Attached files
file | filename |
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EX-32.1 - China Integrated Energy, Inc. | v178906_ex32-1.htm |
EX-23.1 - China Integrated Energy, Inc. | v178906_ex23-1.htm |
EX-31.2 - China Integrated Energy, Inc. | v178906_ex31-2.htm |
EX-31.1 - China Integrated Energy, Inc. | v178906_ex31-1.htm |
EX-10.36 - China Integrated Energy, Inc. | v178906_ex10-36.htm |
EX-10.35 - China Integrated Energy, Inc. | v178906_ex10-35.htm |
EX-10.38 - China Integrated Energy, Inc. | v178906_ex10-38.htm |
EX-10.40 - China Integrated Energy, Inc. | v178906_ex10-40.htm |
EX-10.37 - China Integrated Energy, Inc. | v178906_ex10-37.htm |
EX-10.39 - China Integrated Energy, Inc. | v178906_ex10-39.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
x
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
Fiscal Year Ended: December 31, 2009
or
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
Transition Period from __________ to __________
Commission
File No. 000-25413
China
Integrated Energy, Inc.
( Exact
Name of Registrant as Specified in its Charter)
Delaware
|
65-0854589
|
(State
or Other Jurisdiction of
Incorporation
or Organization)
|
(I.R.S.
Employer Identification No.)
|
Dongxin
Century Square, 7th
Floor
Hi-Tech
Development District
Xi’an, Shaanxi Province, People’s Republic of
China
|
710043
|
(Address
of Principal Executive Offices)
|
(Zip
Code)
|
Registrant’s
telephone number, including area code: +86-29-8268-3920
Securities
registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.0001
per share
|
NASDAQ Capital
Market
|
(Title of Class)
|
(Name of exchange on which
registered)
|
Securities
registered pursuant to section 12(g) of the Act: None.
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes o No
x
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
preceding 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
o
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes o No o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. ¨
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 ¨
|
Non-accelerated filer (Do not check if a smaller
reporting
company) ¨
|
Smaller reporting company x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes o No
x
The
aggregate market value of 2,291,477 shares held by non-affiliates of the issuer,
based on the last sale price $5.31 of the common stock, as reported on the Over
the Counter Bulletin Board on June 30, 2009, was $12,167,743.
As of
March 22, 2010, there were 33,269,091 shares of the issuer’s common stock, par
value $0.0001 per share, outstanding.
Documents incorporated by
reference: None
TABLE
OF CONTENTS
Page
|
||
PART
I
|
1
|
|
Item
1.
|
Business.
|
1
|
Item
1A.
|
Risk
Factors.
|
20
|
Item
1B.
|
Unresolved
Staff Comments.
|
37
|
Item
2.
|
Properties.
|
37
|
Item
3.
|
Legal
Proceedings.
|
38
|
PART
II
|
39
|
|
Item
4.
|
Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities.
|
39
|
Item
5.
|
Selected
Financial Data.
|
41
|
Item
6.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.
|
41
|
Item
6A.
|
Quantitative and Qualitative Disclosure About Market Risk |
49
|
Item
7.
|
Financial
Statements and Supplementary Data.
|
49
|
Item
8.
|
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure.
|
49
|
Item
8A(T).
|
Controls
and Procedures.
|
49
|
Item
8B.
|
Other
Information.
|
49
|
PART
III
|
50
|
|
Item
9.
|
Directors,
Executive Officers and Corporate Governance.
|
50
|
Item
10.
|
Executive
Compensation.
|
53
|
Item
11.
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters.
|
55
|
Item
12.
|
Certain
Relationships and Related Transactions, and Director
Independence.
|
57
|
Item
13.
|
Principal
Accountant Fees and Services.
|
58
|
PART
IV
|
59
|
|
Item
14.
|
Exhibits,
Financial Statement Schedules.
|
59
|
NOTE REGARDING FORWARD-LOOKING
STATEMENTS
This
Annual Report on Form 10-K contains forward-looking statements. These statements
relate to future events or our future financial performance. We have attempted
to identify forward-looking statements by terminology including “anticipates”,
“believes”, “expects”, “can”, “continue”, “could”, “estimates”, “expects”,
“intends”, “may”, “plans”, “potential”, “predict”, “should” or “will” or the
negative of these terms or other comparable terminology. These statements are
only predictions. Uncertainties and other factors may cause our actual results,
levels of activity, performance or achievements to be materially different from
any future results, levels or activity, performance or achievements expressed or
implied by these forward-looking statements.
PART
I
Item 1.
|
Business.
|
Overview
We are a
leading non-state-owned integrated energy company in China engaged in three
business segments, the wholesale distribution of finished oil and heavy oil
products, the production and sale of biodiesel and the operation of retail gas
stations. Our
primary business segment is the wholesale distribution of finished oil and heavy
oil products. We sell primarily gasoline, diesel and heavy oil in 14 provinces
and municipalities through seven sales offices located in various regions
of China. We also use four oil storage depots located in Shaanxi Province. Of
the four oil storage depots, we own one, lease one and have the rights to use
two of the depots through oil storage service agreements with the state-owned
entities that own such depots. We also have access to a 2.65-kilometer railway
line at our oil storage depot located in Tongchuan City, Shaanxi Province, which
connects to the main railway. We are one of only four non-state-owned
distributors in Shaanxi Province that are licensed to sell both finished oil and
heavy oil products, and are a leading non-state-owned distributor in Shaanxi
Province distributing all grades of gasoline, diesel and heavy oil. We currently
enjoy convenient railway freight access enabling us to reach Sichuan, Guizhou
and Yunnan Provinces. We distributed 158,100 tons and 279,000 tons of finished
oil and heavy oil products in 2008 and 2009, respectively. As a high volume
distributor, we experience high inventory turnover with minimum inventory
exposure, and have therefore been able to maintain a stable margin in our
distribution business despite the volatility of global oil prices. We plan to
grow our wholesale distribution of finished oil and heavy oil business by
increasing our coverage area and further penetrating our existing customers and
territories.
We
operate a 100,000-ton biodiesel production plant located in Tongchuan City,
Shaanxi Province. We believe that we are one of the largest biodiesel producers
in China measured by production capacity as of the end of 2009, and the only
non-state-owned integrated biodiesel producer with a distribution license. We
leverage our wholesale distribution channels to sell our biodiesel to our
existing customers and to acquire new customers. We have been awarded three
patents relating to the use of multiple feedstock interchangeably in biodiesel
production. Our biodiesel feedstock includes non-edible seed oil, waste cooking
oil and vegetable oil residue, most of which have limited alternative uses.
Therefore, our biodiesel production is environmentally friendly and does not
require valuable farmland to grow its feedstock. Our biodiesel can be blended
with regular petro-diesel and used by existing diesel engines with no change in
engine performance. We plan to increase our biodiesel production capacity by
50,000 tons in the next 12 months through construction of a new facility. We
anticipate to complete construction of the new facility by the third quarter of
2010. As a result of the government’s support of bioenergy initiatives, we enjoy
various tax incentives.
We also
operate twelve retail gas stations located in Xi’an City and other areas in
Shaanxi Province, for which we have entered into long-term leases. The average
annual sales volume of each gas station is approximately 8,000 tons, equivalent
to 2.7 million gallons. With our distribution license and stable finished oil
supply, we generate more stable and higher margins from our retail gas stations
than from our wholesale distribution of finished oil and heavy oil business,
since we sell directly to retail end customers. We plan to continue to expand
our portfolio of retail gas stations through leasing or acquisitions. We are
continuously looking for high-traffic locations within and outside of Xi’an City
to add to our retail gas station portfolio.
We have
experienced substantial growth in recent years. Our sales increased to $289.6
million for year ended December 31, 2009 from $216.5 million in the same period
of 2008, representing an increase of 33.8%. Our net income increased to $37.9
million for the year ended December 31, 2009 from $18.7 million in the same
period of 2008, representing an increase of 102.7%.
The
following competitive strengths have been the foundation of our strong
performance, and we expect that they will facilitate our future
growth:
1
Vertically
integrated business model
We are a
leading non-state-owned integrated energy company in China. In 2009, we
distributed 279,000 tons of finished oil and heavy oil products, which made us a
leading wholesale distributor of finished oil and heavy oil products in Shaanxi
Province. We have significant biodiesel production capacity and are the only
non-state-owned integrated biodiesel producer with a distribution license in
China. We began our retail gas station operations in early 2008 and now operate
twelve retail gas stations.
We
believe our vertically integrated business model has the following
benefits:
•
|
Our
existing wholesale and retail distribution channels facilitate sale of our
biodiesel without sacrificing margin to third-party
distributors;
|
•
|
We
have a stable source of supply at lower cost for the production of
biodiesel, better profitability, and enhanced control of our supply chain;
and
|
•
|
Blending
biodiesel with petro-diesel gives us pricing flexibility and a competitive
advantage to gain market share from traditional
distributors.
|
Secured
access to abundant, diversified, and low-cost raw materials for biodiesel
production
We have
access to a stable and diversified source of biodiesel raw materials. In
addition to non-edible seed oil, we also use waste cooking oil and vegetable oil
residue as raw material for biodiesel production. We were awarded three patents
for biodiesel production processes that enable us to use multiple sources of raw
materials interchangeably. We have submitted eight additional patent
applications, of which six have passed the preliminary examination and the other
two have been accepted for review. We maintain a flexible procurement model in
which we adjust the relative quantities of each type of raw material we
purchase, depending on their respective purchase prices, to minimize our raw
material costs. In 2009, non-edible seed oil, vegetable oil residue and waste
cooking oil accounted for approximately 40%, 43% and 17% of our raw material
costs relating to our biodiesel production, respectively.
We are
strategically located in Shaanxi Province in the northwestern region of China,
where the mountainous terrain and abundant sunlight are especially suitable for
planting non-edible oil plants such as Chinese prickly ash, cornel and Chinese
pistache. Shaanxi Province has one of the largest areas of cultivation of
Chinese prickly ash in China. The local farmers in Shaanxi have planted 3.6
million mu, equivalent to 240,000 acres, of Chinese prickly ash and other
non-edible oil plants which represents enough raw materials to produce over
430,000 tons of biodiesel. We have signed raw material purchasing contracts with
local agriculture associations that organize local farmers to harvest and
deliver the non-edible seed oil to us. The purchasing contracts obligate most of
the associations to first offer to sell the feedstock to us. The Shaanxi
Provincial Government plans to permit additional forestlands to be used solely
for the planting of non-edible oil plants. We currently have secured access to
non-edible seed oil for production of approximately 40,000 tons of biodiesel. We
believe the abundant supply of feedstock currently available, in addition to the
non-edible oil plants the government plans to permit farmers to cultivate, is
sufficient for our current needs and will be sufficient for our increasing
demands for raw materials after we increase our production capacity as
planned.
We also
have secured access to vegetable oil residue and waste cooking oil for
production of approximately 60,000 tons of biodiesel through annual contracts
with vegetable oil factories and waste cooking oil collecting
centers.
We
believe our biodiesel feedstock suppliers have a strong incentive to sell their
products to us at competitive prices given that:
•
|
There are very few alternative
uses of non-edible oil seeds, vegetable oil residue and waste cooking
oil;
|
•
|
We are the only non-state-owned
biodiesel producer with commercial scale in northwestern China;
and
|
•
|
We
provide our suppliers with a legitimate means to dispose of waste cooking
oil and vegetable oil residue.
|
2
Established
relationships with our suppliers and customers
We have
been operating in the wholesale distribution of finished oil and heavy oil
business since 1999 and have established strong relationships with our suppliers
and customers. We believe that we have been one of the leading non-state-owned
distributors of finished oil and heavy oil in Shaanxi Province. Our largest
supplier, Shaanxi Yanchang Group, is the fourth largest oil company in China
with over 10 million tons of refinery capacity. We have a long-standing
relationship with Shaanxi Yanchang Group, which includes establishing supply and
purchasing stations with three oil refineries owned by Shaanxi Yanchang Group in
Shaanxi Province.
We focus
on customer satisfaction and believe that we have consistently delivered high
quality products and services to our customers. We believe we have established
our reputation among our customers and are able to maintain long-term
relationships with our customers, as evidenced by our customer retention rate
and the increasing number of new customers. The total number of customers in our
wholesale distribution of finished oil and heavy oil business segment has grown
from 936 in 2008 to 1,180 in 2009. Our sales volume has also
increased significantly over the past three years.
We
believe that both our suppliers and customers prefer to work with us for the
following reasons:
•
|
We are an established player with
a large-scale operation and stable
supply;
|
•
|
We have a strong financial
position and provide flexibility in payment terms;
and
|
•
|
We
have a professional purchase and sales team, which are responsive to
suppliers’ and customers’ needs.
|
Early
mover advantages
We were
one of the first non-state-owned enterprises to engage in the wholesale
distribution of finished oil and heavy oil products in Shaanxi Province. During
the past 10 years, we have gradually built up our operational infrastructure,
including extensive distribution channels, four oil storage depots, and
convenient access to strategic railway lines. We have also obtained relevant
licenses to conduct our wholesale distribution business, which has become
increasingly more difficult for new entrants in our industry to
obtain.
We
believe that being an early mover in this industry has provided us the following
advantages:
•
|
Sales network. We have
sales offices in seven locations with 36 full-time salespersons covering
14 provinces and municipalities in
China.
|
•
|
Storage capability. We
currently use four oil storage depots with total capacity of 59,000 m
3 . We own one of the oil storage
depots, lease one oil storage depot and have the rights to use two oil
storage depots through oil storage service
agreements.
|
•
|
Access
to railway lines. We benefit from convenient access to railway
lines that we use to transport and distribute our oil products from
Shaanxi Province to Yunnan Province, Guizhou Province and Sichuan
Province. We believe that we are currently the only enterprise in Shaanxi
Province that has such a
capability.
|
•
|
Wholesale distribution
license. In June 2000, we were granted a wholesale
distribution license to distribute finished oil products by the State
Economic and Trade Commission. We are now one of the only four
non-state-owned distributors that are licensed to distribute both finished
oil and heavy oil products in Shaanxi
Province.
|
We
believe that our wholesale distribution license and the operational
infrastructure we have built help us to compete effectively and also form a
barrier for any prospective new entrants into our industry.
Experienced
management team with proven track record
We have
an experienced management team led by Mr. Xincheng Gao, our chairman, chief
executive officer and president. Mr. Gao has extensive experience in the
research and marketing of oil products. In 1999, Mr. Gao
founded Xi’an Baorun Industrial Development Co., Ltd. (Xi’an Baorun Industrial)
to process and distribute finished oil and heavy oil products. Prior to founding
Xi’an Baorun Industrial, Mr. Gao worked in the Oil and Chemicals Department of
Shaanxi Province and Zhongtian Oil and Chemical Group, responsible for research
and development and marketing. With Mr. Gao’s vision and leadership, we have
grown from a traditional distributor of finished and heavy oil products to a
leading non-state-owned integrated energy company. Our sales have grown from
$216.5 million in 2008 to $289.6 million in 2009, while net income has grown
from $28.6 million (excluding $9.8 million of non-cash share based compensation
expenses) to $37.9 million over the same period.
3
Most of
the members of our senior management team have worked together since 2005 and
have an average of 10 years of experience in the oil business. We believe our
management team’s in-depth market knowledge and strong track record in the oil
market in China will enable us to take advantage of the anticipated growth in
demand in the energy market.
Our
Growth Strategies
Our key
growth strategies include the following:
Continue
to increase our biodiesel production capacity and improve control of the raw
material supply
We plan
to increase our biodiesel production capacity by 50,000 tons before the end of
2010 through construction of a new facility to supplement the demand for
petro-diesel. We have begun construction to increase capacity in the fourth
quarter of 2009. We anticipate $15 million in capital expenditures to
accomplish this goal. We expect to benefit from the continued
growth in overall energy consumption in China. We believe that we are one of the
largest biodiesel producers in China based on production capacity at the end of
2009 and the only non-state-owned biodiesel producer with a distribution
license. We continue to position ourselves as a leader in terms of capability,
capacity and technology in this young biodiesel industry. Although we have
secured abundant feedstock supply to support our current biodiesel production,
we will continue to work with provincial and local agriculture administrations
and environmental protection agencies for better cooperation and support for
priority purchase of agricultural feedstock, waste cooking oil, and vegetable
oil residue. We also will continue to work with leading universities and
research institutes to develop alternative sources of feedstock to strengthen
our supply chain and cost flexibility for biodiesel raw materials.
Strengthen
our relationship with key suppliers for finished oil and heavy oil and diversify
our supply base
Stability
of supply chain is one of the critical elements of a successful wholesale
distributor of finished oil and heavy oil. We have had a long-term strong
working relationship with Shaanxi Yanchang Group, our largest finished oil and
heavy oil products supplier. We will also continue to maintain good
relationships with other oil suppliers to ensure favorable pricing terms and a
stable supply of oil products. In addition, we are also focused on exploring
opportunities with new suppliers with significant oil resources and better
pricing in different regions to diversify our supply chain and enhance our sales
margin. We have found new vendors in Shandong and Xinjian Provinces to support
our customers in those regions.
Expand
our wholesale and retail distribution network through both organic growth and
potential acquisitions
With
stable and abundant oil supply, we will continue to expand our wholesale
distribution of finished oil and heavy oil products by increasing the number of
our regional sales offices and sales staff in various territories to develop new
markets and a wider customer base. We will also continue penetrating existing
territories to develop new customers and meet increased demand from our existing
customers as their businesses grow. We will continue scouting high traffic
locations to expand our portfolio of retail gas stations to create additional
sales and higher profitability for our overall distribution channels. We foresee
industry consolidation and believe that we are well-positioned to benefit from
such market trends. We are in the position to acquire distressed competitors
with working capital difficulties, if and when opportunities are
presented.
