in net income that mainly due to temporary slowdown of our mines in Guizhou and Yunnan Province. Raw coal production in Yunnan Province slowdown was influenced by the Sizhuang accident in November of 2011 and therefore raw coal production slowed down as consequence. The shortage of raw coal supply forces our washing facilities to slow down the production, as well as the coking factory. Furthermore, during this quarter, due to the Chinese New Year we temporarily paused our operation for a week according to the government’s holiday policy, which also affected our business.

 

Net cash used in investing activities was $19,105,847 during the nine months ended January 31, 2012, compared to $44,576,725 used in investing activities during the same period in 2011. The decrease in cash outflow is due to decrease of cash used for construction-in-progress and property and equipment purchase.

 

Net cash provided by financing activities was $2,096,743 during the nine months ended January 31, 2012, compared to $5,348,982 was used during the same period in 2011.  The decrease of cash inflow was caused by no warrants converting to common stock during this period compared to the proceeds from the conversion of $4.7 million in the same period of last year.

 

We will need to raise additional capital to expand our operations, both to fund additional investments in capital equipment and technology to increase production and improve safety at our existing facilities and to acquire additional profit making operations.

 

Off-Balance Sheet Arrangements:

 

The Company does not have any off-balance sheet financing arrangements.

 

Contractual Obligations

 

As of January 31, 2012, we were contractually obligated to inject capital per our purchase agreements as follows: 

 

 

Total

Less than 1 year

1-2 years

3-5 years

After 5 years

DaPuAn & SuTsong Mines

$

5,027,746

$

-

$

-

$

5,027,746

$

-

L&L Yunnan Tianneng Industry

 

4,000,000

 

-

 

4,000,000

 

-

 

-

DaPing Coal Mine

 

15,321,963

 

15,321,963

 

-

 

-

 

-

Tai Fung

 

1,455,120

 

-

 

1,455,120

 

-

 

-

Total

$

25,804,829

$

15,321,963

$

5,455,120

$

5,027,746

$

-

 
* See note 22 Commitments and Contingencies sub-heading acquisition of Weishe Mine.

33


 

 

Critical Accounting Policies and Estimates 

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires our management to make assumptions, estimates and judgments that affect the amounts reported, including the notes thereto, and related disclosures of commitments and contingencies, if any.  We have identified certain accounting policies that are significant to the preparation of our financial statements.  These accounting policies are important for an understanding of our financial condition and results of operation. Critical accounting policies are those that are most important to the portrayal of our financial conditions and results of operations and require management's difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.  Certain accounting estimates are particularly sensitive because of their significance to financial statements and because of the possibility that future events affecting the estimate may differ significantly from management's current judgments.  We believe the following critical accounting policies involve the most significant estimates and judgments used in the preparation of our financial statements.

 

Our critical accounting policies are discussed in “Management's  Discussion and Analysis or Plan of Operation” in our Annual Report on Form 10-K for the year ended April 30, 2011 and Quarterly Reports on Form 10-Q for the quarter ended July 31 and October 31. Those critical accounting policies remained unchanged at January 31, 2012.

 

Item 3.   Quantitative and Qualitative Disclosures about Market Risk

 

While our reporting currency is the U.S. Dollar, 100% of our consolidated revenues and consolidated costs and expenses are denominated in Renminbi (“RMB”). Substantially all of our assets are denominated in RMB.  As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between the U.S. Dollar and the RMB.  If the RMB depreciates against the U.S. dollar, the value of our RMB revenues, earnings and assets as expressed in our U.S. dollar financial statements will decline.  We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.

 

Despite there being a coal shortage due to the continued growth of the Chinese economy, which has in turn led to upward movement of coal prices, market risks do exist if the market demand situation in China changes.

 

Item 4.   Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Based on an evaluation under the supervision and with the participation of the Company’s management, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”) were effective as of January 31, 2012 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms and (ii) accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control Over Financial Reporting

 

The Company, with the assistance of our independent internal controls consultant, has for some time now  proceeded to make specific changes to address the deficiencies of our internal controls. The company has continued  to improve its  internal controls that have materially affected  our controls  including those  internal controls over financial reporting  as follows:

 

1.            Improved the design and documentation related to multiple levels of review over financial statements included in our SEC forms 10-Q and 10-K;

2.            Expanded the design and assessment test work over the monitoring function of entity level controls;

3.             Enhanced documentation retention policies over test work related to our continuous management assessments of internal control effectiveness;

4.            Expanded documentation practices and policies related to various key controls to provide support and audit trails for both internal management assessment as well as external auditor testing; and

5.            Improved the design and documentation related to multiple levels of review over financial statements included in our quarterly SEC form 10-Q.

Since April 30, 2011, the Company has also completed the necessary improvements to our internal controls with the assistance of independent internal controls consulting firm and from comments received from our auditors while in the performance of their annual audit and reviews of our quarterly filings. Further, our internal control consultants conducted extensive internal controls testing in the following areas: equity grants and stock administration, financial reporting (including impairment testing, period end reconciliation, and financial reporting), IT general and application controls (security and access, capturing and processing information, end user computing, data backup and restoration), and each internal control tested effective.  Also the company employs a team of in-house internal control audit personnel. The Company believes that all deficiencies will be fully remediated by the reporting period of April 30, 2012.