Continue
application process to obtain oil import/export license
In 2008,
we submitted an application for an oil import/export license. The approval
process for this license is lengthy. We will continue working with the
governmental agencies to obtain the license to broaden our business
scope.
Enhance
R&D efforts to improve biodiesel production technology and
efficiency
We will
continue investing resources and working closely with leading universities and
research and development institutes that specialize in agricultural research to
develop new technologies for more efficient and cost-effective
biodiesel production. We will also continue to search for alternative feedstock
to enhance the availability of raw materials and reduce costs of feedstock for
biodiesel production.
4
Material
Risks
We
believe the following are the major risks that may materially affect
us:
|
•
|
We
rely on a limited number of third party suppliers for our supply of
finished oil and heavy oil products and the loss of any such supplier,
particularly our largest supplier, could have a material adverse effect on
our operations.
|
|
•
|
We
are highly dependent on the revenue contribution from our wholesale
distribution of finished oil and heavy oil business segment. A reduction
in sales from this segment would cause our revenues to decline and
materially harm our business.
|
|
•
|
Our
ability to operate at a profit is partially dependent on market prices for
petroleum and biodiesel fuels, which are subject to government control in
the PRC. If petroleum and biodiesel prices drop significantly, we may be
unable to maintain our current
profitability.
|
|
•
|
In
the past we have derived a significant portion of our sales from a few
large customers. If we were to lose any of such customers, our business,
operating results and financial condition could be materially and
adversely affected.
|
|
•
|
Our
legal right to lease certain properties or accept storage services from
third parties could be challenged by property owners, regulatory
authorities or other third parties, which could prevent us from continuing
to utilize our oil storage depots, biodiesel production facility and
retail gas stations, which are located on such leased properties, or could
increase the costs associated with utilizing those
facilities.
|
|
•
|
The
current economic and credit environment could have an adverse effect on
demand for certain of our products and services, which would in turn have
a negative impact on our results of operations, our cash flows, our
financial condition, our ability to borrow and our stock
price.
|
|
•
|
The
distribution of finished oil is primarily dependent on the sufficiency of
necessary infrastructure and access to means of transport, including rail
transportation, which may not be available on a cost-effective basis, if
at all.
|
For a
more detailed discussion of these and other risks that we face, please see “Risk
Factors” on page 20 and other information included in this Annual
Report.
Business
Segments
Wholesale
Distribution of Finished Oil and Heavy Oil Products
Oil
supply
We sell
on a wholesale basis a variety of oil products including gasoline, diesel, heavy
oil and naphtha. Gasoline and diesel represent the majority of oil products
consumed in China. Automobiles are the most important driver of gasoline
consumption in China. Diesel is mainly used in vehicles and agricultural
machines with diesel engines. Heavy oil is broadly used as fuel for ship
boilers, heating furnaces, metallurgical furnaces and other industrial furnaces.
Wholesale distribution of finished oil and heavy oil products accounted for
approximately 67.6% of our total sales in 2009 and approximately 66.3% of our
total sales in 2008
Based on
volume, we purchased approximately 65.5% of our gasoline and diesel oil products
from our top five suppliers in 2009. During 2009, based on cost, we purchased
approximately 30.8% (compared to 52.0% in 2008) of our gasoline and diesel oil
products from Shaanxi Yanchang Group, with whom we have had a strong
relationship since establishing Xi’an Baorun Industrial, which included
establishing supply and purchasing stations with three oil refineries that are
owned by Shaanxi Yanchang Group in Shaanxi Province. While we depend on Shaanxi
Yanchang Group for the majority of our gasoline and oil supply needs, we are
actively seeking other sources of oil supply and believe that we can find
alternative suppliers with comparable terms within a reasonable amount of time
without any significant disruption in our operations.
Storage
We use
four oil storage depots, which in the aggregate have the capacity to store
approximately 59,000 m 3 of oil
products. We constructed one oil storage depot located within our biodiesel
production facility in Tongchuan City, Shaanxi Province, lease one oil storage
depot and have the rights to use two state-owned oil storage depots through oil
storage service agreements. The terms of the lease agreement and the oil storage
service agrements range from two years to eight years and these agreements are
renewable. Average annual rental and service expense of each oil storage depot
is approximately RMB 0.7 million ($0.1 million). Two of the state-owned depots
are located on railways that provide us convenient access for distributing our
products. We also have access to a 2.65-kilometer railway track connecting the
oil storage depots located within our biodiesel production facility to the main
railway in Tongchuan City, Shaanxi Province.
5
Sales
and Marketing
We
developed a stable sales network for our products in 14 provinces, including
Shaanxi, Henan, Hebei, Shandong, Shanxi, Hunan, Hubei, Jiangxi, Guizhou, Yunnan,
Fujian and Xinjiang; and two municipalities, Beijing and Shanghai. We now employ
36 full-time salespersons in sales offices located in Chengdu City, Yingbuo City
in Shandong Province and the cities of Yanglian, Lingtong, Shangqiao,
Chengxiang, and Yongpin in Shaanxi Province. As our business expands, we intend
to further expand our sales network and develop more sales channels. For our
wholesale distribution of finished oil and heavy oil business segment, we plan
to increase our distribution to an additional two provinces in the next 18
months, adding additional salespersons and establishing more regional sales
offices. We plan to increase our sales volume through increasing our
distribution footprint and further penetrating existing customers and business
territories.
Customers
We
currently sell our finished oil and heavy oil products to regional distributors
in China that supply to retail service stations and directly to end users
through our retail gas stations. We have adopted different terms for payment
based upon the financial strength of the customer. For example, we have entered
into agreements with PetroChina, SINOPEC, and other state-owned enterprises
whereby we deliver products to agreed-upon locations and these customers agree
to pay us after delivery. However, we require partial pre-payment in advance and
cash on delivery from our customers that operate distributorships or own and
operate private gas stations. These customers typically pay 10% to 15% of the
total purchase price of the products to be delivered in
advance, and when delivery takes place, they pay the remaining amounts owed. In
2008 and 2007, there was no customer that accounted for 10% or more of our
sales. We did not experience any uncollectible accounts receivable or bad debt
write-offs over the past three years.
For the
year ended December 31, 2008 and 2009, our top five customers purchased
approximately $49.3 million and $113.2 million of our products,
representing approximately 22.8% and 39.1% of our sales during the period,
respectively. China Petroleum and Chemical Corporation Chuanyu Trading Co.,
Ltd., our largest customer, accounted for approximately 26.6% of our sales in
2009.
Competition
We are
one of the only four non-state-owned enterprises licensed to distribute both
finished oil and heavy oil products in Shaanxi Province. Although barriers to
entry in our industry are high due to stringent licensing requirements and the
need for significant storage capacity for products, we face competition from
companies located in other provinces and within Shaanxi Province that also
engage in the wholesale distribution of finished and heavy oils. Such companies
may have greater financial resources, sales resources, storage capacity and
transportation capacity than we do, and may have exclusive supply and purchase
arrangements with suppliers as a result of long-term relationships.
In
addition to SINOPEC and PetroChina, we estimate that we have approximately ten
major non-state-owned competitors in Shaanxi Province that also distribute
finished oil products similar to ours, including Shaanxi Dongda Petro-Chemical
Co., Ltd., Shaanxi Dayun Petrochemical Material Co., Ltd. and Baoji Huahai
Industry Corp.
We
believe we have the following advantages over our competitors in this
market:
•
|
Oil wholesale distribution
license. In June 2000, we were granted a wholesale distribution license to
distribute finished oil products by the State Economic and Trade
Commission. We are now one of the only four non-state-owned distributors
that are licensed to distribute both finished oil and heavy oil products
in Shaanxi Province.
|
•
|
Supply advantage. Shaanxi
Yanchang Group, one of the four largest qualified crude oil and gas
exploration enterprises in China, is our largest oil supplier. In Shaanxi
Province, we are one of the only few entities that have established
supplying and purchasing stations with Shaanxi Yanchang
Group.
|
•
|
Railway access. We benefit from
convenient access to a railway line in Shaanxi Province to distribute our
oil products. We believe we are currently the only enterprise in Shaanxi
Province that has railway access to distribute oil products directly to
Yunnan, Guizhou and Sichuan
Provinces.
|
•
|
Storage capability. We have an
aggregate oil depot storage capacity of 59,000 m 3 . Aside from the need for strong
funding support, new entrants to this industry must also have significant
storage capacity to be able to compete, which is a barrier to entry for
new competitors.
|
6
Production
and Sale of Biodiesel
Production
In 2006,
we built a 10,000 square meter biodiesel production facility with annual design
capacity of 100,000 tons. We commenced production at this facility in October
2007. The production of biodiesel is achieved through the effective performance
of all equipment necessary for production. Initial production in 2008 required
adjustments to equipment and a full debugging process. Our achievable
utilization rate, after taking into account required periodic maintenance, is
90%. We plan to increase production capacity by 50,000 tons through construction
of a new facility in the next 12 months. We anticipate to complete construction
of the new biodiesel production facility by the third quarter of
2010.
Raw
Material Supply
We have
access to a range of biodiesel raw materials. Besides non-edible seed oil, we
can also use waste cooking oil and vegetable oil residue as raw material for
biodiesel production. We have signed raw material purchasing contracts with
local associations such as Tongchuan City Chinese Prickly Ash Association, the Forestry Bureau of Yongshou County, the Forest and Fruits
Production Managing Station of Danfeng County, the Forestry Bureau of Ningqiang
County and the Forestry Bureau of Liuba County, some of which are governmental
entities. These associations organize local farmers to plant and harvest oil
plants. The purchasing contracts obligate most of the associations to first
offer to sell the feedstock to us. If the supply of feedstock is greater than
our demand, they can then sell any remaining feedstock to other
companies.
Shaanxi
Province is one of the largest cultivators of Chinese prickly ash, an oil plant,
in China. Together, the local farmers in Shaanxi Province have planted
approximately 2,560,000 mu (equivalent to 173,000 acres) of Chinese prickly ash,
850,000 mu (equivalent to 57,000 acres) of cornel and 150,000 mu (equivalent to
10,000 acres) of Chinese pistache. Even though we could satisfy all of our
current feedstock demands solely with Chinese prickly ash, we diversify our
feedstock supply with other oil plants, waste cooking oil and vegetable oil
residue, because the costs of these raw materials are lower than Chinese prickly
ash. There is also significant acreage of wild oil plants that grow throughout
Shaanxi Province. However, because the feedstock available from the local
associations currently satisfies our supply demands, we do not rely on any
supplies of wild oil plants for our production needs. We believe that the
abundant supply of feedstock currently available in Shaanxi Province is
sufficient for our current needs and will be sufficient for our expanded demands
for raw material once we expand our biodiesel production facility or acquire a
new facility.
We have
established cooperation relationships with two pre-processing factories for oil
extraction from non-edible oil seeds or oil plant seeds.
Sales
and Marketing
We
continue to leverage our distribution infrastructure to sell our biodiesel to
existing customers and to acquire new customers. The main advantages of
biodiesel over petro-diesel are pricing, efficiency, safety (due to a higher
flash point) and the fact that biodiesel is environmentally friendly. Our
targeted markets are power plants, marine transportation companies, seaport
operations and other industrial customers which consume large volumes of diesel
fuel.
Customers
We
primarily target oil product trading companies in China (i.e., sales
subsidiaries of SINOPEC and PetroChina) and end users (i.e., gas stations,
electric power companies and shipping companies) as our customers. Approximately
20% of the biodiesel we produce is blended with petro-diesel and sold to next
tier oil distributors and gas stations. The remaining 80% is sold to power
plants and marine transportation companies. We do not believe that our sales are
affected by seasonality.
7
Competition
Currently,
we are the only non-state owned biodiesel producer with a distribution license
in China. We may face significant competition from current and future companies
that intend to compete in the biodiesel market. In the area of biodiesel fuel
production, we are not aware of the existence of any significant competitors in
Shaanxi Province. However, we face competition from companies in other
geographic areas in China and foreign competitors that export their biodiesel to
China.
We
believe that we have the following advantages over our competitors in this
market:
•
|
Stable supply of
feedstock. We have a stable source of various types of
feedstock for biodiesel production, such as Chinese pistache and Chinese
prickly ash. Some local governments have agreed to first offer their
feedstock to us. We have also entered into agreements with four Xi’an City
EPA-designated waste cooking oil processing companies to secure needed
waste cooking oil at favorable
prices.
|
•
|
Production
capacity. We estimate that the production output of biodiesel
in China will be approximately 800,000 tons in 2010. Gushan Environmental
Energy and our company are currently the only two companies in China with
annual production capacity of at least 100,000 tons. We plan to increase
our biodiesel production capacity by 50,000 tons through construction of a
new facility prior to the end of 2010. To that end we began
construction to increase capacity during the fourth quarter of
2009.
|
•
|
Stable
distribution channels. We have established sales networks and
channels and strong industrial relationships with our customers. Under the
Measures on the
Administration of the Finished Oil Market , only companies that
obtain a Finished Oil Wholesale Distribution License are permitted to
distribute biodiesel on a wholesale basis. Because Xi’an Baorun Industrial
has a Finished Oil Wholesale Distribution License, we are able to produce
and distribute biodiesel on a wholesale basis while other biodiesel
producers must rely on distributors that have obtained Finished Oil
Wholesale Distribution Licenses to distribute their products. Since
biodiesel and petro-diesel share the same market, we can distribute our
biodiesel through our existing distribution channels to reduce
costs.
|
8
Operation
of Retail Gas Stations
We sell
all grades of gasoline and diesel at our twelve retail gas stations. Our
customers include automobile, bus and truck drivers. Our competitors are other
privately owned and state-owned gas stations. Our advantages are that (i) as a
well-established finished oil distributor, we have a stable and sufficient oil
supply to support our retail gas station operations at a higher margin; (ii) we
sell blended diesel with a blending ratio of 15.0% of biodiesel and 85.0% of
petro-diesel to end customers at the same price as petro-diesel, which provides
us with additional profitability from our retail gas station operations, and
(iii) we maintain competitive pricing to attract customers. We will seek to
continue to expand our retail gas station portfolio.
Other
Business Information
Research
and Development
•
|
On December 18, 2005, we entered
into an agreement with Xi’an Petroleum University for the technology
transfer of operating processes for blending finished oil products,
related chemical formula and related composition. The contract is valid
for ten years.
|
•
|
On February 20, 2006, we entered
into an agreement with Xi’an Petroleum University for research and
development of biodiesel production. We own the patent for any biodiesel
production technology that results from this
arrangement.
|
•
|
On September 4, 2006, we entered
into an agreement with Beijing Qingda Kema Technology Co., Ltd. for
research and development of biodiesel production processes, chemical
composition of catalyst, and transfer of technical know-how to
us.
|
•
|
On
January 4, 2007, we entered into an agreement with Northwest A & F
University for research and development and technical assistance for
improvement of processing raw materials, including waste cooking oil,
non-edible seed oil and cooking oil residue, for biodiesel
production.
|
We own
three utility model patents and have submitted eight other patent applications,
of which six invention patent applications have passed preliminary examination
and two utility model patent applications have been accepted for review. In
practice, we propose the subject matter to be researched and pursuant to these
agreements we entrust our research and development partners to perform the
research and analysis and provide advanced technology services. We incurred
approximately $55,000 and $38,000 in research and development expenditures for
2008 and 2009, respectively.
Intellectual
Property
Our core
technologies consist of: (i) know-how technologies to improve the quality of
finished oil and heavy oil products, and (ii) three utility model patents
related to biodiesel production. We do not have patent protection for our
know-how technologies and our eight patent applications are pending approval
from the SIPO.
Between
2006 and 2009, we filed the following 11 patent applications listed below with
the SIPO, all of which are related to our biodiesel production. The SIPO has
approved the first three applications for utility model patents, allowed the
next six invention patent applications to pass preliminary examination and
accepted the remaining two utility model patent applications for
review.
•
|
Application No. 200820221671.0
for a new gas-liquid distributor of material filling
tower
|
•
|
Application No. 200620137855.X
for a new reaction vessel for preparing biodiesel and composite
diesel
|
9
•
|
Application No. 200620137854.5
for a new reaction equipment for preparing
biodiesel
|
•
|
Application No. 200610152508.9
for a biodiesel processing
technique
|
•
|
Application No. 200610152506.X
for a new composite catalyst for preparing
biodiesel
|
•
|
Application No. 200610152507.4
for a new technology for processing biodiesel with catalyst or splitting
decomposition in liquid or gas
face
|
•
|
Application No. 200810017853.0
for a new technique for disposing biodiesel esterification reaction
equipment with inert metal
lead
|
•
|
Application No. 200810017849.4
for a new method for preparing biodiesel with supercritical
technology
|
•
|
Application No. 20081001784.8 for
a new technique for producing biodiesel and its byproducts with molecular
distillation
|
•
|
Application No. 200820028705.4
for an anti-corrosion device for biodiesel esterification
reaction
|
•
|
Application
No. 200820221682.9 for a new kind of material filling
tower.
|
We have
patent protection for each of our utility model patents for a period of ten
years from the date of filing. If our invention patents are approved, they will
be valid for a period of 20 years from the date of filing. Upon expiration, the
renewal process requires us to re-apply for patent protection.
We
developed technologies for the production of biodiesel jointly with the Xi’an
Petroleum University and Northwest A & F University. We developed our
proprietary technology for the production of biodiesel jointly with Beijing
Qingda Kema Technology Co., Ltd. and we were permitted to use this technology
under a contract dated September 4, 2006. We have the right to use the oil
mixing technology developed by Xi’an Petroleum University for ten years under a
contract entered into on December 18, 2005.
We
maintain property insurance for some of our premises and accidental liability
insurance. We do not have any business liability, interruption or litigation
insurance coverage for our operations in China. Although it is available,
insurance companies in China offer limited business insurance products. We have
determined that the risks of interruption, cost of such insurance and the
difficulties associated with acquiring such insurance on commercially reasonable
terms make it impractical for us to purchase such insurance. Therefore, we are
subject to business and product liability exposure. Business or product
liability claims or potential regulatory actions could materially and adversely
affect our business and financial condition. We maintain director and officer
liability insurance for our directors and executive officers.
Environmental
Matters
We
believe that we are in compliance with present environmental protection
requirements in all material respects. Our production processes generate noise,
waste water, gaseous wastes and other industrial wastes. We have installed
various types of anti-pollution equipment in our facilities to reduce, treat,
and where feasible, recycle the wastes generated in our production process. Our
operations are subject to regulation and periodic monitoring by local
environmental protection authorities.
Employees
As of
December 31, 2009, we had 229 full-time
employees. Among them, 69 of our employees worked at our Xi’an headquarters; 53
at our biodiesel production facility in Tongchuan City; 35 at our oil storage
depots and 72 at our retail gas stations;. We believe we have good relationships
with our employees.
Legal
Proceedings
We may be
subject to legal proceedings, investigations and claims incidental to the
conduct of our business from time to time. We are not currently a party to any
legal proceedings. We are also not aware of any legal proceeding, investigation
or claim, or other legal exposure that could have a material adverse effect on
our business, financial condition or results of operations.
10
Industry
and Market Overview
China
Oil Markets
Industry
Overview
According
to the U.S. Energy Information Administration, China’s crude oil proven reserves
stood at approximately 16,000 million barrels at the end of 2008. Despite its
abundant oil resources, the country faces a huge imbalance between oil supply
and demand among its different regions. China’s major oilfields are mostly
located in the northeastern and northwestern regions, which together supply
nearly 50.0% but consume only 20.0% of China’s finished oil. While the
northeastern and northwestern areas have a surplus of refined oil products, the
eastern and south-central regions, where 60.0% of China’s finished oil products
are consumed, are in shortage of finished oil products, and the southwest region
relies on supplies from other parts of the country. As a result, transportation
of finished oil products in China is characterized by the “North to South” and
“West to East” patterns.
In 2008,
China produced 1.4 billion barrels of crude oil and became the world’s fifth
largest oil producer. China’s three state-owned enterprises, namely SINOPEC,
PetroChina, CNOOC, and a provincially owned enterprise, Shaanxi Yanchang Group,
held 98.3% of China’s crude oil proven reserves and 86.8% of China’s refinery
capacity as of the end of 2008. CNOOC is primarily engaged in the offshore
exploration and production of crude oil and sells its products to refineries for
downstream processing. SINOPEC and PetroChina are fully integrated energy
companies engaged in exploration and production of crude oil and natural gas,
refining of crude oil, and marketing and distribution of refined petroleum
products. Most of the crude oil refined by SINOPEC and PetroChina is distributed
and sold through their self-owned or franchised gas stations while the remainder
is sold to third-party distributors to achieve greater sales coverage. Shaanxi
Yanchang Group engages in the exploration and production of crude oil and
natural gas and refining of crude oil. It relies on third-party distributors
like us to market and distribute refined petroleum products. The table below
sets forth certain operational information of SINOPEC, PetroChina, CNOOC and
Shaanxi Yanchang Group in 2008.
SINOPEC
(1)
|
PetroChina
(2)
|
CNOOC
(3)
|
Shaanxi
Yanchang
Group
(4)
|
China
Total
|
||||||||||||||||
Crude
oil proven reserves
(million
barrels)
|
2,841
|
11,221
|
1,580
|
n/a
|
16,000
|
(5)
|
||||||||||||||
Refinery
throughputs
(million
tons per year)
|
169
|
116
|
None
|
11
|
341
|
(6)
|
||||||||||||||
Number
of service stations
|
29,279
|
17,456
|
None
|
None
|
95,740
|
(7)
|
||||||||||||||
Refined
products sold
(million
tons)
|
123
|
87
|
None
|
10
|
280
|
(8)
|
Source:
(1)
|
SINOPEC 2008 Annual
Report
|
(2)
|
PetroChina 2008 Annual
Report
|
(3)
|
CNOOC 2008 Annual
Report
|
(4)
|
Shaanxi Yanchang Group Corporate
Website
|
(5)
|
United States Energy Information
Administration
|
(6)
|
BP Statistical Review of World
Energy June 2009 Report
|
(7)
|
MOFCOM
|
(8)
|
CEIC
|
Shaanxi
Province, where our company is located, is in proximity to the Changqing
oilfield, one of China’s largest oil and gas reserves, and to the southwestern
region of China, where there is a significant shortage of finished oil products.
Capitalizing on the Changqing oilfield’s abundant crude oil resources, SINOPEC,
PetroChina and Shaanxi Yanchang Group have built refineries for an aggregate
annual capacity of approximately 18.5 million tons in Shaanxi
Province.
11
Increasing
Shortage of Crude Oil in China and New Pricing Regime to Counter Refined Oil
Shortage
Rapid
economic development in China has resulted in increased energy demand. The
demand for crude oil in China has exceeded the supply, which has caused China to
become increasingly dependent on imported oil. According to the U.S. Energy
Information Administration, China’s demand for crude oil surged from 1.77
million barrels/day in 1980 to 7.57 million barrels/day in 2007, while the
supply of crude oil increased from 2.11 million barrels/day to only 3.73 million
barrels/day during the same period. During 2001 to 2008, China’s demand for
gasoline and diesel also grew at a compounded annual growth rate of 8.4% and
9.2%, respectively.
For the
past nine years, China’s refined oil market has been operating as a managed
market-based system. China has kept retail prices of finished oil products fixed
to protect consumers against rising costs while most Western countries have
allowed prices to be set by market supply and demand. The fixed-price system
often leads to fuel shortages as the profits of domestic oil refineries are
squeezed when the cost of crude oil rises but the selling prices of refined oil
products are fixed. Effective as of January 1, 2009, the NDRC implemented a new
pricing regime for refined oil products, aimed to link domestic oil prices more
closely to changes in the global crude oil prices in a controlled manner. Under
this pricing regime, the domestic selling price of refined oil products are
determined on the basis of the corresponding international crude oil prices and
by taking into consideration the average domestic processing costs, taxes,
selling expenses and an appropriate profit margin.
Source: U.S. Energy Information Administration | Source: CEIC |
12
China’s
Retail Gas Stations
With
China’s rapid economic development, continuous improvement in transportation
infrastructure and rapid increase in motor vehicle ownership, the number of gas
stations in China has been increasing. There were merely 3,600 gas stations in
the mid 1980s, but the number of gas stations grew to 5,000 in the 1990s, and
reached 67,609 by the end of 2000. The following chart sets forth the total
number of gas stations from 2000 to 2008:
Source:
(1)
|
Analysis of Investment
Opportunities and Prospects in China’s Gas Station Industry, 2009 –
2012
|
(2)
|
MOFCOM
|
At the
end of 2008, state-owned gas stations accounted for 53.3% of the total number of
gas stations in China, while non-state-owned gas stations accounted for 46.7%
and foreign-invested stations accounted for 2.0%.
China’s
Biodiesel Market
Biodiesel
Biodiesel
is a cleaner-burning and renewable fuel produced from animal fats, vegetable
oil, and waste cooking oil. The chemical properties of biodiesel are very
similar to those of petro-diesel, and biodiesel has the potential for replacing
petro-diesel in many applications. Biodiesel is made through a chemical process
called transesterification, which separates the glycerin from the fat or
vegetable oil. The process generates two products — methyl esters (the chemical
name for biodiesel) and glycerin (a byproduct with value for use in soaps and
other products).
Biodiesel
contains no petroleum, but it can be blended at any ratio with petro-diesel to
create a biodiesel blend. It can be used in compression-ignition (diesel)
engines with little or no modification. Biodiesel provides a number of benefits
compared to diesel, including:
•
|
No sulfur dioxide emission, a
major component of acid rain, and emits less carbon dioxide than
traditional diesel;
|
•
|
Reduction of smoke
particulates;
|
•
|
Biodegradable and breaks down as
fast as sugar;
|
•
|
Better lubrication which reduces
engine wear;
|
•
|
Safer to use, handle and store
due to its high flash point;
and
|
•
|
Produced from renewable energy
sources.
|
13
Favorable Market Dynamics Support
Long-Term Growth
In
response to the rise in global oil prices, global warming and other
environmental awareness issues, the PRC government has begun to encourage
renewable energy consumption and has implemented various policies to support the
production of biodiesel. The PRC government plans to increase its consumption of
biofuel, of which two million tons are estimated to be biodiesel, and its
proportion of renewable energy consumption to approximately 15.0% of China’s
total energy consumption in 2020 from approximately 7.5% in 2005.
Biodiesel
is classified as an “encouraged industry” by the NDRC. Businesses engaged in
biodiesel production are entitled to receive certain benefits and incentives
extended by the government, such as grants and interest-free loans.
However,
China’s biodiesel industry is still underdeveloped, which we believe provides
opportunities for us in this market. The following table sets forth the
production volume of biodiesel in China from 2005 through 2007 and forecasts for
2008 through 2010.
Source:
China Biodiesel Industry Investment Value Report 2008, China
Venture
In
February 2005, China enacted the Renewable Energy Law , which
aims to promote the development and utilization of renewable energy, improve the
energy structure, diversify energy supplies, safeguard energy security, protect
the environment and realize sustainable development of the economy and society.
This legislation states that fuel retail businesses must begin to include
“biological liquid fuel” in their sales or they will be subject to fines as
China is seeking to reduce its dependence on fossil fuels in its diesel
transportation vehicles.
Governmental
Regulation
Finished
Oil and Heavy Oil Distribution
We have
been engaging in the wholesale distribution of finished and heavy oil business
in the PRC since 2000. Prior to 2006, significant gaps existed in the laws and
regulations on finished oil markets, and the relevant rules for this industry
were, to some extent, inconsistent and subject to the discretion of the relevant
government authorities.
In 2006,
greater specificity was added to the rules for commercial activities in the
finished oil market with the enactment of the Measures on the Administration of
the Finished Oil Market (promulgated on December 4, 2006 by the MOFCOM
and effective as of January 1, 2007), or the Measures. This regulation provides
comprehensive details on the finished oil wholesale and resale application
procedures, qualification requirements, and rules for annual inspections.
Enterprises (foreign or domestic-funded) meeting certain requirements can submit
applications to the MOFCOM for a certificate of approval to conduct gasoline and
diesel (including bio-diesel) wholesale, retail and storage
businesses.
The first
step required in applying to engage in the wholesale of finished oil is a
preliminary examination by the provincial MOFCOM where the enterprise is
located. Thereafter, the provincial MOFCOM will forward the application
materials together with its opinions on the preliminary examination to the
MOFCOM, which will then decide on whether to grant the Certificate of Approval
for the Wholesale of Finished Oil.
14
An
enterprise applying to engage in the finished oil wholesale business must, among
other requirements, possess the following:
(i)
|
long-term and stable supply of
finished oil;
|
(ii)
|
a legal entity with a registered
capital of no less than RMB 30
million;
|
(iii)
|
a finished oil depot, which shall
have a capacity not smaller than 10,000 m 3 , conforming to the local urban
and rural planning requirements, and be approved by other relevant
administrative departments;
and
|
(iv)
|
facilities
for unloading finished oil such as conduit pipes, special railway lines,
and transportation vehicles with a capacity of 10,000 tons or more to
transport refined oil on the highway or over water to
ports.
|
In
practice, it has become increasingly difficult for enterprises (particularly
foreign-funded enterprises) to meet the requirement (iii) above. As both the
number of available oil depots and state land and resources are reaching full
capacity, it is more of a challenge to obtain a finished oil depot with a
capacity not smaller than 10,000 m 3
.
The
application procedure for the retail of finished oil is similar to that for
wholesale except that the preliminary examination takes place at the
administrative department for commerce at the municipal level, and the
certificate of approval is issued at the provincial level.
An
enterprise applying to engage in the finished oil retail business must, among
other requirements, possess the following:
(i)
|
long-term and stable channels to
finished oil supply and a supply agreement with an enterprise that has
been qualified to engage in the wholesale business of finished oil for a
period of three years or more in line with its business
scale;
|
(ii)
|
qualified professional and
technical personnel to handle inspections, metrology, storage and fire
safety and the safe production of finished oil;
and
|
(iii)
|
gas stations designed and built
to comply with the relevant national standards and approved by the
relevant administrative
department.
|
Xi’an
Baorun Industrial has the certificates of approval for both the wholesale and
retail of finished oil, including for the retail of finished oil at each of its
seven retail gas stations. As such, we do not have to rely on other companies to
distribute the biodiesel fuel that we produce.
Enterprises
possessing certificates of approval are subject to annual inspection by the
relevant provincial MOFCOM which will review:
(i)
|
the execution and performance of
finished oil supply
agreements;
|
(ii)
|
the operation results of the
enterprise for the previous
year;
|
(iii)
|
whether the enterprise and its
supporting facilities are in compliance with the technical requirements
under the Measures; and
|
(iv)
|
the
current measures, among other measures, being taken by the enterprise
regarding quality control, metrology, fire safety, security and
environmental protection.
|
If we
pass the annual inspection, the certificates of approval we hold will continue
to be valid. An enterprise failing an annual inspection will be ordered to
rectify all deficiencies within a certain time limit by the MOFCOM and/or its
provincial branches. If such deficiencies have not been rectified within the
specified time limit, its certificates of approval shall be revoked by the
original issuing authority.
Pricing
for Finished Oil
The NDRC
regulates domestic oil prices as part of its macro-management over the economy
in order to control dramatic fluctuations in oil prices.
The Administrative Measures on Oil
Prices ( trial
implementation ) promulgated by the NDRC on May 7, 2009 stipulates that
the NDRC will adjust domestic finished oil prices when the international market
price for crude oil changes more than four percent over 22 consecutive working
days. By contrast, crude oil prices are determined solely by enterprises
engaging in this industry.
15
The NDRC
adjusts domestic finished oil prices by modifying the retail price cap for
gasoline and diesel in all provinces, autonomous regions, and directly
administered municipalities. Thereafter, the administrative authorities at the
provincial level adjust the wholesale price caps by deducting RMB 30 per ton
from the corresponding retail price caps. Where there are no specific
contractual arrangements for a supplier’s delivery to a retailer, the wholesale
price caps may be further deducted to take into account the retailer’s
transportation cost among other expenses.
The Administrative Measures on Oil
Prices stipulates that the domestic finished oil prices shall be
calculated according to the normal profit rate for refiners when the crude oil
price on the international market is lower than $80 per barrel. When the
international crude oil market price exceeds $130 per barrel, the NDRC will
adopt certain fiscal and tax policies to ensure the continuing production and
supply of refined oil products. Further, gasoline and diesel prices will only be
increased slightly (if at all) in consideration of manufacturers and consumers,
as well as the stability of the national economy.
The exact
formula for calculating finished oil prices domestically has not been published.
However, the NDRC has stated that such formula is based on the weighted average
of the international market prices, together with the average domestic
processing costs, taxes, fees incurred in distribution channels, and suitable
profits for refiners. Moreover, the NDRC adjusts the cost index seasonally in
accordance with the actual situation with respect to prices.
Biodiesel
The
Standing Committee of the National People’s Congress promulgated the Renewable Energy Law on
February 28, 2005, which took effect as of January 1, 2006. The purpose of this
law is to facilitate the development and utilization of renewable energy,
including biological liquid fuel and energy crops. Under Article 16, oil-selling
enterprises shall include biological liquid fuel conforming to the national
standards into their fuel-selling systems, in accordance with the regulations of
the energy authorities at the national or provincial level. An oil-selling
enterprise that fails to include biological liquid fuel into their fuel-selling
systems in accordance with the national standards will be liable for any
resulting losses to a biological liquid fuel production enterprise. Further, the
energy authorities at the national or provincial level shall order such
oil-selling enterprise to rectify the non-conformance within a stipulated period
of time, and impose a fine less than the amount of the said resulting losses if
the rectification is not made.
Environmental
Protection
The
relevant PRC governmental authorities set national and local environmental
protection standards, as well as examine and issue approvals on environmental
aspects of different stages of various projects. We are required to file an
environmental impact statement, or in some cases, an environmental impact
assessment outline, to obtain such approvals. The filing must demonstrate that
the project in question conforms to applicable environmental standards.
Generally speaking, environmental protection bureaus will issue approvals and
permits for projects using modern pollution control measurement
technology.
The PRC
national and local environmental laws and regulations impose fees for the
discharge of waste substances above prescribed levels, require the payment of
fines for serious violations and provide that the PRC national and local
governments may, at their own discretion, close or suspend any facility which
fails to comply with orders requiring it to cease or improve operations causing
environmental damage.
In
accordance with the requirements of the environmental protection laws of the
PRC, we have installed the necessary environmental protection equipment, adopted
advanced environmental protection technologies, established responsibility
systems for environmental protection and reported to and registered with the
relevant local environmental protection department.
In
addition, to the best of our knowledge, we have complied with the necessary
environmental procedures with respect to the construction of our biodiesel
factory. The governmental authorities reviewed the environmental impact report
prepared on our behalf by a professional institution that we retained prior to
the commencement of construction. In January 2008, after the completion of
construction, we obtained environmental approvals from the governmental
authorities.
Dangerous
Chemicals
PRC laws
and regulations on dangerous chemicals require that a Safe Production Permit, or
the Permit, be obtained for all facilities used to manufacture dangerous
chemicals. We obtained the Safe Production Permit in April 2007, which is valid
for a period of three years. It can thereafter be renewed for an additional
three years, provided that the facility has not had any fatalities from
accidents and has passed periodic inspections by the local administrative
authorities for work safety during the term of the Permit.