34


 

 

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

 

We are not currently a party to any legal proceedings in material nature and we are not aware of any material pending legal proceeding to which any of our officers, directors, or any beneficial holders of 5% or more of our voting securities are adverse to us or have a material interest adverse to us, other than the legal proceeding described below:

 

On August 26, 2011, a federal securities law class action complaint was filed against the Company, certain officers and directors (i.e., Dickson V. Lee and Ian G. Robinson) and a former officer (i.e., Jung Mei (Rosemary) Wang) in the United States District Court, Western District of Washington at Seattle on behalf of a class consisting of all persons who purchased the common stock of the Company during the period August 13, 2009 through August 2, 2011, inclusive, and who were damaged thereby (the “Securities Class Action”).  It alleges that the Company filed false and misleading reports with the SEC from August 13, 2009 to August 2, 2011, primarily based upon an amendment the Company filed to its 2010 Annual Report on Form 10-K on July 28, 2010 and a report published by the Glaucus Research Group on August 2, 2011.   On December 15, 2011, the court appointed Gregg Irvin as lead plaintiff, and he filed an amended complaint and second amended complaint on February 8 and March 2, 2012, respectively, naming four other current and former directors as defendants (i.e., Shirley Kiang, Robert Lee, Dennis Bracy and Robert Okun).

 

On November 4, 2011, a complaint was filed by Larew P. Stouffer, an individual, in a derivative suit against the Company as nominal defendant, and against certain existing officers/employees and/or directors (i.e., Dickson V. Lee, Norman Mineta, Ian G. Robinson, Robert W. Lee, Shirley Kiang, Dennis Bracy, Syd S. Peng) and certain former officers and/or directors (i.e., Edward L. Dowd, Andrew M. Leitch, Robert Okun, Joseph J. Borich, Jung Mei Wang and David Lin) in the First Judicial District Court of the State of Nevada for Carson City (the “Stouffer Derivative Suit”).  It mainly alleges that the defendants breached fiduciary duties to the Company and its shareholders, wasted corporate assets by paying certain officers and directors who breached their fiduciary duties, were unjustly enriched by accepting compensation while breaching fiduciary duties, and committed wrongful acts in concerted action. 

 

On November 15, 2011, a complaint was filed by Russell L. Bush, an individual, in a derivative suit against the Company as nominal defendant, and against all existing directors (i.e., Dickson V. Lee, Norman Mineta, Ian G. Robinson, Robert W. Lee, Shirley Kiang, Dennis Bracy, Syd S. Peng) in the United States District Court, Western District of Washington at Seattle (the “Bush Derivative Suit”, with the Stouffer Derivative Suit, the “Derivative Suits”).  It mainly alleges that the defendants breached fiduciary duties by failing to install proper internal control and overseeing system, and were unjustly enriched by accepting compensation while breaching fiduciary duties. 

 

We have notified our insurance carrier of the Securities Class Action and the Derivative Suits, have retained outside legal counsels, and intend to defend these lawsuits vigorously.

35


 

 

Item 1A. Risk Factor

 

You should carefully consider the risks described below together with the other information set forth in this Form 10-Q, which could materially affect our business, financial condition or future results.  The risks described below are not the only risks facing our company.  The risks described below are not the only ones that we face.  Additional risks not presently known to us or that we currently deem immaterial may also affect our business, operating results and financial condition.

Risks Relating to the Company and Our Business

Our business and results of operations depend on the volatile People’s Republic of China domestic coal markets.

Substantially all of our coal business is conducted in the People’s Republic of China (“PRC” or “China”), and as a result, our business and operating results depend on the domestic supply and demand for coal and coal products in China. The domestic coal markets are cyclical and have historically experienced pricing volatility, which reflects, among other factors, the conditions of the PRC and global economies and demand fluctuations in key industries that have high coal consumption, such as the power generation and steel industries. Difficult economic conditions in recent periods have resulted in lower coal prices, which in turn negatively affect our operational and financial performance. For example, after reaching record high levels in 2008, the price of domestic coal in China fell in 2009 due to weakening demand as a result of the global economic downturn. The domestic and international coal markets are affected by supply and demand. The demand for coal is primarily affected by the global economy and the performance of power generation, chemical, metallurgy and construction materials industries. The availability and prices of alternative sources of energy, such as natural gas, oil, hydropower, solar and nuclear power also affect the demand for coal. The supply of coal, on the other hand, is primarily affected by the geographical location of coal reserves, the transportation capacity of coal transportation railways, the volume of domestic and international coal supplies and the type, quality and price of competitors’ coal. A significant rise in global coal supply or a reduction in coal demand may have an adverse effect on coal prices, which in turn, may reduce our profitability and adversely affect our business and results of operations.

Our mining operations are inherently subject to changing conditions that could adversely affect our profitability.

Our coal operations are inherently subject to changing conditions that can adversely affect our levels of production and production costs for varying lengths of time and can result in decreases in profitability. We are exposed to commodity price risk related to the purchase of diesel fuel, wood, explosives and steel. In addition, weather and natural disasters (such as earthquakes, landslides, flooding, and other similar occurrences), unexpected maintenance problems, key equipment failures, fires, variations in thickness of the layer, or seam, of coal, amounts of overburden, rock and other natural materials, variations in rock and other natural materials and variations in geological conditions can be expected in the future to have, a significant impact on our operating results. Prolonged disruption of production at the mine would result in a decrease in our revenues and profitability, which could be material. Other factors affecting the production and sale of our coal and coke that could result in decreases in our profitability include:

·         sustained high pricing environment for raw materials, including, among other things, diesel fuel, explosives and steel;

·         changes in the laws and/or regulations that we are subject to, including permitting, safety, labor and environmental requirements;

·         labor shortages; and

·         changes in the coal markets and general economic conditions.

 

36


 

Our results of operations depend on our ability to acquire new coal mines and other coal-related businesses.