16
Foreign-invested
Enterprises Engaging in Oil-related Businesses
Under the
Catalogue of Industries for
Guiding Foreign Investment , jointly promulgated by the MOFCOM and the
NDRC on October 31, 2007 and effective as of December 1, 2007, each of the
wholesale of oil products, the construction and operation of petrol stations and
the production of liquid biofuels ( i.e. , fuel ethanol,
biodiesel) falls within the restricted category for foreign investment. Foreign
investors can only engage in commercial activities involving liquid biofuels or
retail of finished oil (where the foreign investor possesses 30 or more gas
stations or where it sells different brands of oil through different
distributors) through a joint venture with a Chinese partner, and the Chinese
partner must hold a controlling interest in the joint venture. As a result of
these restrictions, we conduct our business in the PRC via a domestic entity,
Xi’an Baorun Industrial, established by three PRC citizens. Please refer to “Our
History and Corporate Structure — Corporate Structure — Contractual
Agreements with Xi’an Baorun Industrial” for more information regarding our
control relationship with Xi’an Baorun Industrial.
SAFE
Regulations Pertaining to Overseas-Listed Companies
Circular
75
The SAFE
issued the Circular on Issues
Relevant to Foreign Exchange Control with Respect to the Round-trip Investment
of Funds Raised by Domestic Residents Through Offshore Special Purpose
Vehicles , or Circular 75, on October 21, 2005. Circular 75 requires PRC
residents and citizens to register with their local SAFE branches before
establishing or acquiring the control of any company outside of China by using
domestic assets or equities for the purpose of equity financing. PRC residents
and citizens who are stockholders of offshore special purpose companies
established before November 1, 2005 were required to conduct overseas investment
registration with the local SAFE branches before March 31, 2006. Further, PRC
residents and citizens must register all major changes relating to
capitalization (including overseas equity or convertible bonds financing) within
30 days upon the occurrence of such changes.
Failure
to comply with the registration procedures set forth in Circular 75 and any
other rules and regulations may result in restrictions on the relevant PRC
subsidiary, including the payment of dividends and other distributions to its
offshore parent or affiliate and the capital inflow from the offshore entity.
Non-compliance may also subject relevant PRC residents to penalties under PRC
foreign exchange administration regulations, and may result in liability under
PRC law for foreign exchange evasion.
Stock
Option Rules
On March
28, 2007, the SAFE promulgated the Application Procedures of Foreign
Exchange Administration for Domestic Individuals Participating in an
Overseas-Listed Company’s Employee Stock Holding or Stock Option Plan ,
or the Stock Option Rules. The Stock Option Rules stipulate that PRC individuals
who have been granted stock options and other types of stock-based awards by an
overseas listed company are required to obtain approval from their local SAFE
branches through an agent of the overseas listed company (generally its PRC
subsidiary or a financial institution).
The
failure by any entities or PRC individuals to complete their SAFE registration
pursuant to the requirement of the SAFE or its local branches or the Individual Foreign Exchange
Rules may subject these entities or PRC individuals to fines and legal
sanctions, and may also limit our ability to contribute additional capital into
our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute
dividends to their shareholders or otherwise materially adversely affect their
business.
As a
company listed on a stock exchange in the United States, we and our PRC
directors, management personnel, employees, consultants and employees of our
equity investee who have been granted share options and other awards under our
equity incentive plan are subject to the Stock Option Rules.
17
Our
History and Corporate Structure
The
following diagram illustrates our corporate structure .
Company
History
We were
incorporated in the State of Delaware in July 1998 under the corporate name
“A.M.S. Marketing, Inc.” and in October 2003, we changed our name to
“International Imaging Systems, Inc.” Until January 2007, we were engaged in the
business of marketing pre-owned, brand name photocopy machines and employee
leasing. We then began to pursue an acquisition strategy to acquire an
undervalued business that demonstrated room for growth.
We
acquired Baorun China Group Limited, or Baorun Group, pursuant to a Share
Exchange Agreement, dated October 23, 2007 with Baorun Group, Redsky Group and
Princeton Capital Group LLP, or Princeton Capital Group, Castle Bison, Inc. and
Stallion Ventures, LLC. Together, Redsky Group and Princeton Capital Group owned
shares constituting 100% of the issued and outstanding ordinary shares of Baorun
Group. Pursuant to the terms of the Share Exchange Agreement, Redsky Group and
Princeton Capital Group transferred to us all of their shares in Baorun Group in
exchange for the issuance of 22,454,545 shares of our common stock to Redsky
Group and 1,500,000 shares of our common stock to Princeton Capital Group. As a
result of this share exchange, Baorun Group became our wholly owned subsidiary,
and Redsky Group and Princeton Capital Group acquired an aggregate of
approximately 94.11% of our common stock.
On
November 15, 2007, through a merger of a wholly owned subsidiary, China Bio
Energy Holding Group Co., Ltd., our corporate name was changed from
“International Imaging Systems, Inc.” to “China Bio Energy Holding Group Co.,
Ltd.” On September 17, 2009, we changed our name to “China Integrated Energy,
Inc.”
Corporate
Structure
We are
engaged in three business segments: (1) the wholesale distribution of finished
oil and heavy oil products; (2) the production and sale of biodiesel; and (3)
the operation of retail gas stations. We operate our business through certain
contractual agreements between Redsky Industrial and Xi’an Baorun Industrial.
Redsky Industrial is our indirect wholly owned subsidiary that is a registered
wholly foreign owned enterprise in the PRC. Xi’an Baorun Industrial is based in
Xi’an, Shaanxi Province, and owned by three Chinese citizens, including our
chairman, chief executive officer and president, Mr. Xincheng Gao, who owns a
70% equity interest in Xi’an Baorun Industrial.
Contractual
Agreements with Xi’an Baorun Industrial
We do not
own any equity interest in Xi’an Baorun Industrial. In order to meet domestic
ownership requirements under PRC law, which restricts foreign companies from
operating in the finished oil and biodiesel industry, Redsky Industrial executed
a series of exclusive contractual agreements with Xi’an Baorun Industrial, which
allow us, among other things, to secure significant rights to influence Xi’an
Baorun Industrial’s businessoperations, policies and
management, to approve all matters requiring stockholder approvals, and give us
the right to include 100% of the annual net income earned by Xi’an Baorun
Industrial as part of our consolidated financial statements. In addition, to
ensure that Xi’an Baorun Industrial and its stockholders perform their
obligations under these contractual arrangements, the stockholders have pledged
to Redsky Industrial all of their equity interests in Xi’an Baorun Industrial.
If and when the current restrictions under PRC law on foreign ownership of
Chinese companies engaging in the finished oil and biodiesel industry in China
are lifted, Redsky Industrial may exercise its option to purchase the equity
interests in Xi’an Baorun Industrial directly.
18
Since
Baorun Group owns Redsky Industrial, which effectively controls Xi’an Baorun
Industrial, Xi’an Baorun Industrial is deemed a subsidiary of Baorun Group,
which is our legal subsidiary. Based on Xi’an Baorun Industrial’s contractual
relationship with Redsky Industrial as set forth in the Exclusive Business
Cooperation Agreement (as described below), we have determined that Xi’an Baorun
Industrial should be deemed to be our VIE in accordance with FASB
Interpretations — FIN 46(R): Consolidation of Variable Interest Entities (as
amended) (FIN 46(R)). Under FIN 46(R), Xi’an Baorun Industrial is to be
presented as our consolidated subsidiary.
The
contractual agreements Redsky Industrial entered into with Xi’an Baorun
Industrial and its stockholders include the following:
Exclusive
Business Cooperation Agreement
Pursuant
to an Exclusive Business Cooperation Agreement entered into between Redsky
Industrial and Xi’an Baorun Industrial on October 19, 2007, as amended on March
24, 2008, Redsky Industrial has the exclusive right to provide complete
technical support, business support and related consulting services, which
include, among others, technical services, business consultations, equipment or
property leasing, marketing consultancy and product research. Xi’an Baorun
Industrial has agreed to pay the service fee on a monthly basis to Redsky
Industrial equal to 100% of the monthly net income of Xi’an Baorun Industrial.
This agreement is subject to renewal at the option of both Redsky Industrial and
Xi’an Baorun Industrial. Redsky Industrial has the right to early termination of
this agreement for any reason upon a 30 days’ prior written notice. Xi’an Baorun
Industrial only has the right to early termination of this agreement in the
event of the gross negligence of, or fraudulent acts by Redsky
Industrial.
Exclusive
Option Agreements
Under the
Exclusive Option Agreements dated October 19, 2007 entered into among Redsky
Industrial, each of the three stockholders of Xi’an Baorun Industrial and Xi’an
Baorun Industrial, the stockholders of Xi’an Baorun Industrial have irrevocably
granted to Redsky Industrial or its designated person, an exclusive option to
purchase, to the extent permitted by PRC law, a portion or all of their
respective equity interests in Xi’an Baorun Industrial for a purchase price
either to be designated by Redsky Industrial or to be determined based on the
evaluation of the equity interests required by PRC law. Redsky Industrial or its
designated person has the sole discretion to decide when to exercise the option,
whether in part or in full. Each of these agreements has a ten-year term,
subject to renewal at Redsky Industrial’s election.
Equity
Pledge Agreements
Under the
Equity Pledge Agreements dated October 19, 2007, entered into among Redsky
Industrial, Xi’an Baorun Industrial and each of the three stockholders of Xi’an
Baorun Industrial, the stockholders of Xi’an Baorun Industrial have pledged
their equity interests in Xi’an Baorun Industrial to guarantee Xi’an Baorun
Industrial’s performance of its obligations under the Exclusive Business
Cooperation Agreement. If Xi’an Baorun Industrial fails to perform its payment
obligations under the Exclusive Business Cooperation Agreement, or if Xi’an
Baorun Industrial or any of its stockholders breaches his/her respective
contractual obligations under the agreement, or upon the occurrence of an event
of default, Redsky Industrial is entitled to certain rights, including the right
to dispose of the pledged equity interests. The stockholders of Xi’an Baorun
Industrial have agreed not to dispose of the pledged equity interests or take
any actions that would prejudice Redsky Industrial’s interests. Each of the
Equity Pledge Agreements will be valid until all the payments due under the
Exclusive Business Cooperation Agreement have been paid by Xi’an Baorun
Industrial and Xi’an Baorun Industrial no longer has any obligations under the
Exclusive Business Cooperation Agreement. Since the Exclusive Business
Cooperation Agreement may be renewed at Redsky Industrial’s option, the equity pledge will remain in effect with each such renewal of the
Exclusive Business Cooperation Agreement, and until all payments due under the
Exclusive Business Cooperation are paid in full by Xi’an Baorun
Industrial.
19
Irrevocable
Powers of Attorney
Under the
irrevocable powers of attorney, each of the three stockholders of Xi’an Baorun
Industrial has granted to Redsky Industrial the power to exercise all voting
rights of such stockholder in stockholders’ meetings, including, but not limited
to, the power to determine the sale, pledge or transfer of, or otherwise dispose
of all or part of such stockholder’s equity interests in, and to appoint and
elect the directors, the legal representative (chairperson), chief executive
officer and other senior management of Xi’an Baorun Industrial.
Item
1A.
|
Risk
Factors.
|
Investing
in our securities involves a great deal of risk. Careful consideration should be
made of the following factors as well as other information included in this
prospectus before deciding to purchase our securities. You should pay particular
attention to the fact that we conduct all of our operations in China and are
governed by a legal and regulatory environment that in some respects differs
significantly from the environment that may prevail in the U.S. and other
countries. Our business, financial condition or results of operations could be
affected materially and adversely by any or all of these risks.
THE
FOLLOWING MATTERS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL
CONDITION, LIQUIDITY, RESULTS OF OPERATIONS OR PROSPECTS, FINANCIAL OR
OTHERWISE. REFERENCE TO THIS CAUTIONARY STATEMENT IN THE CONTEXT OF A
FORWARD-LOOKING STATEMENT OR STATEMENTS SHALL BE DEEMED TO BE A STATEMENT THAT
ANY ONE OR MORE OF THE FOLLOWING FACTORS MAY CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENT OR
STATEMENTS.
Risks
Related to Our Business
We
rely on a limited number of third-party suppliers for our supply of finished oil
and heavy oil products and the loss of any such supplier, particularly our
largest supplier, could have a material adverse effect on our
operations.
We are
dependent upon our relationships with third parties for our supply of finished
oil and heavy oil products. Our five largest suppliers provided 77.6% and 65.5%
of the finished oil and heavy oil products we sold in the years ended December
31, 2008 and 2009, respectively, with our largest supplier providing
approximately 52.0% and 30.8%, respectively, in such periods. Should any of
these suppliers, and in particular our largest supplier, terminate their supply
relationships with us, fail to perform their obligations as agreed, or enter
into the finished oil or heavy oil products business in competition with us, we
may be unable to procure sufficient amounts of finished oil and heavy oil
products to fulfill our demand. If we are unable to obtain adequate quantities
of finished oil and heavy oil products at economically viable prices, our
customers could seek to purchase products from other suppliers, which could have
a material adverse effect on our revenues.
We
are highly dependent on the revenue contribution from our wholesale distribution
of finished oil and heavy oil business segment. A reduction in sales from this
segment would cause our revenues to decline and materially harm our
business.
We
currently derive a significant majority of our sales from our wholesale
distribution of finished oil and heavy oil products business segment, which
accounted for 66.3% and 67.6% of our total sales in the years ended December 31,
2008 and 2009, respectively. As a result, should there be an adverse industry
trend in the petroleum sector, our limited diversification could result in our
results of operations declining substantially and suffering disproportionately
compared to our competitors that have diversified their revenue
sources.
Our
ability to operate at a profit is partially dependent on market prices for
petroleum and biodiesel fuels, which are subject to government control in the
PRC. If petroleum and biodiesel prices drop significantly, we may be unable to
maintain our current profitability.
Our
results of operations and financial condition are affected by the selling prices
of petroleum and biodiesel fuel products. Prices are subject to and determined
by market forces and actions by the PRC government over which we have no
control. In the years ended December 31, 2008 and 2009, our average selling
prices for petroleum and biodiesel fuel were $3.05 and $2.96 per gallon,
respectively, and $2.99 and $2.94 per gallon, respectively.
Although
the current price-setting mechanism for refined petroleum products in China
allows the PRC government to adjust prices in the PRC market when the average
international crude oil price fluctuates beyond certain levels within a certain
time period, the PRC government still retains full discretion as to whether or
when to adjust the refined petroleum products price. The PRC government can also
be expected to exercise price control over refined petroleum products once
international crude oil price experiences sustained growth or becomes
significantly volatile. As a result, our results of operations and financial
condition may be materially and adversely affected by the fluctuation of market
prices of crude oil and refined petroleum products as well as the discretionary
actions of the PRC government.
20
We
face substantial competition in our wholesale distribution of finished oil and
heavy oil business segment.
We are
one of the only four non-state-owned enterprises that are licensed to distribute
both finished oil and heavy oil products in Shaanxi Province. Although barriers
to entry in our industry are high due to stringent licensing requirements and
the need for significant storage capacity for products, we face competition from
companies located in other provinces and within Shaanxi Province that also
engage in the wholesale distribution of finished and heavy oils. Such companies
may have greater financial resources, sales resources, storage capacity and
transportation capability than we do, and may have exclusive supply and purchase
arrangements with suppliers as a result of long-term relationships.
Our
competitors include China Petroleum and Chemical Corporation, or SINOPEC, and
PetroChina Co., Ltd., or PetroChina, both of which have greater resources, brand
recognition and access to more extensive distribution channels than we
do.
In
addition, we estimate that we have approximately ten major non-state-owned
competitors in Shaanxi Province that also distribute finished oil and heavy oil
products similar to ours, including Shaanxi Dongda Petro-Chemical Co., Ltd.,
Shaanxi Dayun Petrochemical Material Co., Ltd., and Baoji Huahai Industry
Corp.
An
increase in competition arising from an increase in the number or size of
competitors in the wholesale distribution of finished oil and heavy oil may
result in price reductions, reduced gross profit margins, loss of our market
share and departure of key management personnel, any of which could adversely
affect our financial condition and profitability.
Our
biodiesel products face substantial competition. Other companies may discover,
develop, acquire or commercialize products earlier or more successfully than we
do.
Existing
and future domestic competitors in the biodiesel industry, who may have a
greater presence in other regions through government support, may be able to
secure a significant market share in regions where we currently do not have
operations. In addition, our potential competitors might be able to secure raw
materials at lower costs than we can and could therefore threaten our
competitive position, which could significantly impact our profitability and
future prospects. Our domestic competitors include Gushan Environment Energy
Ltd., China Biodiesel International Holdings Co., Ltd., China Clean Energy Inc.,
East River Energy Resources and Science Technology (Zhejiang) Ltd., SINOPEC,
China National Offshore Oil Corporation, or CNOOC, and PetroChina, most of which
have greater resources, brand recognition and access to more extensive
distribution channels than we do.
We also
face potential competition from foreign producers of biodiesel, which may have
greater financial research and development resources than we do. Biodiesel is a
relatively new product that was initially introduced outside the PRC, and the
technology for producing biodiesel may be more advanced in countries other than
the PRC. If foreign competitors, or domestic competitors relying on alliances
with or support from foreign producers, enter the PRC biodiesel market, they may
develop biodiesel that is more economically viable, which would adversely affect
our ability to compete and our results of operations.
In
addition, new technologies may be developed or implemented for alternative
energy sources and products that use such energy sources. Advances in the
development of fuels other than biodiesel or diesel, or the development of
products that use energy sources other than diesel, such as gasoline hybrid
vehicles and plug-in electric vehicles, could significantly reduce demand for
biodiesel and thus affect our sales. Biodiesel also faces competition from fuel
additives that help diesel burn cleaner and therefore reduce the comparative
environmental benefits of biodiesel in relation to diesel. Other clean energy
sources such as ethanol, liquefied petroleum gas, hydrogen and electricity from
clean sources may be more cost-effective to produce, store, distribute or use,
more environmentally friendly, or otherwise more successfully developed for
commercial production in the PRC than our products. These other energy sources
may also receive greater government support than our products in the form of
subsidies, incentives or minimum use requirements. As a result, demand for our
products may decline, our business model may no longer be viable, and our
results of operations and financial condition may be materially and adversely
affected.
Any
increase in competition arising from an increase in the number or size of
competitors or from competing technologies or other clean energy sources may
result in price reductions, reduced gross profit margins, loss of our market
share and departure of key management, any of which could adversely affect our
financial condition and profitability.
Our
limited history for producing biodiesel may not serve as an adequate basis to
judge our future prospectus and results of operations.
Currently,
we have only one production facility, which began producing biodiesel in October
2007, and we began selling biodiesel at the end of 2007. Our limited operating
history as a producer and distributor of biodiesel makes it difficult for
prospective investors to evaluate our business. Therefore, our operations are
subject to all of the risks, challenges, complications and delays frequently
encountered in connection with the operation of any new business, as well as
those risks that are specific to the biodiesel industry. Investors should
evaluate us in light of the problems and uncertainties frequently encountered by
companies attempting to develop markets for new products, services, and
technologies. Despite best efforts, we may never overcome these obstacles to
financial success.
21
Our
production and sale of biodiesel business segment is dependent upon the
implementation of our business plan, as well as our ability to enter into
agreements with third parties for the provision of necessary feedstock sources
and the sale and distribution of our biodiesel on terms that will be
commercially viable for us. There can be no assurance that our efforts will be
successful or result in sales or profit. If we fail to execute on our business
plan, there could be a material adverse effect on our operations.
The
commercial success of our products depends on the degree of their market
acceptance among the petroleum and biodiesel fuel community. If our products do
not attain market acceptance among the petroleum and biodiesel fuel community,
our operations and profitability would be adversely affected.
Our
customers continually evaluate their product specifications in response to the
latest developments in the energy market. Our success will depend on our ability
to continue to meet our customers’ current and future requirements. We expect,
therefore, to require significant ongoing investment to preserve our ability to
comply with these standards in order to ensure continued product acceptance and
customer retention.
Additionally,
the biodiesel market is at a relatively early stage of development and the
extent to which biodiesel products will be widely adopted is uncertain. The
biodiesel industry may also be particularly susceptible to economic downturns.
Market data in the biodiesel industry is not as readily available as data in
other more established energy industries where trends can be assessed more
reliably from data gathered over a longer period of time. If biodiesel
technology proves unsuitable for widespread adoption or if demand for biodiesel
products fails to develop sufficiently, we may not be able to grow our business
or generate sufficient revenues to sustain our profitability. In addition,
demand for biodiesel products in our targeted markets, including China, may not
develop or may develop to a lesser extent than we anticipated.
The
distribution of finished oil is primarily dependent on the sufficiency of
necessary infrastructure and access to means of transport, including rail
transportation, which may not be available on a cost-effective basis, if at
all.
Our
wholesale distribution of finished oil and heavy oil business segment depends
heavily on the availability of infrastructure and means of transportation,
including but not limited to adequate highway or rail capacity, including
sufficient numbers of dedicated tanker trucks or cars and sufficient storage
facilities.
In
connection with entering into oil storage services agreements through which we
use two state-owned oil depots, we currently benefit from convenient railway
freight access located near such depots, which enables us to reach certain parts
of China, including Sichuan, Yunnan and Guizhou Provinces, to which other
distribution companies in Shaanxi Province currently do not have easy access.
There can be no assurance that the PRC government will continue to allow us to
utilize this railway.
Our
gross margins in our wholesale distribution of finished oil and heavy oil
products and in our operation of retail gas station segments are principally
dependent on the spread between the average purchase price and the average
selling price. If the average purchase price increases and the average selling
price of our products does not similarly increase or if the average selling
price of our products decreases and the average purchase price does not
similarly decrease, our margins will decrease and results of operations will be
harmed.
Our gross
margins in the wholesale distribution of finished oil and heavy oil products and
in the operation of retail gas stations depend principally on the spread between
the average purchase price and the average selling price we are able to realize
for our products. The spread between the average purchase price for petroleum
and the average selling price of our products has been relatively stable since
2007. Prices for petroleum in the PRC are primarily influenced by the guidance
prices set by the National Development and Reform Commission, or the NDRC, and
supply and demand for petroleum-based fuel, rather than production costs. Any
decrease in the spread between the average purchase price and the prices we are
able to realize for our products, whether as a result of an increase in purchase
prices or policy determinations by the NDRC, would adversely affect our
financial performance and cash flows.
Our
future success substantially depends on our ability to significantly increase
both our biodiesel production capacity and output.
Our
future success depends on our ability to significantly increase both our
production capacity and our output. In particular, we intend to expand our
biodiesel production capacity within the next several years. Our ability to
establish additional production capacity and increase output is subject to
significant risks and uncertainties, including:
•
|
the
ability to raise significant additional funds to purchase raw materials
and to build additional production facilities, which we may be unable to
obtain on reasonable terms or at
all;
|
•
|
delays
and cost overruns as a result of a number of factors, many of which may be
beyond our control, such as increases in raw materials prices and problems
with equipment vendors;
|
•
|
delays
or denial of required approvals by relevant government
authorities;
|
•
|
diversion
of significant management attention and other
resources;
|
22
•
|
failure
to maintain the lease for the land (and buildings) or to acquire
additional land and buildings to be used for our biodiesel production and
storage; and
|
•
|
failure
to execute our expansion plan
effectively.
|
If we are
unable to establish or successfully operate additional production capacity or to
increase production output, or if we encounter any of the risks described above,
we may be unable to expand our business and decrease costs to improve our
profitability as planned. Even if we do expand our production capacity and
output, we may be unable to generate sufficient customer demand for our
biodiesel to support our increased production levels.
In
the past we have derived a significant portion of our sales from a few large
customers. If we were to lose any of such customers, our business, operating
results and financial condition could be materially and adversely
affected.
Our
customer base has been highly concentrated. Our top five customers accounted for
approximately 23.3% and 39.1% of our sales for the years ended December 31, 2008
and 2009, respectively. Our largest customer China Petroleum and
Chemical Corporation Chuanyu Trading Co., Ltd. accounted for approximately 4.23%
and 26.6% of our sales, respectively, during such periods. As our customer base
may change from year-to-year, and during such years that our customer base is
highly concentrated, the loss of, or reduction of our sales to, any of such
major customers could have a material adverse effect on our business, operating
results and financial condition. See “Business — Business Segments — Wholesale
Distribution of Finished Oil and Heavy Oil — Customers” for a description of our
largest customers.
We
depend on our key executives, and our business and growth may be severely
disrupted if we lose their services.
Our
future success depends substantially on the continued services of our key
executives. In particular, we are highly dependent upon Mr. Xincheng Gao, our
chairman, chief executive officer and president, who has established
relationships within the industries we operate. If we lose the services of one
or more of our current executive officers, we may not be able to replace them
readily, if at all, with suitable or qualified candidates, and may incur
additional expenses to recruit and retain new officers with industry experience
similar to our current officers, which could severely disrupt our business and
growth. In addition, if any of our executives joins a competitor or forms a
competing company, we may lose some of our suppliers or customers. Furthermore,
as we expect to continue to expand our operations and develop new products, we
will need to continue attracting and retaining experienced management and key
research and development personnel.
Competition
for qualified candidates could cause us to offer higher compensation and other
benefits in order to attract and retain them, which could have a material
adverse effect on our financial condition and results of operations. We may also
be unable to attract or retain the personnel necessary to achieve our business
objectives, and any failure in this regard could severely disrupt our business
and growth.
The
current economic and credit environment could have an adverse effect on demand
for certain of our products and services, which would in turn have a negative
impact on our results of operations, our cash flows, our financial condition,
our ability to borrow and our stock price.
Since
late 2008, global market and economic conditions have been disrupted and
volatile. Concerns over increased energy costs, geopolitical issues, the
availability and cost of credit, the U.S. mortgage market and a declining
residential real estate market in the U.S. have contributed to this increased
volatility and diminished expectations for the economy and the markets going
forward. These factors, combined with volatile oil prices, declining business
and consumer confidence and increased unemployment, have precipitated a global
recession.
It is
difficult to predict how long the current economic conditions will persist,
whether they will deteriorate further, and which of our products, if not all of
them, will be adversely affected. As a result, these conditions could adversely
affect our financial condition and results of operations.
Our
gross margin in our production and sale of biodiesel segment is principally
dependent on the spread between feedstock prices and biodiesel prices. If the
unit cost of feedstock increases and the average selling price of biodiesel does
not similarly increase or if the average selling price of biodiesel decreases
and the unit cost of feedstock does not similarly decrease, our margin will
decrease and results of operations will be harmed.
Our gross
margin in the production and sale of biodiesel segment depends principally on
the spread between feedstock and biodiesel prices. The spread between biodiesel
prices and feedstock prices has narrowed significantly since September 2008.
Prices for vegetable oil residue, waste cooking oil and non-edible oil seeds,
which have historically been our principal feedstocks and comprised
approximately 88.3% of total cost of goods sold of our production and sale of
biodiesel segment during the year ended December 31, 2009, do not necessarily
have a direct price relationship to the price of biodiesel in a particular
period. Prices for non-edible oil seeds, vegetable oil residue and waste cooking
oil are principally influenced by general inflation, market and regulatory
factors. Biodiesel prices, however, are primarily influenced by the guidance
prices set by the NDRC and supply and demand for petroleum-based diesel fuel,
rather than biodiesel production costs. This lack of correlation between
production costs and product prices means that we may be unable to pass
increased feedstock costs on to our customers. In the last two years, the prices
of vegetable oil residue, waste cooking oil and non-edible oil seeds have
fluctuated substantially due to increased demand in China resulting from its
rapid economic development. Any decrease in the spread between biodiesel prices
and feedstock prices, whether as a result of an increase in feedstock prices or
a reduction in biodiesel prices, would adversely affect our financial condition
and results of operations.
23
The
biodiesel industry faces a number of challenges, and there is no established
market for biodiesel in the PRC where biodiesel is not considered a principal
source of energy for any purpose.
Biodiesel
has only recently been produced for commercial applications in the PRC. The
market for biodiesel products is currently confined to specific regions and is
relatively small at the national level. There is no established market in the
PRC where biodiesel is considered a principal source of energy for vehicles
operating on diesel or for any other purpose. We cannot assure you that
biodiesel will be widely accepted or will reach a broader consumer base in the
PRC. Our future prospects and operational results will be adversely affected if
demand for biodiesel and the biodiesel industry in the PRC fail to
develop.
The
global biodiesel industry is also at an early stage of development and
acceptance, as compared to other more established energy industries, and
significant growth has occurred only recently. Demand for biodiesel may not grow
as rapidly as expected, or at all. Biodiesel and the global biodiesel industry
also face a number of obstacles and drawbacks, including:
•
|
potentially
increased nitrogen oxide (NOx) emissions as compared with most
formulations of diesel;
|
•
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gelling
at lower temperatures than diesel, which can require the use of low
percentage biodiesel blends in colder climates or the use of heated fuel
tanks;
|
•
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potential
water contamination that can complicate handling and long-term
storage;
|
•
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reluctance
on the part of some auto manufacturers and industry groups to endorse
biodiesel and their recommending against the use of biodiesel or high
percentage biodiesel blends;
|
•
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potentially
reduced fuel economy due to the lower energy content of biodiesel as
compared with diesel;
|
•
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potentially
impaired growth due to a lack of infrastructure such as dedicated rail
tanker cars and truck fleets, sufficient storage facilities, and refining
and blending facilities.
|
The
success of our expansion plans depends on growth in domestic demand for
biodiesel, and we may face overcapacity if the biodiesel market in the PRC does
not develop as expected. If overcapacity occurs, the expenditures we incur to
expand our facilities and increase our capacity may not result in increased
sales, which could cause our results of operations to be materially and
adversely affected.
Our
biodiesel business depends on the sufficiency of necessary infrastructure which
may not occur on a timely basis, if at all, and our operations could be
adversely affected by the failure to develop infrastructure or disruptions to
that infrastructure.
Substantial
development of infrastructure will depend upon persons and entities outside of
our control, and the control of others in the biodiesel industry, generally.
Areas requiring expansion include, but are not limited to:
•
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adequate
highway or rail capacity, including sufficient numbers of dedicated tanker
trucks or cars;
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•
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sufficient
storage facilities for feedstock and
biodiesel;
|
•
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increases
in truck fleets capable of transporting biodiesel within localized
markets; and
|
•
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expansion
of independent filling stations.
|
Substantial
investments required for these infrastructure changes and expansions may not be
made or they may not be made on a timely basis. Any delay or failure in making
the changes to or expansion of infrastructure could hurt the demand or prices
for our biodiesel products, impede our delivery of biodiesel products, impose
additional costs on us or otherwise have a material adverse effect on our
results of operations or financial position. Our business is dependent on the
continuing availability of infrastructure and any infrastructure disruptions
could have a material adverse effect on our business.
Our
business will suffer if we cannot obtain, maintain or renew necessary permits or
licenses.
All PRC
enterprises in the finished oil and biodiesel industries are required to obtain
from various PRC governmental authorities certain permits and licenses,
including, without limitation, an Approval Certificate for Wholesale
Distribution of Finished Oil, a Dangerous Chemical Distribution License and a
Safe Production Permit. We have obtained permits and licenses required for the
distribution of finished oil. In addition, in connection with the construction
of our new biodiesel factory, which was completed in October 2007, we obtained
an environmental impact assessment report in January 2008. However, certain
other necessary permits relating to our biodiesel factory are outstanding.
Failure to obtain all necessary approvals/permits may subject us to various
penalties, such as fines or being required to vacate from the facilities where
we currently operate our business.
24
These
permits and licenses are subject to periodic renewal and/or reassessment by the
relevant PRC government authorities and the standards of compliance required in
relation thereto may from time to time be subject to change. We intend to apply
for renewal and/or reassessment of such permits and licenses when required by
applicable laws and regulations, however, we cannot assure you that we can
obtain, maintain or renew the permits and licenses or accomplish the
reassessment of such permits and licenses in a timely manner. Any changes in
compliance standards, or any new laws or regulations that may prohibit or render
it more restrictive for us to conduct our business or increase our compliance
costs may adversely affect our operations or profitability. Any failure by us to
obtain, maintain or renew the licenses, permits and approvals, may have a
material adverse effect on the operation of our business. In addition, we may
not be able to carry on business without such permits and licenses being renewed
and/or reassessed.
If
we fail to adequately protect or enforce our intellectual property rights, or to
secure rights to patents of third parties, our business could be significantly
impaired.
Our
success, competitive position and future revenues will depend in part on our
ability to obtain and maintain patent protection for our products, methods,
processes and other technologies, to preserve our trade secrets, to prevent
third parties from infringing on our proprietary rights and to operate without
infringing the proprietary rights of third parties.
To date,
we have filed 11 patent applications with the State Intellectual Property Office
of the PRC, or the SIPO. We were granted two utility model patents in 2008, and
one utility model patent in 2009. The other eight patent applications have all
been accepted by the SIPO, and six of them have passed the preliminary
examination. In accordance with the PRC Patent Law, all utility model patents
granted to us will be valid for 10 years from the date of filing. Accordingly,
the two patents granted in 2008 were filed in 2006 and will be valid until 2015,
and the patent granted in 2009 was filed in 2008 and will be valid until
2017.
However,
we cannot fully predict the degree and range of protection these patents will
afford us against competitors. Third parties may find ways to invalidate or
otherwise circumvent our proprietary technology. Third parties may attempt to
obtain patents claiming aspects similar to our patent applications. If we need
to initiate litigation or administrative proceedings, such actions may be costly
whether we win or lose. To help protect our proprietary know-how and inventions
for which patents may be unobtainable or difficult to obtain, such as our core
technology for oil processing, we rely on trade secret protection and
confidentiality agreements. If any of our intellectual property is disclosed,
our value would be significantly impaired, and our business and competitive
position would suffer.
If
we infringe the rights of third parties, we could be prevented from selling
products, forced to pay damages and compelled to defend against
litigation.
If our
products, methods, processes and other technologies infringe proprietary rights
of other parties, we may have to obtain licenses (which may not be available on
commercially reasonable terms, if at all), redesign our products or processes,
stop using the subject matter claimed in the asserted patents, pay damages, or
defend litigation or administrative proceedings, which may be costly whether we
win or lose. All of the above could result in a substantial diversion of
valuable management resources and we could incur substantial costs.
We
believe we have taken reasonable steps, including comprehensive internal and
external prior patent searches, to ensure we have the freedom to operate under
our intellectual property rights, and that our development and commercialization
efforts can be carried out as planned without infringing others’ proprietary
rights. However, a third-party patent may have been filed or will be filed that
may contain subject matter of relevance to our development, causing a
third-party patent holder to claim infringement. Resolving such issues has
traditionally resulted, and could in our case result, in lengthy and costly
legal proceedings, the outcome of which cannot be predicted
accurately.
Our
legal right to lease certain properties or accept oil storage services from
third parties could be challenged by property owners, regulatory authorities or
other third parties, which could prevent us from continuing to utilize our oil
storage depots, biodiesel production facility and retail gas stations, which are
located on such leased properties, or could increase the costs associated with
utilizing those facilities.