The recoverable coal reserves in mines decline as coal is extracted from them. In addition, the coal related business in China is heavily regulated by the PRC government, which, among other things, imposes limits on the amount of coal that may be extracted. As a result, our ability to significantly increase our production capacity at existing mines is limited, and our ability to increase our coal production will depend on acquiring new mines. Our existing mines are the DaPuAn, SuTsong, Ping Yi, and Da Ping coal mines.

Our ability to acquire new coal mines and to expand production capacity in China and to procure related licenses and permits is subject to approval of the PRC government (including local governments.) Delays in securing or failure to secure relevant PRC government approvals, licenses or permits, as well as any adverse change in government policies, may hinder our expansion plans, which may materially and adversely affect our profitability and growth prospects. We cannot assure you that our future acquisitions, expansions, or investments will be successful.

Furthermore, we cannot assure you that we will be able to identify suitable acquisition targets or acquire these targets on competitive terms and in a timely manner. We may not be able to successfully develop new coal mines or expand our existing ones in accordance with our development plans or at all. We may also fail to acquire or develop additional coal washing and coking facilities in the future. Failure to successfully acquire suitable targets on competitive terms, develop new coal mines or expand our existing coal mines and other coal related operations could have an adverse effect on our competitiveness and growth prospects. Further, the benefits of an acquisition may take considerable time and other resources to develop and we cannot assure investors that any particular acquisition or joint venture will produce the intended benefits. Moreover, the identification and completion of these transactions may require us to expend significant management time and effort and other resources.

If we fail to obtain additional financing we will be unable to execute our business plan.

As we continue to expand our business, we require capital infusions from the capital market. Under our current business strategy, our ability to grow will depend on the availability of additional funds, suitable acquisition targets at an acceptable cost, and working capital. Our ability to compete effectively, to reach agreements with acquisition targets on commercially reasonable terms, to secure critical financing and to attract professional managers is critical to our success. We will require additional funds to complete recent acquisitions, as well as to make future acquisitions, continue improving our current coal mines and other coal processing facilities, and to obtain regulatory approvals for our operations. We intend to seek additional funds through public or private equity or debt financing, strategic transactions and/or from other sources. However, there are no assurances that future funding will be available on favorable terms or at all. If additional funding is not obtained, we will need to reduce, defer or cancel development programs, planned initiatives or overhead expenditures, to the extent necessary. The failure to fund our capital requirements would have a material adverse effect on our business, financial condition and results of operations.

Coal reserve estimates may not be indicative of reserves that we actually recover.

The coal reserves disclosed for the mines from which we have the right to extract coal are the estimated quantities (based on applicable reporting regulations) that under present and anticipated conditions have the potential to be economically mined and processed. However, the amount of coal that we may extract from a given mine is limited by the mining rights granted to us by local governmental authorities. In addition, there are numerous uncertainties inherent in estimating quantities of coal reserves and in projecting potential future rates of coal production including many factors beyond our control. Reserve engineering is a subjective process of estimating underground deposits of reserves that cannot be measured in an exact manner and the accuracy of any reserve estimate is a function of the quality of available data and engineering and geological interpretation and judgment. Estimates of different engineers may vary (e.g., in coal grade and reserve quantity) and results of our mining/drilling and production subsequent to the date of an estimate may justify revision of estimates. Reserve estimates may require revision based on actual production experience and other factors. In addition, several factors including the market price of coal, reduced recovery rates or increased production costs due to inflation or other factors may render certain estimated proved and probable coal reserves uneconomical to exploit and may ultimately result in a restatement of reserves. This may have a material adverse effect on our business, operating results, cash flows and financial condition.

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U.S.-listed companies with substantial business operations in China have recently become subject to increased scrutiny, criticism and negative publicity.

Since 2010, a number of U.S. publicly-listed companies with substantial operations in China have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the United States Securities and Exchange Commission (“SEC”) resulting in loss of share value. Much of the scrutiny and negative publicity has centered around accounting weaknesses, inadequate corporate governance and, in some cases, allegations of fraud. As a result of such scrutiny and negative publicity, the stock prices of most U.S. publicly-listed reverse merger companies and other public companies with operations in China have sharply decreased in recent months.   

 

Our industry is heavily regulated and we may not be able to remain in compliance with all such regulations and we may be required to incur substantial costs in complying with such regulation.

We are subject to extensive regulation by China’s Mining Ministry and by other provincial, county and local authorities in jurisdictions in which our products are processed or sold, regarding the processing, storage, and distribution of our product. Our processing facilities are subject to periodic inspection by national, province, county and local authorities. We may not be able to comply with current laws and regulations, or any future laws and regulations. To the extent that new regulations are adopted, we will be required to adjust our activities in order to comply with such regulations. We may be required to incur substantial costs in order to comply. Our failure to comply with applicable laws and regulations could subject us to civil remedies, including fines, injunctions, recalls or seizures, as well as potential criminal sanctions, which could have a material and adverse effect on our business, operations and finances. Changes in applicable laws and regulations may also have a negative impact on our sales.

Government regulation of our operations imposes additional costs on us, and future regulations could increase those costs or limit our ability to mine, crush, clean, process and sell coal. China’s central, provincial and local authorities regulate the coal mining industry with respect to matters such as employee health and safety, permitting and licensing requirements, air quality standards, water pollution, plant and wildlife protection, reclamation and restoration of mining properties after mining is completed, the discharge of materials into the environment, surface subsidence from underground mining and the effects that mining has on groundwater quality and availability. We are required to prepare and present to China’s central, provincial and local authorities data pertaining to the effect or impact that any proposed processing of coal may have upon the environment. The costs, liabilities and requirements associated with these regulations may be costly and time-consuming and may delay commencement, expansion or continuation of our coal processing operations. The possibility exists that new legislation and/or regulations and orders may be adopted that may materially and adversely affect our operations, our cost structure and/or our customers’ ability to use coal. New legislation or administrative regulations (or judicial interpretations of existing laws and regulations), including proposals related to the protection of the environment that would further regulate and tax the coal industry, may also require us and our customers to change operations significantly or incur increased costs. Certain sales agreements contain provisions that allow a purchaser to terminate its contract if legislation is passed that either restricts the use or type of coal permissible at the purchaser’s plant or results in specified increases in the cost of coal or its use. These factors and legislation, if enacted, could have a material adverse effect on our financial condition and results of operations.