Although
all land in the PRC is owned by the government or by collectives, private
individuals and businesses are permitted to use, lease and develop land for a
specified term without owning the land, the duration of which depends on the
purpose of land use. These rights to use land are termed land use rights. We do
not hold any land use rights with respect to our biodiesel production facility,
oil storage depots or retail gas stations. Instead, our business model relies on
leases with third parties who either own the properties or lease the properties
from the ultimate property owner and, with respect to two of the oil storage
depots that we use, we rely on the oil storage service agreements with two
state-owned entities. There may be challenges to the title of the properties and
the rights to provide oil storage services which, if successful, could impair
the development or operations of our oil storage depots, biodiesel production
facility and retail gas stations on such properties. In addition, we are subject
to the risk of potential disputes with property owners. Such disputes, whether
resolved in our favor or not, may divert management attention, harm our
reputation or otherwise disrupt our business.
25
In most
instances, our immediate lessors do not possess the ultimate land use rights or
proper property use rights, or have not obtained consents or approvals from the
holders of the land use rights or relevant regulatory authorities to sublease
the land or storage space to us. A lessor’s failure to duly obtain the title to
the property or to receive any necessary approvals from the ultimate holders of
the land use rights, the primary lease holder or relevant regulatory
authorities, as applicable, could potentially result in the invalidation of our
lease, the renegotiation of such lease leading to less favorable terms or, in
serious cases, require us to vacate the properties that we occupy or pay a fine.
With regard to the two state-owned depots that provide storage services to us,
their failure to obtain necessary approvals or to fulfill their obligations of
filing or registering with relevant regulatory authorities of such storage
services under PRC laws and regulations could invalidate such storage service
agreements and we may have to stop using such storage services. The building
ownership or leasehold in connection with our oil storage depots, biodiesel
production facility and gas retail operations could be subject to similar
challenges.
In
addition, three of our gas stations are located on pieces of land which are not
permitted to be used for any non-agricultural purposes. We have not been
informed by any regulatory authority that we should cease to use such land.
However, we cannot assure you that we will be able to continue to use such land
in the future. If we are required to vacate from such land by any regulatory
authorities, our business and results of operations may be adversely
affected.
The
failure of our lessors to transfer gas station operating permits to us may
materially affect our ability to conduct retail gas business.
Under PRC
law, the operation of gas stations requires various permits. In this regard, we
conduct our retail gas station business by leasing twelve gas stations from
third parties who have obtained the requisite permits. To date, we have obtained
all of the necessary operating permits for six gas stations. The operating
permits for the remaining retail gas station are still in the process of being
transferred subject to the approval of relevant regulatory authorities. While
the lease agreement requires the lessor to transfer its operating permits to us,
we cannot guarantee that such permits will be transferred to us in a timely
manner. If the lessor fails to transfer any of the necessary operating permits,
we may not be able to conduct business at such retail gas station, and may be
subject to warning, suspension of business, a fine of up to three times the
illegal gains, or a fine of up to RMB 30,000.
Our
lessors’ failure to comply with lease registration and other compliance
requirements under PRC law may subject these lessors or us to fines or other
penalties that may negatively affect our ability to utilize our oil storage
depots, our biodiesel production facility or our retail gas
stations.
We are
subject to a number of land and property-related legal requirements. For
instance, under PRC law, all lease agreements are required to be registered with
the local housing bureau. Currently, none of the owners of the oil storage
depots, biodiesel production facility and some retail gas stations we
operate and manage has obtained registrations or approval of their leases from
the relevant regulatory authorities as required although we continue to request
that they obtain such registrations or approvals. The failure of our lessors to
register these leases and agreements as required by law or to have the leases
approved may subject these lessors or us to fines, result in our being required
to vacate the properties or other penalties which may negatively affect our
ability to operate or use the biodiesel production facility, the oil storage
depots and retail gas stations covered under those leases.
Accidents
or injuries in or around our oil storage depots, biodiesel production facility
or retail gas stations may adversely affect our reputation and subject us to
liability.
There are
inherent risks of accidents or injuries when working in or around our oil
storage depots, biodiesel production facility or retail gas stations. Death and
accidents could prevent us from renewing our safety production permits. One or
more accidents or injuries at any of our oil storage depots or at our biodiesel
production facility or retail gas stations could adversely affect our safety
reputation among customers and potential customers and increase our costs if we
are required to take additional measures to make our safety precautions more
effective. If accidents or injuries occur, we may be held liable for costs
related to the injuries. Our current insurance policy, which covers claims as a
result of accidental injuries, may not provide adequate coverage and we may be
unable to renew our insurance policies or obtain new insurance policies without
increases in our insurance premiums or decreases in coverage
levels.
Power
shortages, natural disasters, terrorist acts or other events could disrupt our
operations and have a material adverse effect on our business, financial
position or results of operations.
Our
business could be materially and adversely affected by power shortages, natural
disasters, terrorist attacks or other disruptive events in the PRC. For example,
in early 2008, parts of the PRC were affected by severe snow storms that
significantly impacted public transportation systems and the power supply in
those areas. In May 2008, Sichuan Province in the PRC suffered a strong
earthquake measuring approximately 8.0 on the Richter scale that caused
widespread damage and casualties. The May 2008 Sichuan earthquake had a material
adverse effect on the general economic conditions in the areas affected by the
earthquake and severely affected the transportation systems in those areas. Any
future natural disasters, terrorist attacks or other disruptive events in the
PRC could cause a reduction in usage of, or other severe disruptions to, public
transportation systems and could have a material adverse effect on our business,
financial position or results of operations.
26
We
may be unable to maintain an effective system of internal control over financial
reporting, and as a result we may be unable to accurately report our financial
results.
Our
reporting obligations as a public company place a significant strain on our
management, operational and financial resources and systems. If we fail to
maintain an effective system of internal control over financial reporting, we
could experience delays or inaccuracies in our reporting of financial
information, or non-compliance with the Securities and Exchange Commission, or
the SEC, reporting and other regulatory requirements. This could subject us to
regulatory scrutiny and result in a loss of public confidence in our management,
which could, among other things, adversely affect our stock price.
If
we require additional financing, we may not be able to find such financing on
satisfactory terms or at all.
Our
capital requirements may be accelerated as a result of many factors, including
timing of development activities, underestimates of budget items, unanticipated
expenses or capital expenditures, future product opportunities with
collaborators and future business combinations. Our future growth strategy
includes the construction or acquisition of biodiesel facilities that will
enable us to produce more biodiesel fuel. Consequently, we may need to seek
additional debt or equity financing, which may not be available on favorable
terms, if at all, and which may be dilutive to our stockholders.
We may
seek to raise additional capital through public or private equity offerings or
debt financings. To the extent we raise additional capital by issuing equity
securities, our stockholders may experience dilution. To the extent that we
raise additional capital by issuing debt securities, we may incur substantial
interest obligations, may be required to pledge assets as security for the debt
and may be constrained by restrictive financial and/or operational covenants.
Debt financing would also be superior to our stockholders’ interest in
bankruptcy or liquidation.
Our
insurance may not cover all claims made against us.
Currently
we have property and accidental injury insurance policies. If we were held
liable for amounts and claims exceeding the limits of our insurance coverage or
outside the scope of our insurance coverage, the costs to cover any such
shortfalls could significantly reduce and put a strain on our available cash. In
addition, we do not have any business disruption insurance coverage for our
operations to cover losses that may be caused by natural disasters or other
disruptive events, such as an epidemic of H1N1 virus, SARS or avian flu. Any
business disruption or natural disaster may result in our incurring substantial
costs and diversion of our resources.
Risks
Related to Our Corporate Structure
We
rely on contractual arrangements with Xi’an Baorun Industrial and its
stockholders for our operations in the PRC, which may not be as effective in
providing control over Xi’an Baorun Industrial as direct ownership.
We have
no equity ownership interest in Xi’an Baorun Industrial, and rely on contractual
arrangements with Xi’an Baorun Industrial and its stockholders to control and
operate Xi’an Baorun Industrial. We describe these arrangements in more detail
under “Our History and Corporate Structure — Corporate Structure
— Contractual Agreements with Xi’an Baorun Industrial.” These
contractual arrangements may not be as effective in providing control over Xi’an
Baorun Industrial as direct ownership would be. For example, Xi’an Baorun
Industrial could fail to take actions required for our business despite its
contractual obligation to do so. If Xi’an Baorun Industrial, or any of its
stockholders, fails to perform their respective obligations under agreements
with us, we may have to incur substantial costs and resources to enforce such
arrangements and may have to rely on legal remedies under PRC law, including
seeking specific performance or injunctive relief, and claiming damages, which
may not be effective. In addition, we may not be able to renew these agreements
with Xi’an Baorun Industrial and its stockholders when they expire.
Our
contractual arrangements with Xi’an Baorun Industrial are governed by PRC law
and provide for the resolution of disputes through arbitration in the PRC.
Accordingly, these contracts would be interpreted in accordance with PRC law and
any disputes would be resolved in accordance with PRC legal procedures. The
legal environment in the PRC is not as developed as in the United States and
uncertainties in the Chinese legal system could limit our ability to enforce
these contractual arrangements. In the event that we are unable to enforce these
contractual arrangements, our business, financial condition and results of
operations could be materially and adversely affected.
If
the PRC government determines that the contractual arrangements that establish
the structure for operating our business do not comply with applicable
regulations, our business could be adversely affected.
The
government of the PRC restricts foreign investment in energy businesses (e.g.,
finished oil distribution and biodiesel production) in the PRC. Consequently, we
operate our business in the PRC through contractual arrangements with Xi’an
Baorun Industrial. Although we believe we comply with current regulations of the
PRC, we cannot assure you that our current ownership and operating structure
would not be found to be in violation of any current or future PRC laws or
regulations or other regulatory requirements and policies. If the PRC government
determines that our structure or operating arrangements do not comply with
applicable law, it could:
27
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revoke
our business and operating licenses, require us to discontinue or restrict
our operations;
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restrict
our right to collect revenues;
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require
us to restructure our operations;
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impose
additional conditions or requirements with which we may not be able to
comply;
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impose
restrictions on our business operations or on our customers;
or
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take
other regulatory or enforcement actions against us that could be harmful
to our business.
|
In
addition, the equity pledge among Redsky Industrial and Xi’an Baorun Industrial
and Xi’an Baorun Industrial’s stockholders has not been registered and may be
deemed to be invalid under PRC law.
The
controlling stockholder of Xi’an Baorun Industrial may have potential conflicts
of interest with us, which may adversely affect our business.
Mr.
Xincheng Gao, our chairman, chief executive officer and president is the
controlling stockholder of Xi’an Baorun Industrial and through his equity
ownership in Redsky Group Limited, or Redsky Group, our majority stockholder,
Mr. Xincheng Gao is also a beneficial owner of our common stock. He is also a
director of both Xi’an Baorun Industrial and us. Conflicts of interests among
his roles as stockholder, officer and director of both Xi’an Baorun Industrial
and us may arise. We cannot assure you that when conflicts of interests arise,
he will act in the best interests of our company or that conflicts of interests
will be resolved in our favor. In addition, he may breach or cause Xi’an Baorun
Industrial to breach or refuse to renew the existing contractual arrangements
that allow us to receive economic benefits from Xi’an Baorun Industrial.
Currently, we do not have existing arrangements to address potential conflicts
of interests between Mr. Xincheng Gao and us. We rely on Mr. Xincheng Gao to
abide by the laws of Delaware, which provides that directors owe fiduciary
duties to us, requiring them to act in good faith and in our best interests and
not to use their positions for personal gains. If we cannot resolve any
conflicts of interests or disputes between us and Mr. Gao, in his capacity as
the controlling stockholder of Xi’an Baorun Industrial, we would have to rely on
legal proceedings, which could result in disruption of our
business.
Our
contractual arrangements with Xi’an Baorun Industrial may be subject to scrutiny
by the PRC tax authorities and we could be required to pay additional taxes,
which could substantially reduce our consolidated net income and the value of
your investment.
We could
face material and adverse tax consequences if the PRC tax authorities determine
that our contractual arrangements with Xi’an Baorun Industrial were not priced
at arm’s length for purposes of determining tax liabilities. If the PRC tax
authorities determine that these contracts were not entered into on an
arm’s-length basis, they may adjust our income and expenses for PRC tax purposes
in the form of a transfer pricing adjustment. A transfer pricing adjustment
could result in a reduction, for PRC tax purposes, of deductions recorded by
Xi’an Baorun Industrial, which could adversely affect us by increasing the tax
liabilities of Xi’an Baorun Industrial. This increased tax liability could
further result in late payment fees and other penalties to Xi’an Baorun
Industrial for underpaid taxes. Any payments we make under these arrangements or
adjustments in payments under these arrangements that we may decide to make in
the future will be subject to the same risk. Prices for such services will be
set prospectively and therefore we do not know whether any of the payments to be
made under the contracts will or will not be considered at arm’s length for
purposes of determining tax liabilities.
Risks
Related to Doing Business in China
PRC
laws and regulations restrict foreign investment in China’s finished oil
products industry. We have entered into contractual agreements with Xi’an Baorun
Industrial to control and realize the benefits of the business. We are relying
upon PRC laws and there is substantial uncertainty regarding the interpretation
and application of current or future PRC laws and regulations.
Since we
are deemed to be foreign persons or foreign-funded enterprises under PRC laws
and are restricted to invest in companies operating in the finished oil products
industry, we operate our businesses in China through Xi’an Baorun Industrial, an
operating company that is owned by PRC citizens and not by us. Accordingly, our
Chinese subsidiary, Redsky Industrial, entered into a series of exclusive
contractual agreements with Xi’an Baorun Industrial. Although we believe we are
in compliance with current PRC regulations, we cannot be sure that the PRC
government would view these contractual arrangements to be in compliance with
PRC licensing, registration or other regulatory requirements, with existing
policies or with requirements or policies that may be adopted in the future.
Because this structure has not been challenged or examined by PRC authorities,
uncertainties exist as to whether the PRC government may interpret or apply the
laws governing these arrangements in a way that is contrary to the opinion of
our PRC counsel. If we, our wholly owned subsidiaries, Xi’an Baorun Industrial
or the stockholders of Xi’an Baorun Industrial, were found to be in violation of
any existing PRC laws or regulations, the relevant regulatory authorities would
have broad discretion to deal with such violation, including, but not limited to
the following:
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levying
fines;
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confiscating
income;
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revoking
licenses;
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requiring
a restructure of ownership or operations;
and/or
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requiring
the discontinuance of our
businesses.
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Any of
these or similar actions could cause significant disruption to our business
operations or render us unable to conduct our business operations and may
materially adversely affect our business, financial condition and results of
operations.
Adverse
changes in political and economic policies of the PRC government could have a
material adverse effect on the overall economic growth of China, which could
materially and adversely affect our business.
All of
our operations are conducted in China and all of our sales are made in China.
Accordingly, our business, financial condition, results of operations and
prospects are affected significantly by economic, political and legal
developments in China. The PRC economy differs from the economies of most
developed countries in many respects, including:
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the
amount of government involvement;
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the
level of development;
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the
growth rate;
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the
control of foreign exchange; and
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the
allocation of resources.
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While the
PRC economy has grown significantly since the late 1970s, the growth has been
uneven, both geographically and among various sectors of the economy. The PRC
government has implemented various measures to encourage economic growth and
guide the allocation of resources. Some of these measures benefit the overall
PRC economy, but 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.
The PRC
economy has been transitioning from a planned economy to a more market-oriented
economy. Although the PRC government has in recent years implemented measures
emphasizing the utilization of market forces for economic reform, the reduction
of state ownership of productive assets and the establishment of sound corporate
governance in business enterprises, a substantial portion of the productive
assets in China is still owned by the PRC government. The continued control of
these assets and other aspects of the national economy by the PRC government
could materially and adversely affect our business. The PRC government also
exercises significant control over economic growth in China through the
allocation of resources, controlling payment of foreign currency-denominated
obligations, setting monetary policy and providing preferential treatment to
particular industries or companies. Efforts by the PRC government to slow the
pace of growth of the PRC economy could result in decreased capital expenditure
by energy users, which in turn could reduce demand for our
products.
Any
adverse change in the economic conditions or government policies in China could
have a material adverse effect on the overall economic growth and the level of
energy investments and expenditures in China, which in turn could lead to a
reduction in demand for our products and consequently have a material adverse
effect on our business and prospects.
The
payment of dividends in the PRC is subject to limitations. We may not be able to
pay dividends to our stockholders.
We
conduct all of our business through our consolidated subsidiaries and affiliated
companies incorporated in the PRC. We rely on dividends paid by these
consolidated subsidiaries for our cash needs, including the funds necessary to
pay any dividends and other cash distributions to our stockholders, to service
any debt we may incur and to pay our operating expenses. The payment of
dividends by entities established in the PRC is subject to limitations.
Regulations in the PRC currently permit payment of dividends only out of
accumulated profits as determined in accordance with accounting standards and
regulations in the PRC, subject to certain statutory procedural requirements.
Each of our PRC subsidiaries, including wholly foreign owned enterprises is also
required to set aside at least 10.0% of their after-tax profit based on PRC
accounting standards each year to their general reserves or statutory reserve
fund until the aggregate amount of such reserves reaches 50.0% of their
respective registered capital. Our statutory reserves are not distributable as
loans, advances or cash dividends. In addition, if any of our PRC subsidiaries
incurs debt on its own behalf in the future, the instruments governing the debt
may restrict its ability to pay dividends or make other distributions to us. As
of December 31, 2009, our PRC subsidiaries had allocated RMB36.1 million ($4.9
million) to these reserves, consisting of general and statutory reserves. Any
limitations on the ability of our PRC subsidiaries to transfer funds to us could
materially and adversely limit our ability to grow, make investments or
acquisitions that could be beneficial to our business, pay dividends and
otherwise fund and conduct our business.
29
There
are significant uncertainties under the EIT Law regarding our PRC enterprise
income tax liabilities, such as tax on dividends paid to us by our PRC
subsidiary and tax on any dividends we pay to our non-PRC corporate
stockholders.
The EIT
Law provides that enterprises established outside of the PRC whose “de facto
management bodies” are located in the PRC are considered as a “tax-resident
enterprise” and are generally subject to the uniform 25.0% enterprise income tax
rate on global income. Under the implementation regulations to EIT Law, “de
facto management body” refers to a managing body that in practice exercises
overall management control over the production and business, personnel,
accounting and assets of an enterprise. In addition, on April 22, 2009, the
State Administration of Taxation of the PRC issued the Notice on the Issues Regarding
Recognition of Overseas Incorporated Enterprises that are Domestically
Controlled as PRC Resident Enterprises Based on the De Facto Management Body
Criteria, which was retroactively effective as of January 1, 2008. This
notice provides that an overseas incorporated enterprise that is controlled
domestically will be recognized as a “tax-resident enterprise” if it satisfies
all of the following conditions: (i) the senior management responsible for daily
production/business operations are primarily located in the PRC, and the
location(s) where such senior management execute their responsibilities are
primarily in the PRC; (ii) strategic financial and personnel decisions are made
or approved by organizations or personnel located in the PRC; (iii) major
properties, accounting ledgers, company seals and minutes of board meetings and
stockholder meetings, etc, are maintained in the PRC; and (iv) 50.0% or more of
the board members with voting rights or senior management habitually reside in
the PRC. If the PRC tax authorities determine that we are a “tax-resident
enterprise,” we may be subject to enterprise income tax at a rate of 25.0% on
our worldwide income. This may have an impact on our effective tax rate, and may
result in a material adverse effect on our net income and results of operations.
In addition, dividends paid by us to our non-PRC corporate stockholders as well
as gains realized by such stockholders from the sale or transfer of our stock
may be subject to a PRC tax under the EIT Law, and we may be required to
withhold PRC tax on dividends paid to our non-PRC corporate
stockholders.
In
addition, under the EIT Law and the Arrangement between the PRC and the
Hong Kong Special Administrative Region on the Avoidance of Double Taxation and
Prevention of Fiscal Evasion, or the Double Taxation Arrangement, which
became effective on January 1, 2007, if both we and our Hong Kong subsidiary,
Baorun Group, are considered as “non-tax-resident enterprises,” dividends from
our PRC subsidiaries paid to us through our Hong Kong subsidiary may be subject
to a withholding tax at a rate of 5.0%. Furthermore, the ultimate tax rate will
be determined by treaty between the PRC and the tax residence of the holder of
the PRC subsidiary. We are actively monitoring the application of the
withholding tax and are evaluating appropriate organizational changes to
minimize the corresponding tax impact.
Our
business benefits from certain government incentives. Expiration of, or changes
to, these incentives could have a material adverse effect on our operating
results by significantly increasing our tax expenses.
A number
of PRC government initiatives promote the adoption of clean energy sources, such
as biodiesel. For example, pursuant to the Renewable Energy Medium and
Long-Term Development Plan issued by the NDRC in September 2007, the PRC
targets to increase its consumption of energy from renewable sources to 15.0% of
total energy consumption in the PRC by 2020. The plan also includes the
promotion of renewable energy sources. Under the plan, the PRC aims to increase
its annual consumption of biofuel, with the consumption of biodiesel targeted at
two million tons per year by 2020. According to the Renewable Energy Law of the
PRC, local governments are required to prepare a renewable energy
development plan and provide financial support to renewable energy projects in
rural areas. Further, the government may grant businesses engaged in biodiesel
production certain benefits and incentives, while petroleum marketing
enterprises are required to include biodiesel products that comply with the
state standard with respect to fuel sales. These government initiatives could be
modified or eliminated altogether. Such a change in policy could adversely
affect the growth of the biodiesel market and cause our revenues to decline.
Changes to or elimination of initiatives designed to increase general acceptance
of clean energy sources could result in decreased demand for our products and
have a material adverse effect on our business, results of operations and
financial condition.
Furthermore,
we cannot assure you that demand for our products will increase or that we will
otherwise benefit from such regulations. For example, the PRC Ministry of
Finance has issued the Temporary Regulation on the
Management of Special Funds for the Development of Renewable Resources.
Pursuant to this regulation, special funds will be provided to companies for the
development of renewable resources, including petroleum substitutes. These funds
may be used to promote advancement in the development of energy sources that
compete with biodiesel, which may in turn reduce demand for
biodiesel.
If
environmental regulations are relaxed in the future, or if the enforcement of
environmental regulations is not sufficiently rigorous, we may not be able to
compete effectively against other manufacturers of energy products, including
traditional and other clean energy source products. For example, under the Rules on the Management of Waste Oil
for Food Producers, food producers must properly dispose of waste cooking
oil or sell waste cooking oil to waste cooking oil processing entities or waste
collection entities rather than discharging waste cooking oil into the
environment or reusing it for human consumption. However, in practice, these
rules may not be strictly enforced and waste oil may be disposed of through
illegal means by some food producers, which would reduce the supply of waste
cooking oil available for our production. Our business prospects and results of
operations may be adversely affected as a result of any of the foregoing
factors.
30
We
face risks related to health epidemics and outbreak of contagious
disease.
Our
business could be materially and adversely affected by the effects of H1N1 flu
(swine flu), avian flu, severe acute respiratory syndrome or other epidemics or
outbreaks. In April 2009, an outbreak of H1N1 flu (swine flu) first occurred in
Mexico and quickly spread to other countries, including the U.S. and the PRC. In
the last decade, the PRC has suffered health epidemics related to the outbreak
of avian influenza and severe acute respiratory syndrome. Any prolonged
occurrence or recurrence of H1N1 flu (swine flu), avian flu, severe acute
respiratory syndrome or other adverse public health developments in the PRC may
have a material adverse effect on our business and operations. These health
epidemics could result in severe travel restrictions and closures that would
restrict our ability to ship our products. Potential outbreaks could also lead
to temporary closure of our production facilities, our suppliers’ facilities
and/or our end-user customers’ facilities, leading to reduced production,
delayed or cancelled orders, and decrease in demand for our products. Any future
health epidemic or outbreaks that could disrupt our operations and/or restrict
our shipping abilities may have a material adverse effect on our business and
results of operations.
Our
operations may not develop in the same way or at the same rate as might be
expected if the PRC economy were similar to the market-oriented economies of
member countries in the Organization for Economic Co-Operation and Development,
or OECD.
The
economy of the PRC has historically been a nationalistic, “planned economy,”
meaning it functions and produces according to governmental plans and pre-set
targets or quotas. In certain aspects, the PRC’s economy has been transitioning
to a more market-oriented economy. However, there can be no assurance of the
future direction of these economic reforms or the effects these measures may
have. The PRC economy also differs from the economies of most countries
belonging to OECD, an international group of member countries sharing a
commitment to democratic government and market economy. For
instance:
•
|
the
number and importance of state-owned enterprises in the PRC is greater
than in most OECD countries;
|
•
|
the
level of capital reinvestment is lower in the PRC than in most OECD
countries; and
|
•
|
Chinese
policies make it more difficult for foreign firms to obtain local currency
in China than in OECD
jurisdictions.
|
As a
result of these differences, our operations may not develop in the same way or
at the same rate as might be expected if the PRC economy were similar to those
of OECD member countries.
The
PRC economic cycle may negatively impact our operating results.
The rapid
growth of the PRC economy before 2008 generally led to higher levels of
inflation. The PRC economy has more recently experienced a slowing of its growth
rate. A number of factors have contributed to this slow-down, including
appreciation of the Renminbi, or RMB, the currency of China, which has adversely
affected China’s exports. In addition, the slow-down has been exacerbated by the
recent global crisis in the financial services and credit markets, which has
resulted in significant volatility and dislocation in the global capital
markets. It is uncertain how long the global crisis in the financial services
and credit markets will continue and the significance of the adverse impact it
may have on the global economy in general, or the Chinese economy in particular.
Slowing economic growth in China could result in slowing growth and demand for
our services which could reduce our revenues. In the event of a recovery in the
PRC, renewed high growth levels may again lead to inflation. Government attempts
to control inflation may adversely affect the business climate and growth of
private enterprise. In addition, our profitability may be adversely affected if
prices for our products rise at a rate that is insufficient to compensate for
the rise in inflation.
Fluctuation
in the value of the Renminbi may have a material adverse effect on your
investment.
The value
of the Renminbi against the U.S. dollar and other currencies may fluctuate and
is affected by, among other things, changes in China’s political and economic
conditions. The conversion of Renminbi into foreign currencies, including U.S.
dollars, has historically been set by the People’s Bank of China. On July 21,
2005, the PRC government changed its policy of pegging the value of the Renminbi
to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate
within a band against a basket of certain foreign currencies, determined by the
Bank of China, against which it can rise or fall by as much as 0.3% each day.
This change in policy resulted in an approximately 17.5% appreciation in the
value of the Renminbi against the U.S. dollar between July 21, 2005 and December
31, 2009. Since the adoption of this new policy, the value of Renminbi against
the U.S. dollar has fluctuated on a daily basis within narrow ranges, but
overall has further strengthened against the U.S. dollar. There remains
significant international pressure on the PRC government to further liberalize
its currency policy, which could result in a further and more significant
appreciation in the value of the Renminbi against the U.S. dollar. Appreciation
or depreciation in the value of the Renminbi relative to the U.S. dollar would
affect our financial results reported in U.S. dollar terms without giving effect
to any underlying change in our business or results of operations. In addition,
if we decide to convert our Renminbi into U.S. dollars for the purpose of making
payments for dividends on our common stock or for other business purposes,
appreciation of the U.S. dollar against the Renminbi would have a negative
effect on the U.S. dollar amount available to us.
31
Changes
in foreign exchange regulations in the PRC may affect our ability to pay
dividends in foreign currency or conduct other foreign exchange
business.
The PRC
government imposes controls on the convertibility of Renminbi into foreign
currencies and, in certain cases, the remittance of currency out of the PRC. We
receive substantially all of our revenues in Renminbi, which is currently not a
freely convertible currency. Shortages in the availability of foreign currency
may restrict our ability to remit sufficient foreign currency to pay dividends,
or otherwise satisfy foreign currency-denominated obligations. Under existing
PRC foreign exchange regulations, payments of current account items, including
profit distributions, interest payments and expenditures from the transaction,
can be made in foreign currencies without prior approval from the PRC State
Administration of Foreign Exchange, or the SAFE, by complying with certain
procedural requirements. However, approval from appropriate governmental
authorities is required where Renminbi 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.
The PRC
government may also at its discretion restrict access in the future to foreign
currencies for current account transactions. If the foreign exchange control
system prevents us from obtaining sufficient foreign currency to satisfy our
currency demands, we may not be able to pay certain of our expenses as they come
due.
Our
ability to implement our business plan is dependent on many factors, including
our ability to receive various governmental permits.
In
accordance with PRC laws and regulations, we are required to maintain various
licenses and permits in order to operate our business including, without
limitation, a Safety Production Permit, an Approval Certificate for Wholesale
Distribution of Finished Oil and a Dangerous Chemical Distribution License. We
are required to comply with applicable production safety standards in relation
to our production processes and our premises and equipment are subject to
periodical inspections by regulatory authorities to ensure compliance with the
dangerous chemical safety production laws and regulations and finished oil
distribution and retail laws and regulations. Failure to pass these inspections,
or the loss or suspension of some or all of our production activities, could
disrupt our operations and adversely affect our business.
Our
business benefits from preferential tax treatment and changes to this treatment
could adversely affect our operating results.
Prior to
the effectiveness of the EIT Law, the rate of income tax on companies in China
may vary depending on the availability of preferential tax treatment or
subsidies based on their industry or location. However, pursuant to the EIT Law,
a uniform enterprise income tax of 25.0% is generally applied to all
“tax-resident enterprises” under the EIT Law as to their global income, and
“High and New Technology Enterprises” enjoy a preferential tax rate of 15.0%.
Two notices issued by the local State Taxation Bureau stipulate that Xi’an
Baorun Industrial is to enjoy an enterprise tax exemption for the years from
2004 to the end of 2010. In this connection, the EIT Law provides that
enterprises enjoying a fixed-term tax exemption or tax reduction shall, in
accordance with the provisions of the State Council, continue to enjoy such
exemption or reduction after the implementation hereof until the expiration of
the term of such exemption or reduction.
The EIT
Law further provides grandfather treatment for enterprises which were qualified
as “High and New Technology Enterprises” under the previous income tax laws and
were established before March 16, 2007, provided that they continue to meet the
criteria for New Technology Enterprises after January 1, 2008. The grandfather
provision allows these enterprises to continue to enjoy the tax holidays
provided by the previous income tax laws and regulations. Xi’an Baorun
Industrial was qualified as a High and New Technology Enterprise in 2009 and
thus, subject to the approval by competent authorities, will be subject to a
15.0% tax rate starting from 2011 in accordance with the EIT Law and other
relevant regulations.
Given the
short history of the EIT Law, uncertainties remain with respect to its future
interpretation and implementation. We cannot guarantee that the preferential tax
treatment granted to Xi’an Baorun Industrial will not be challenged and repealed
by higher level tax authorities, or that any future implementation rules will be
issued that are inconsistent with the current interpretation of the EIT Law. If
our operating entities are unable to qualify for income tax holidays, our
effective income tax rate will increase significantly and we may have to pay
additional income taxes to make up for amounts previously unpaid. This could
have a material adverse effect on our operations.
Recent
PRC regulations relating to the establishment of offshore special purpose
companies by PRC residents limit our ability to inject capital into our PRC
subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or
otherwise adversely affect us.
The SAFE
issued a public notice in October 2005, requiring PRC residents to register with
the local SAFE branch before establishing or acquiring the control of any
company outside of China for the purpose of financing that offshore company with
assets or equity interest in a PRC company. Anytime such special purpose
vehicles, or SPVs, have a major capital change event (including overseas equity
or convertible bonds financing), all PRC resident stockholders must conduct a
registration relating to the change within 30 days of occurrence of the event.
On May 29, 2007, the SAFE issued an additional notice, clarifying some
outstanding issues and providing standard operating procedures for implementing
the prior notice. According to the new notice, the SAFE set up seven schedules
that track registration requirements for offshore fundraising and roundtrip
investments.
In March
2008, Xincheng Gao, who indirectly controls our company, registered with the
SAFE’s Shaanxi Branch. We understand that he plans to update his registration to
reflect the latest capital changes to each of our SPVs. However, we cannot
guarantee that the SAFE will issue the updated registration certificate in a
timely manner.
32
Further,
pursuant to the above notices, if our PRC resident stockholders or beneficial
owners such as Mr. Xincheng Gao fail to adhere to any of the registration
requirements, or if they make any false representations to obtain the
registration for roundtrip investments in onshore entities or the SPVs, they may
face fines and other legal sanctions. In addition, such actions may also impede
our ability to contribute additional capital or extend loans to our PRC
subsidiaries, impede our PRC subsidiaries’ ability to pay dividends or otherwise
distribute profits to us, or otherwise adversely affect us.
We
may face PRC regulatory risks relating to our equity incentive
plan.
On March
28, 2007, the SAFE promulgated a notice requiring PRC individuals who are
granted stock options and other types of stock-based awards by an overseas
publicly-listed company to obtain approval from the local SAFE branch through an
agent of the overseas publicly-listed company (generally its PRC subsidiary or a
financial institution).
We have
urged our PRC management personnel, directors, employees and consultants who
have been granted stock options under our 2003 Equity Incentive Plan to register
them with the local SAFE pursuant to the said regulation. However, we cannot
ensure that each of these individuals have carried out all of the required
registration procedures.
If we, or
any of these persons, fail to comply with the relevant rules or requirements, we
may be subject to penalties, and may become subject to more stringent review and
approval processes with respect to our foreign exchange activities, such as our
PRC subsidiaries’ dividend payment to us or borrowing foreign currency loans,
all of which may adversely affect our business and financial
condition.
PRC
regulations relating to mergers and acquisitions of domestic enterprises by
foreign investors may increase the administrative burden we face and create
regulatory uncertainties.
On August
8, 2006, six PRC regulatory agencies, namely, the PRC Ministry of Commerce, or
the MOFCOM, the State Assets Supervision and Administration Commission, or the
SASAC, the State Administration for Taxation, the State Administration for
Industry and Commerce, the China Securities Regulatory Commission, or the CSRC,
and the SAFE, jointly adopted the Regulations on Mergers and
Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A
Rule, which became effective on September 8, 2006. The M&A Rule purports,
among other things, to require SPVs, formed for overseas listing purposes
through acquisitions of PRC domestic companies and controlled by PRC companies
or individuals, to obtain the approval of the CSRC prior to publicly listing
their securities on an overseas stock exchange. Based on our understanding of
current PRC laws, we are not sure whether the M&A Rule would require us or
our entities in China to obtain the approval from the CSRC or any other
regulatory agencies in connection with the transaction contemplated by the Share
Exchange Agreement we entered into on October 23, 2007.
Further,
if the PRC government finds that we or our Chinese stockholders did not obtain
the CSRC approval, which the CSRC may think we should have obtained before
executing the Share Exchange Agreement or conducting this offering, we could be
subject to severe penalties. The M&A Rule does not stipulate the specific
penalty terms, so we are not able to predict what penalties we may face, and how
such penalties will affect our business operations or future
strategy.
The
Chinese government exerts substantial influence over the manner in which we must
conduct our business activities.