Our business operations and financial results may be adversely affected by present or future environmental regulations, coal industry standards and safety requirements, including recent mine shut downs.

As a producer of coal products in China, we are subject to significant, extensive and increasingly stringent environmental protection laws, governmental regulations on coal standards and safety requirements. These laws and regulations, among other things:

·         impose fees for the discharge of waste substances and pollutants;

·         require the establishment of reserves for reclamation and rehabilitation;

·         impose fines for serious environmental offenses; and

·         authorize the PRC government, at its discretion, to close any facility that it determines has failed to comply with environmental regulations, operating standards, and suspend any coal operations that cause excessive environmental damage. 

Some of our operations are based on traditional, old coal extraction and processing techniques, which are popular in China, and which produce waste water, gas emissions and solid waste materials. The PRC government has tightened enforcement of applicable laws and regulations and adopted more stringent environmental and operational standards. We believe that our coal mining, washing and coking operations comply in all material respects with existing Chinese environmental and safety standards. However, some of our mines were recently subject to what we believe county-wide shut downs and safety inspection of coal mines by the local governments and it remains unclear when or if operations will be resumed to their full production level. If we are unable to resume operations to full production level in a timely manner, our results of operations will be harmed.

In addition, our budgeted amount for environmental and safety regulatory compliance may not be sufficient, and we may need to allocate additional funds for this purpose. If we fail to comply with current or future environmental and safety laws and regulations, we may be required to pay penalties or fines or take corrective actions, any of which may have a material adverse effect on our business operations and financial condition. China is a signatory to the 1992 United Nations Framework Convention on Climate Change and the 1997 Kyoto Protocol, which are intended to limit greenhouse gas emissions. On March 14, 2011, the PRC government approved the Twelfth Five-Year Plan for National Economic and Social Development, which sets goals to decrease the amount of energy consumed per unit of GDP by 16% from 2010 levels, cap energy use at 4 billion tons of coal equivalents by 2015 and reduce the carbon emissions by 17% from 2010 levels by 2015. Efforts to reduce energy consumption, use low-carbon coal, and control greenhouse gas emissions could materially reduce coal consumption, which would adversely affect our revenue and our business.

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We depend on key persons and the loss of any key person could adversely affect our operations.

The future success of our investments in China is dependent on our management team, including Mr. Dickson V. Lee, our Chairman and Chief Executive Officer, and our professional team and advisors. If one or more of our key personnel are unable or unwilling to continue in their present positions, we may not be able to easily replace them, and we may incur additional expenses to recruit and train new personnel. The loss of our key personnel could severely disrupt our business and its financial condition and results of operations could be materially and adversely affected. Furthermore, since the industries we invest in are characterized by high demand and intense competition for talent, we may need to offer higher compensation and other benefits in order to attract and retain key personnel in the future. We cannot assure investors that we will be able to attract or retain the key personnel needed to achieve our business objectives. While Mr. Dickson V. Lee is covered by a one-year term accident insurance policy in China, which is paid for by the Company, we currently do not maintain “key person” life insurance coverage for any of our officers.   

Our business is highly competitive and increased competition could reduce our sales, earnings and profitability.

The coal business is highly competitive in China and we face substantial competition in connection with the marketing and sale of our products. Some of our competitors are well established, have greater financial, marketing, personnel and other resources, have been in business for longer periods of time than we have, and have products that have gained wide customer acceptance in the marketplace. The greater financial resources of our competitors will permit them to implement extensive marketing and promotional programs. We could fail to expand our market share, and could fail to maintain our current share. Increased competition could also result in overcapacity in the Chinese coal industry in general. The coal industry in China has experienced overcapacity in the past. During the mid-1970s and early 1980s, a growing coal market and increased demand for coal in China attracted new investors to the coal industry, spurred the development of new mines and resulted in added production capacity throughout the industry, all of which led to increased competition and lower coal prices. Similarly, an increase in future coal prices could encourage the development of expanded capacity by new or existing coal processors. Any overcapacity could reduce coal prices in the future and our profitability would be impaired.

We may suffer losses resulting from industry-related accidents and lack of insurance.

We operate coal mines and related facilities that may be affected by water, gas, fire or structural problems and earthquakes. As a result, we, like other companies operating coal mines, have experienced accidents that have caused property damage and personal injuries. Although we continuously reviews our existing operational standards, including insurance coverage and have implemented safety measures, fire training at our mining operations and provided on-the-job training for our employees and workers, there can be no assurance that industry-related accidents, earthquakes or other disasters will not occur in the future. The insurance industry in China is still in its development stage, and Chinese insurance companies offer only limited business insurance products. We currently only have work-related injury insurance for our employees at the DaPuAn, SuTsong, Ping Yi, and Da Ping mines and limited accident insurance for staff and miners working in China. Any uninsured losses and liabilities incurred by us could have a material adverse effect on our financial condition and results of operations.

Disruptions to the Chinese railway transportation system and the other limited modes of transportation by which we deliver our products may adversely affect our ability to sell our coal products.

A substantial portion of the coal products we sell is transported to our customers by the Chinese national railway system. As the railway system has limited transportation capacity and cannot fully satisfy coal transportation requirements, discrepancies between capacity and demand for transportation exist in certain areas of the PRC. No assurance can be given that we will continue to be allocated adequate railway transport capacity or acquire adequate rail cars, or that we will not experience any material delay in transporting our coal as a result of insufficient railway transport capacity or rail cars.

Some of our business operations depend on a single transportation carrier or a single mode of transportation to deliver our coal products. Disruption of any of these transportation services due to weather-related problems, flooding, drought, accidents, mechanical difficulties, strikes, lockouts, bottlenecks, and other events could temporarily impair our ability to supply coal to our customers. Our transportation providers may face difficulties in the future that may impair our ability to supply coal to our customers, resulting in decreased revenues.  

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Our continued operations of coal mines are dependent on our ability to obtain and maintain mining licenses and other PRC government approvals for our mining operations.

Unlike land in the United States, much of which is owned by private individuals, the land and underlying minerals in China belongs to the PRC government and is only leased to lessees such as us on a long-term basis, ranging from 40 to 70 years. Further, coal reserves are owned by the PRC government, which issues mining licenses and exclusive mining rights for a particular mine to a mining operator on a long term basis (normally 50 years). This license allows the mining operators to operate and extract coal from the mine. Thus, coal mining licenses are the exclusive evidence of approval of a coal mine’s mining rights by the PRC government. The government charges all mining operators an upfront fee plus a surcharge ranging from 2%-3% of the value of the coal excavated from the ground. There can be no assurances that we will be able to obtain additional mining licenses (including licenses to expand our production capacity at our existing mines) and rights for additional mines or to maintain such licenses for our existing operations. The loss or failure to obtain or maintain these licenses in full force and effect will have a material adverse impact on our ability to conduct our business and on our financial condition. 

Furthermore, the coal industry in China is heavily regulated by the government for safety and operational reasons. Several licenses and permits are required in order to operate a coal mine. These licenses and permits, once issued, are reviewed typically once a year. Failure to comply with such regulations could result in fines or temporary or permanent shutdowns of our mining operations, which would adversely impact our business and results of operations.

Risks inherent to mining could increase the cost of operating our business.

Our coal mining operations are subject to conditions beyond our control that can delay coal deliveries or increase the cost of mining at particular mines for varying lengths of time. These conditions include weather and natural disasters, unexpected maintenance problems, key equipment failures, variations in coal seam thickness, variations in the amount of rock and soil overlying the coal deposit, variations in rock and other natural materials and variations in geologic conditions.

As with all underground coal mining companies, our operations are affected by mining conditions such as a deterioration in the quality or thickness of faults and/or coal seams, pressure in mine openings, presence of gas and/or water inflow and propensity for spontaneous combustion, as well as operational risks associated with industrial or engineering activity, such as mechanical breakdowns. Although we have conducted geological investigations to evaluate such mining conditions and adapt our mining plans to address them, there can be no assurance that the occurrence of any adverse mining conditions would not result in an increase in our costs of production, a reduction of our coal output or the temporary suspension of our operations.

Underground mining is also subject to certain risks such as methane outbursts and accidents caused by roof weakness and ground-falls. There can be no assurance that the occurrence of such events or conditions would not have a material adverse impact on our business and results of operations.

We have not maintained sufficient documentation of our internal control over financial reporting for the year ended April 30, 2010 and 2011, and have identified material weaknesses in our system of internal controls relating to the same.  

We are subject to reporting obligations under the U.S. securities laws. The SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring every public company to include a management report on such company’s internal controls over financial reporting in its Annual Report, which contains management’s assessment of the effectiveness of our internal controls over financial reporting. Our management conducted an assessment of the effectiveness of our internal control over financial reporting as of April 30, 2010 and 2011 concluded that we did not maintain effective controls over the process of ensuring timely preparation of our financial reporting as of and for the fiscal years ended April 30, 2010 and 2011. In addition, our auditor, Kabani & Co. Inc., identified material weaknesses in our system of internal controls relating to the same. During the last two fiscal years, we have taken several steps to improve our internal control procedures, including adding additional internal and external resources. Until we are able to ensure the effectiveness of our internal controls, any material weaknesses may materially adversely affect our ability to report accurately our financial condition and results of operations in a timely and reliable manner. Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future. Effective internal controls, particularly those related to revenue recognition, are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our stock. Furthermore, we anticipate that we will incur considerable costs and use significant management time and other resources in an effort to comply with Section 404 and other requirements of the Sarbanes-Oxley Act. We also expect these developments will make it more difficult and more expensive for us to attract and retain additional members to the board of directors (both independent and non-independent), and additional executives. 

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Risks Related to Doing Business in China

Our Chinese operations pose certain risks because of the evolving state of the Chinese economy and Chinese political, legislative and regulatory systems. Changes in the interpretations of existing laws and the enactment of new laws may negatively impact our business and results of operation.

Although our principal executive office is located in Seattle, Washington, all of our current coal business operations are conducted in China. Accordingly, our results of operations, financial condition and prospects are subject to economic, political and legal developments in China. China’s economy differs from the economies of most developed countries in many respects, including its levels of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. Doing business in China involves various risks including internal and international political risks, evolving national economic policies, governmental policy on coal industry, as well as financial accounting standards, expropriation and the potential for a reversal in economic conditions. Since the late 1970s, the Chinese government has been reforming its economic system. These policies and measures may from time to time be modified or revised. While the Chinese economy has experienced significant growth in the past 20 years, growth has been uneven across different regions and among various economic sectors of China. Furthermore, while the Chinese government has implemented various measures to encourage economic development and guide the allocation of resources, some of these measures may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us. Also, since early 2004, the Chinese government has implemented certain measures to control the pace of economic growth including certain levels of price controls on raw coking coal. Such controls could cause our margins to be decreased. In addition, such measures may cause a decrease in the level of economic activity in China, which in turn could adversely affect our results of operations and financial condition. Adverse changes in economic policies of the Chinese government or in the laws and regulations, if any, could have a material and adverse effect on the overall economic growth of China, and could adversely affect our business operations.

There are substantial uncertainties regarding the application of Chinese laws, especially with respect to existing and future foreign investments in China. Despite China having its own securities laws and regulators, the Chinese legal system is in a developmental stage and has historically not enforced its Chinese securities law as rigidly as their U.S. counterparts. The interpretation and application of existing Chinese laws, regulations and policies, and the stated positions of the Chinese authorities may change and possible new laws, regulations or policies will impact our business and operations. Because of the evolving nature of the law, it will be difficult for us to manage and plan for changes that may arise. China’s judiciary is relatively inexperienced in enforcing corporate and commercial law, resulting in significant uncertainty as to the outcome of any litigation in China. Consequently, there is a risk that should a dispute arise between us and any party with whom we have entered into a material agreement in China, we may be unable to enforce such agreements under the Chinese legal system. Chinese law will govern almost all of our acquisition agreements, many of which may also require the approval of Chinese government agencies. Thus, we cannot assure investors that we will be able to enforce any of our material agreements or that remedies will be available outside China.

Our business is and will continue to be subject to central, provincial, local and municipal regulation and licensing in China. Compliance with such regulations and licensing can be expected to be a time-consuming, expensive process. Compliance with foreign country laws and regulations affecting foreign investment, business operations, currency exchange, repatriation of profits and taxation will increase the risk of investing in our securities.

On April 15, 2011, the Guizhou province of China, in which the Company operates two of its four coal mines, issued a provincial-level notice/order (the “Guizhou Consolidation Policy”) that set forth the following key requirements, among others—by the end of 2013: (i) the total number of coal-mine related business enterprises in the Guizhou province (“Guizhou Coal Enterprise”) shall be limited to no more than 200; (ii) each Guizhou Coal Enterprise in Gui Yang City of Guizhou province shall reach at least the capacity to produce One Million (1,000,000) tons of coal per year; (iii) each Guizhou Coal Enterprise in Liu Pan Shui City of Guizhou province shall reach at least the capacity to produce Two Million (2,000,000) tons of coal per year; (iv) for certain coal mines, the mechanization level for coal-mine development and coal mining shall reach, respectively, 70% and 45% (by the end of 2015, 80% and 55% respectively.)  While the Guizhou Consolidation Policy has opened the door for the Company to acquire/consolidate additional smaller coal mines in the Guizhou province at faster speed and at attractive prices, the Company is also aware that the Company’s current coal-production capacity and mechanization level have not met the requirements set forth in the Guizhou Consolidation Policy, but we intend to work diligently to meet the requirements in the policy by the end of 2013. 

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Restrictions on Chinese currency may limit our ability to obtain operating capital and could restrict our ability to move funds out of China.

The Chinese currency, the Renminbi (RMB), is not a freely convertible currency, which could limit our ability to obtain sufficient foreign currency to support our business operations and could impair the ability of our Chinese subsidiaries to pay dividends or other distributions to us. We rely on the Chinese government’s foreign currency conversion policies, which may change at any time, in regard to our currency exchange needs. We currently receive all of our revenues in Renminbi, which is not freely convertible into other foreign currencies. In China, the government has control over Renminbi reserves through, among other things, direct regulation of the conversion of Renminbi into other foreign currencies and restrictions on foreign imports. Although foreign currencies which are required for “current account” transactions can be bought freely at authorized Chinese banks, the proper procedural requirements prescribed by Chinese law must be met. Current account items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from the Chinese State Administration of Foreign Exchange by complying with certain procedural requirements. However, approval from appropriate government authorities is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies. At the same time, Chinese companies are also required to sell their foreign exchange earnings to authorized Chinese banks and the purchase of foreign currencies for capital account transactions still requires prior approval of the Chinese government. This type of heavy regulation by the Chinese government of foreign currency exchange restricts certain of our business operations and a change in any of these government policies, or any other, could further negatively impact our operations.

Our ownership structure is subject to regulatory controls by the PRC government, including approvals and timely payments in connection with our acquisitions. Failure to obtain such approvals or to timely remit required payments may cause the unwinding of our acquisitions.

On October 21, 2005, the PRC State Administration of Foreign Exchange (“SAFE”) issued a circular (“Circular 75”), effective November 1, 2005, which repealed Circular 11 and Circular 29, which previously required Chinese residents to seek approval from SAFE before establishing any control of a foreign company or transfer of China-based assets or equity for the shares of the foreign company. SAFE also issued a news release about the issuance of Circular 75 to make it clear that China’s national policies encourage the efforts by Chinese private companies and high technology companies to obtain offshore financing. Circular 75 confirmed that the uses of offshore special purpose vehicles (“SPV”) as holding companies for PRC investments are permitted as long as proper foreign exchange registrations are made with SAFE. As China continues to develop its legal system, additional legal, administrative, and regulatory rules and regulations may be enacted, and we may become subject to the additional rules and regulation applicable to the our Chinese subsidiaries.

Our Chinese subsidiaries, Kunming Biaoyu Industrial Boiler Co., Ltd. (“KMC”) and L&L Yunnan Tianneng Industry Co. Ltd. (“TNI”), have been registered as American subsidiaries, and all required capital contributions have been made into them. We own our equity ownership interest in the DaPuAn and SuTsong Mines through a nominee who is a Chinese citizen that holds our equity ownership in trust for our benefit under an agency agreement executed in April 2008, and we refer to the operations as “L & L Coal Partners” Because this equity will be held by a nominee, no SAFE approval is necessary for it. We believe that Circular 75 and other related Circulars or regulations may likely be further clarified by SAFE, in writing or through oral comments by officials from SAFE, or through implementation by SAFE in connection with actual transactions. However, if we fail to obtain the required PRC government approvals for our acquisitions or fail to remit all of the required payments for acquisitions, such acquisitions may be deemed void or unwound. Should this occur, we may seek to acquire the equity interest of our subsidiaries through other means, although no assurance can be given that we will be able to do so, nor can we assure that we will be successful if we do.

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We may have to incur unanticipated costs because of the unpredictability of the Chinese legal system.

The Chinese legal system has many uncertainties. The Chinese legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since 1979, Chinese legislation and regulations have enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently-enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the Chinese legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until sometime after the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.  

It will be difficult for any shareholder to commence a legal action against our executives. Most of our assets are located in China.

Because our directors and officer(s) reside both within and outside of the United States, it may be difficult for an investor to enforce his or her rights against them or to enforce United States court judgments against them if they live outside the United States. Most of our assets are located outside of the United States in China. Additionally, we plan to continue acquiring other energy-related entities in China in the future. It may therefore be difficult for investors in the United States to enforce their legal rights, to effect service of process upon us or our directors or officers, or to enforce judgments of United States courts predicated upon civil liabilities and criminal penalties on us or our directors and officers under federal securities laws. Moreover, China currently does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgments of courts.

We are subject to currency fluctuations from our Chinese operations and fluctuations in the exchange rate may negatively affect our expenses and results of operations, as well as the value of our assets and liabilities.

Effective July 21, 2005, The People’s Bank of China announced that the Renminbi (RMB) exchange rate regime changed from a fixed rate of exchange based upon the U.S. dollar to a managed floating exchange rate regime based upon market supply and demand of a basket of currencies. On July 26, 2005, the exchange rate against the Renminbi was adjusted to 8.11 Renminbi per U.S. dollar from 8.28 Renminbi per U.S. dollar, which represents an adjustment of approximately two percent. As of January 31, 2012, the Renminbi appreciated to approximately RMB 6.31 per U.S. Dollar. It is expected that the revaluation of the Renminbi and the exchange rate of the Renminbi may continue to change in the future. Fluctuations in the exchange rate between the RMB and the United States dollar could adversely affect our operating results. Results of our business operations are translated at average exchange rates into United States Dollars for purposes of reporting results. As a result, fluctuations in exchange rates may adversely affect our expenses and results of operations as well as the value of our assets and liabilities. Fluctuations may adversely affect the comparability of period-to-period results. We do not use hedging techniques to eliminate the effects of currency fluctuations. Thus, exchange rate fluctuations could have a material adverse impact on our operating results and stock prices.

New governmental regulation relating to greenhouse gas emissions may subject us to significant new costs and restrictions on our operations.

Climate change is receiving increasing attention worldwide. Many scientists, legislators and others attribute climate change to increased levels of greenhouse gases, including carbon dioxide, which has led to significant legislative and regulatory efforts to limit greenhouse gas emissions. There are bills pending in Congress that would regulate greenhouse gas emissions. While US regulations are not applicable in China, China has agreed to reduce greenhouse gas emissions per unit of GDP which may reduce the rate of growth in coal consumption in China. Additionally as China begins to implement more stringent environmental and safety regulations our mining and operational costs may increase.   

Failure to comply with the United States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.

We are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some that may compete with us, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in the PRC. We can make no assurance, however, that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.

 

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Risks Related to Our Common Stock

The market price of our stock may be volatile.

The market price of our stock may be volatile and subject to wide fluctuations in response to factors including the following:

·         actual or anticipated fluctuations in our quarterly operating results;

·         changes in financial estimates by securities research analysts;

·         conditions in coal energy markets;

·         changes in the economic performance or market valuations of other coal energy companies;

·         announcements by us or our competitors of new products, acquisitions, strategic partnerships, joint ventures or capital commitments;

·         addition or departure of key personnel;

·         fluctuations of exchange rates between RMB and the U.S. dollar; and

·         general economic or political conditions in China.

In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our stock.   

Our corporate actions are substantially influenced by our principal stockholders and affiliated entities.

Members of our management and their affiliated entities own or have the beneficial ownership right to approximately 30% of our outstanding common shares, representing approximately 30% of our voting power. These stockholders, acting individually or as a group, could exert substantial influence over matters such as approving mergers or other business combination transactions. In addition, because of the percentage of ownership and voting concentration in these principal stockholders and their affiliated entities, elections of our board of directors will generally be within the control of these stockholders and their affiliated entities. While all of our stockholders are entitled to vote on matters submitted to our stockholders for approval, the concentration of shares and voting control presently lies with these principal stockholders and their affiliated entities. As such, it would be difficult for stockholders to propose and have approved proposals not supported by management. There can be no assurances that matters voted upon by our officers and directors in their capacity as stockholders will be viewed favorably by all stockholders of the company.

 

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We have the right to issue additional common stock and preferred stock without the consent of our stockholders. If we issue additional shares in the future, this may result in dilution to our existing stockholders and could decrease the value of your shares.

Our articles of incorporation, as amended, authorize the issuance of 120,000,000 shares of common stock and 2,500,000 shares of preferred stock. Our board of directors has the authority to issue additional shares up to the authorized capital stated in the articles of incorporation. Our board of directors may choose to issue some or all of such shares to acquire one or more businesses or to provide additional financing in the future. The issuance of any such shares may result in a reduction of the book value or market price of the outstanding shares of our common stock. If we do issue any such additional shares, such issuance also will cause a reduction in the proportionate ownership and voting power of all other stockholders. Further, any such issuance may result in a change of control of our company.

Our business strategy calls for strategic acquisitions of additional coal mines and other coal-related businesses. It is anticipated that future acquisitions will require cash and issuances of our capital stock, including our common stock, warrants, preferred shares or convertible bonds in the future. To the extent we are required to pay cash for any acquisition, we anticipate that we would be required to obtain additional equity and/or debt financing from either the public sector, or private financing. Equity financing would result in dilution for our stockholders. Stock issuances and equity financing, if obtained, may not be on terms favorable to us, and could result in dilution to our stockholders at the time(s) of these stock issuances and equity financings.

Our authorized preferred stock constitutes what is commonly referred to as “blank check” preferred stock. This type of preferred stock allows our board of directors to divide the preferred stock into series, to designate each series, to fix and determine separately for each series any one or more relative rights and preferences and to issue shares of any series without further stockholder approval. This authorized preferred stock allows our board of directors to hinder or discourage an attempt to gain control of us by a merger, tender offer at a control premium price, proxy contest or otherwise. Consequently, the preferred stock could entrench our management. In addition, the market price of our common stock could be materially and adversely affected by the existence of the preferred stock.

Certain SEC rules and FINRA sales practices may limit a stockholder’s ability to buy and sell and our stock, which could adversely affect the price of our common stock.

 

The SEC has adopted Rule 15g-9 which generally defines “penny stock” to be any equity security that has a market price (as defined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. If the trading price of our common stock falls below $5.00 per share, the open-market trading of our common stock is subject to the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and “accredited investors”. The term “accredited investor” refers generally to institutions with assets in excess of $5,000,000 or individuals with a net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC, which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer’s confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities. We believe that the penny stock rules discourage investor interest in and limit the marketability of our common stock.

 

In addition to the “penny stock” rules described above, the Financial Industry Regulatory Authority (“FINRA”) has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low priced securities will not be suitable for at least some customers. FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock and have an adverse effect on the market for our shares.

 

Stockholders should have no expectation of any dividends.

The holders of our common stock are entitled to receive dividends only when, as and if declared by the board of directors out of funds legally available therefore. To date, we have not declared nor paid any cash dividends. Our board of directors does not intend to declare any dividends in the foreseeable future, but instead intends to retain all earnings, if any, for use in our business operations.

 

45


 

Item 1B. Unresolved Staff Comments

 

The Company has outstanding unresolved comments from the SEC from a letter it received on January 12, 2012 relating to its Registration Statement on Form S-1 filed with the SEC on December 8, 2011, its Form 10-Q for the fiscal quarter ended October 31, 2011.        

 

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds

 

On August 29, 2011, Dickson Lee, Chairman and CEO of the Company, converted $420,000 of his prior loan to the Company into 49,411 shares of common stock of the Company at the conversion price of $8.50/share.

 

Effective October 28, 2011, the Company issued with Board approval promissory notes (unsecured) to certain accredited investors and employees of the Company in the principal amount of $384,872 (including irrevocable commitment to contribute.)  The proceeds of the notes were used primarily for general business purposes in the U.S.  The notes mature on the 330th day from the dates of receipt of cash contribution from the holders of the notes and the Company may prepay all or any portion of the notes without penalty.  Interest is payable on the unpaid balance of the notes at an annual rate of 10%.  As further consideration for providing this financing, the holders of the notes have also received warrants to purchase an aggregate of 96,218 shares of the Company’s common stock at an exercise price of $4.00 per share (closing price per share of LLEN stock as of October 28, 2011: $2.63).  The warrants expire at the end of the four-year period following the maturity dates of the corresponding promissory notes.  The issuance and sale of the warrants was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.

 

During the period between November 1, 2011 and January 31, 2012, the Company issued a total of10,000 shares of its common stock to accredited investors outside of the U.S. pursuant to Regulation S of the Securities Act of 1933, Rule 506 of Regulation D, and/or Section 4(2) of the Securities Act of 1933 for an aggregate of $25,000.  The first issuance occurred on August 4, 2011.  The proceeds were used primarily for general business purposes in the U.S. 

 

Transaction Date

Invest amount

# of Shares

12/12/2011

$ 25,000

10,000

 

 

During the period between November 1, 2011 and January 31, 2012, the Company issued a total of 100,000 shares of its common stock to an accredited investor in the U.S. pursuant to Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933 for an aggregate of $200,000.  The proceeds were used primarily for general business purposes in the U.S. 

 

Transaction Date

Invest amount

# of Shares

1/10/2012

$ 200,000

100,000

 

Item 3.   Defaults Upon Senior Securities

 

None.

 

Item 4.   Reserved

 

This item was removed and reserved pursuant to SEC Release No. 33-9089A issued on February 23, 2010.

 

Item 5.   Other Information

 

None.

 

Item 6.   Exhibits

 

Exhibit number

Description

31.1

Certification by the Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a)

31.2

Certification by the Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a)

32.1

Certification of the Chief Executive Officer pursuant 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

46


 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

L & L ENERGY, INC.

 

 

 

Date: March 12, 2012

By:

/S/ Dickson V. Lee

 

Name:

Dickson V. Lee, CPA

 

Title:

CEO

 

 

 

 

EXHIBIT 31.1

CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER

I, Dickson V Lee, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of L&L Energy, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;

 

4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have: 

 

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report, based on such evaluation; and

 

d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

 

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

 

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

 

 

L&L ENERGY, INC.