We are
dependent on our relationship with the local government in the province in which
we operate our business. The Chinese government has exercised and continues to
exercise substantial control over virtually every sector of the Chinese economy
through regulation and state ownership. Our ability to operate in China may be
harmed by changes in its laws and regulations, including those relating to
taxation, environmental regulations, land use rights, property and other
matters. The central or local governments of these jurisdictions may impose new,
stricter regulations or interpretations of existing regulations that would
require additional expenditures and efforts on our part to ensure our compliance
with such regulations or interpretations. Accordingly, government actions in the
future, including any decision not to continue to support recent economic
reforms and to return to a more centrally planned economy or regional or local
variations in the implementation of economic policies, could have a significant
effect on economic conditions in China or particular regions thereof, and could
require us to divest ourselves of any interest we then hold in Chinese
properties.
Future
inflation in China may inhibit our ability to conduct business in
China.
In recent
years, the Chinese economy has experienced periods of rapid expansion and high
rates of inflation. During the past ten years, the rate of inflation in China
has been as high as 20.7% and as low as -2.2%. These factors have led to the
adoption by the Chinese government, from time to time, of various corrective
measures designed to restrict the availability of credit or regulate growth and
contain inflation. High inflation may in the future cause the Chinese government
to impose controls on credit and/or prices, or to take other action, which could
inhibit economic activity in China, and thereby harm the market for our
products.
33
Government
regulations on environmental matters in China may adversely impact on our
business.
Our
production facilities are subject to numerous laws, regulations, rules and
specifications relating to human health and safety and the environment. These
laws and regulations address and regulate, among other matters, wastewater
discharge, air quality and the generation, handling, storage, treatment,
disposal and transportation of solid and hazardous wastes and releases of
hazardous substances into the environment. In addition, third parties and
governmental agencies in some cases have the power under such laws and
regulations to require remediation of environmental conditions and, in the case
of governmental agencies, to impose fines and penalties. We make capital
expenditures from time to time to comply with applicable laws and
regulations.
Pursuant
to PRC environmental protection laws and regulations, construction or expansion
of a production facility is subject to certain environment impact assessment
procedures including obtaining the relevant environmental authorities' approval
for the construction project.
All
potential environmental liabilities may not have been identified or properly
quantified and a prior owner, operator, or tenant may have created an
environmental condition unknown to us. We may be potentially liable for damages
or cleanup, investigation or remediation costs in connection with the ownership
and operation of our properties (including locations to which we may have sent
waste in the past) and the conduct of our business.
State and
local environmental regulatory requirements change often. Future laws,
ordinances or regulations might impose material environmental liability or the
current environmental condition of the properties could in the future be
affected by the condition of land or operations in the vicinity of the
properties (such as the presence of underground storage tanks), or by third
parties unrelated to us. Moreover, it is possible that compliance with a new
regulatory requirement could impose significant compliance costs on us. Such
costs could have a material adverse effect on our business, financial condition
and results of operations.
Uncertainties
with respect to the PRC legal system could adversely affect us and we may have
limited legal recourse under PRC law if disputes arise under our contracts with
third parties.
Since
1979, PRC legislation and regulations have significantly 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 non-binding nature, the interpretation and enforcement of these laws and
regulations involve uncertainties. In addition, the PRC 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 some time
after violation.
The
Chinese government has enacted some laws and regulations dealing with matters
such as corporate organization and governance, foreign investment, commerce,
taxation and trade. However, their experience in implementing, interpreting and
enforcing these laws and regulations is limited, and our ability to enforce
commercial claims or to resolve commercial disputes is unpredictable. The
resolution of these matters may be subject to the exercise of considerable
discretion by agencies of the Chinese government, and forces unrelated to the
legal merits of a particular matter or dispute may influence their
determination. Any rights we may have to specific performance, or to seek an
injunction under PRC law, in either of these cases, are severely limited, and
without a means of recourse by virtue of the Chinese legal system, we may be
unable to prevent these situations from occurring. The occurrence of any such
events could have a material adverse effect on our business, financial condition
and results of operations.
We
must comply with the Foreign Corrupt Practices Act.
We are
required to comply with the United States Foreign Corrupt Practices Act, which
prohibits U.S. companies from engaging in bribery or other prohibited payments
to foreign officials for the purpose of obtaining or retaining business. Foreign
companies, including some of our competitors, are not subject to these
prohibitions. Certain of our suppliers are owned by the PRC government and our
dealings with them are likely to be considered to be with government officials
for these purposes. Corruption, extortion, bribery, pay-offs, theft and other
fraudulent practices occur from time-to-time in mainland China. If our
competitors engage in these practices, they may receive preferential treatment
from personnel of some companies, giving our competitors an advantage in
securing business or from government officials who might give them priority in
obtaining new licenses, which would put us at a disadvantage. We could suffer
severe penalties if our employees or other agents were found to have engaged in
such practices.
Risks
Related to this Offering and Our Common Stock
The
outstanding warrants may adversely affect us in the future and cause dilution to
existing stockholders.
We
currently have warrants outstanding to purchase up to 4,007,273 shares of our
common stock. The term of these warrants expire between August 2011 and 2013 and
the exercise prices range from $3.00 to $6.00 per share. Exercise of the
warrants may cause dilution in the equity interests of other stockholders as a
result of the additional common stock that would be issued upon exercise. In
addition, sales of the shares of our common stock issuable upon exercise of the
warrants could have a depressive effect on the price of our stock, particularly
if there is not a coinciding increase in demand by purchasers of our common
stock. Further, the terms on which we may obtain additional financing during the
period any of the warrants remain outstanding may be adversely affected by the
existence of these warrants.
34
Volatility
in our common stock price may subject us to securities litigation.
Stock
markets, in general, have experienced in recent months, and continue to
experience, significant price and volume volatility, and the market price of our
common stock may continue to be subject to similar market fluctuations unrelated
to our operating performance or prospects. This increased volatility, coupled
with depressed economic conditions, could continue to have a depressing effect
on the market price of our common stock. Over the past 12 months, the sales
price of our common stock has fluctuated between $8.05 and $3.50. The following
factors, many of which are beyond our control, may influence our stock
price:
•
|
announcements
of technological or competitive
developments;
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regulatory
developments in the PRC affecting us, our customers or our
competitors;
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announcements
regarding patent or other intellectual property litigation or the issuance
of patents to us or our competitors or updates with respect to the
enforceability of patents or other intellectual property rights generally
in the PRC or internationally;
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actual
or anticipated fluctuations in our quarterly operating
results;
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changes
in financial estimates by securities research
analysts;
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changes
in the economic performance or market valuations of our
competitors;
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•
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addition
or departure of our executive
officers;
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release
or expiration of lock-up or other transfer restrictions on our outstanding
common stock; and
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sales
or perceived sales of additional shares of our common
stock.
|
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. Any of these factors could result in large and sudden
changes in the volume and trading price of our common stock and could cause our
stockholders to incur substantial losses. In the past, following periods of
volatility in the market price of a company’s securities, stockholders have
often instituted securities class action litigation against that company. If we
were involved in a class action suit or other securities litigation, it would
divert the attention of our senior management, require us to incur significant
expense and, whether or not adversely determined, could have a material adverse
effect on our business, financial condition, results of operations and
prospects.
We
do not anticipate paying cash dividends on our common stock in the foreseeable
future.
We do not
anticipate paying cash dividends in the foreseeable future. Presently, we intend
to retain all of our earnings, if any, to finance development and expansion of
our business. PRC capital and currency regulations may also limit our ability to
pay dividends. Consequently, your only opportunity to achieve a positive return
on your investment in us will be if the market price of our common stock
appreciates.
We
will have discretion in applying a portion of the net proceeds of the
public offering and may not use these proceeds in ways that will enhance
the market value of our common stock.
Our
management will have considerable discretion in the application of the proceeds
received by us from the public offering completed in November 2009. Such
proceeds may be used to expand our biodiesel production capacity, acquire new
retail gas stations and for working capital and general corporate purposes. The
investors will not have the opportunity, as part of the investors’ investment
decision, to assess whether the proceeds are being used appropriately. The
investors must rely on the judgment of our management regarding the application
of the net proceeds of the public offering. The net proceeds may be used for
corporate purposes that do not improve our profitability or increase our common
stock price. The net proceeds from the public offering may also be
placed in investments that do not produce income or that lose
value.
The
investors’ ability
to bring an action against us or against our directors and officer, or to
enforce a judgment against us or them, will be limited because we conduct
substantially all of our operations in the PRC and because the majority of our
directors and officers reside outside of the United States.
We are a
Delaware holding company and most of our assets are located outside of the
United States. Most of our current operations are conducted in the PRC. In
addition, most of our directors and officers are nationals and residents of
countries other than the United States. A substantial portion of the assets of
these persons is located outside the United States. As a result, it may be
difficult for investors to effect service of process within the United
States upon these persons. It may also be difficult for investors to
enforce in U.S. courts judgments on the civil liability provisions of the U.S.
federal securities laws against us and our officers and directors, most of whom
are not residents in the United States and the substantial majority of whose
assets are located outside of the United States. In addition, there is
uncertainty as to whether the courts of the PRC would recognize or enforce
judgments of U.S. courts. Our counsel as to PRC law has advised us that the
recognition and enforcement of foreign judgments are provided for under the
PRC Civil Procedures
Law. Courts in the PRC may recognize and enforce foreign judgments in
accordance with the requirements of the PRC Civil Procedures Law
based on treaties between the PRC and the country where the judgment is
made or on reciprocity between jurisdictions. The PRC does not have any treaties
or other arrangements that provide for the reciprocal recognition and
enforcement of foreign judgments with the United States. In addition, according
to the PRC Civil Procedures
Law, courts in the PRC will not enforce a foreign judgment against us or
our directors and officers if they decide that the judgment violates basic
principles of PRC law or national sovereignty, security or the public interest.
So it is uncertain whether a PRC court would enforce a judgment rendered by a
court in the United States.
35
Anti-takeover
provisions of the Delaware General Corporation Law and some provisions in our
certificate of incorporation and bylaws could have a material adverse effect on
the rights of holders of our common stock.
We are
subject to Section 203 of the Delaware General Corporation Law. This provision
generally prohibits a Delaware corporation from engaging in any business
combination with any interested stockholder for a period of three years
following the date the stockholder became an interested stockholder,
unless:
•
|
prior
to such date, the board of directors approved either the business
combination or the transaction that resulted in the stockholder becoming
an interested stockholder;
|
•
|
upon
consummation of the transaction that resulted in the stockholder becoming
an interested stockholder, the interested stockholder owned at least 85.0%
of the voting stock of the corporation outstanding at the time the
transaction commenced, excluding for purposes of determining the number of
shares outstanding those shares owned by persons who are directors and
officers and by employee stock plans in which employee participants do not
have the right to determine confidentially whether shares held subject to
the plan will be tendered in a tender or exchange offer;
or
|
•
|
on
or subsequent to such date, the business combination is approved by the
Board of Directors and authorized at an annual meeting or special meeting
of stockholders and not by written consent, by the affirmative vote of at
least 66.7% of the outstanding voting stock that is not owned by the
interested stockholder.
|
Section
203 defines a business combination to include:
•
|
any
merger or consolidation involving the corporation and the interested
stockholder;
|
•
|
any
sale, transfer, pledge or other disposition of 10.0% or more of the assets
of the corporation involving the interested
stockholder;
|
•
|
subject
to certain exceptions, any transaction that results in the issuance or
transfer by the corporation of any stock of the corporation to the
interested stockholder;
|
•
|
any
transaction involving the corporation that has the effect of increasing
the proportionate share of the stock of any class or series of the
corporation beneficially owned by the interested stockholder;
or
|
•
|
the
receipt by the interested stockholder of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation.
|
In
general, Section 203 defines an “interested stockholder” as any entity or person
beneficially owning 15.0% or more of the outstanding voting stock of a
corporation, or an affiliate or associate of the corporation and was the owner
of 15.0% or more of the outstanding voting stock of a corporation at any time
within three years prior to the time of determination of interested stockholder
status; and any entity or person affiliated with or controlling or controlled by
such entity or person.
Anti-takeover
provisions of the Delaware General Corporation Law, may make it more difficult
to acquire our company or effect a change in control of our company, even if an
acquisition or change in control would be in the interest of our stockholders or
if an acquisition or change in control would provide our stockholders with a
premium for their shares over then current market prices.
Our
certificate of incorporation and bylaws contain provisions that could have the
effect of discouraging potential acquisition proposals or tender offers or
delaying or preventing a change in control of our company, including changes a
stockholder might consider favorable. In particular, our certificate of
incorporation and bylaws, as applicable, among other things, provide
that:
•
|
our
Board of Directors shall have the ability to alter our bylaws without
stockholder approval;
|
•
|
an
advance notice procedure with regard to the nomination of candidates for
election as directors and with regard to business to be brought before a
meeting of stockholders; and
|
•
|
vacancies
on our Board of Directors may be filled by a majority of directors in
office, although less than a
quorum.
|
Such
provisions may have the effect of discouraging a third party from acquiring our
company, even if doing so would be beneficial to its stockholders. These
provisions are intended to enhance the likelihood of continuity and stability in
the composition of our board of directors and in the policies formulated by
them, and to discourage some types of transactions that may involve an actual or
threatened change in control of our company. These provisions are designed to
reduce our vulnerability to an unsolicited acquisition proposal and to
discourage some tactics that may be used in proxy fights.
36
However,
these provisions could have the effect of discouraging others from making tender
offers for our shares. These provisions also may have the effect of preventing
changes in our management.
One
of our directors and officers controls a majority of our common stock and his
interests may not align with the interests of our other
stockholders.
Mr.
Xincheng Gao, our chairman, chief executive officer and president, through
Redsky Group, which he controls, currently beneficially owns approximately 65.9%
of our issued and outstanding common stock as of December 31, 2009. This
significant concentration of share ownership may adversely affect the trading
price of our common stock because investors often perceive a disadvantage in
owning shares in a company with one or several controlling stockholders.
Furthermore, our directors and officers, as a group, have the ability to
significantly influence or control the outcome of all matters requiring
stockholder approval, including the election of directors and approval of
significant corporate transactions, such as mergers, consolidations or the sale
of substantially all of our assets. This concentration of ownership may have the
effect of delaying or preventing a change in control of our company which could
deprive our stockholders of an opportunity to receive a premium for their shares
as part of a sale of our company and might reduce the price of our common stock.
In addition, without the consent of Mr. Gao or Redsky Group, we could be
prevented from entering into transactions that could be beneficial to us. Mr.
Gao or Redsky Group may cause us to take actions that are opposed by other
stockholders as his interests may differ from those of other
stockholders.
Future
issuances of capital stock may depress the trading price of our common
stock.
Any
issuance of shares of our common stock after this offering could dilute the
interests of our existing stockholders and could substantially decrease the
trading price of our common stock. We may issue additional shares of common
stock in the future for a number of reasons, including to finance our operations
and business strategy (including in connection with acquisitions, strategic
collaborations or other transactions).
Sales of
a substantial number of shares of our common stock in the public market could
depress the market price of our common stock, and impair our ability to raise
capital through the sale of additional equity securities. We cannot predict the
effect that future sales of our common stock or other equity-related securities
would have on the market price of our common stock.
Item 1B.
|
Unresolved Staff
Comments.
|
As a
smaller reporting company, this information is not required.
Item 2.
|
Description of
Property.
|
The
following table summarizes, by business segment, the location of real properties
leased by us.
We
entered into a lease agreement with Northwest Fire-resistant Materials Factory
in April 2006, which was amended in July 2008, whereby we were granted the right
to use a piece of land located in Tongchuan City, Shaanxi Province for building
our biodiesel production facility. We pay an annual rent of RMB 700,000 which is
paid in four installments each year during the term of the lease agreement. This
agreement has a term of eight years ending in June 2016.
We
believe our facilities are currently suitable and adequate for our current
needs.
Business
Segment
|
Use
of Property
|
Address
|
Lease
Term
|
|||
Production
and Sale of Biodiesel
|
Biodiesel
production facility
|
Space
within the Northwest Fire-resistant Materials Factory, Tongchuan City,
Shaanxi Province, China
|
2006
– 2016
|
|||
Operation
of Retail Gas Stations
|
Xinyuan
Gas Station
|
Xinhua
Village, Disai Town, Baqiao District, Xi’an, Shaanxi Province,
China
|
2007
– 2027
|
|||
Operation
of Retail Gas Stations
|
Lantian
Gas Station
|
Xihou
Village, Hongqing Community, Baqiao District, Xi’an, Shaanxi Province,
China
|
2009
– 2038
|
|||
Operation
of Retail Gas Stations
|
Fangwei
Road Gas Station
|
Fangwei
Road, Xi’an, Shaanxi Province, China
|
2009
– 2039
|
37
Business
Segment
|
Use
of Property
|
Address
|
Lease
Term
|
|||
Operation
of Retail Gas Stations
|
Northern
Gas Station in
Yang
County Service Stations
|
Yang
County Service Stations, Xihan Expressway, Shaanxi Province,
China
|
2008
– 2023
|
|||
Operation
of Retail Gas Stations
|
Southern
Gas Station in
Yang
County Service Stations
|
Yang
County Service Stations, Xihan Expressway, Shaanxi Province,
China
|
2008
– 2023
|
|||
Operation
of Retail Gas Stations
|
Northern
Gas Station in
Cheng
County Service Stations
|
Cheng
County Service Stations, Xiyu Expressway, Shaanxi Province,
China
|
2008
– 2023
|
|||
Operation
of Retail Gas Stations
|
Southern
Gas Station in
Cheng
County Service Stations
|
Cheng
County Service Stations, Xihan Expressway, Shaanxi Province,
China
|
2008
– 2023
|
Item 3.
|
Legal
Proceedings.
|
In the
normal course of business, we may be subject to claims and litigation. We are
not a party to any material legal proceedings nor are we aware of any
circumstance that may reasonably lead a third party to initiate legal
proceedings against us.
38
PART
II
Item 4.
|
Market for Registrant’s Common
Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities.
|
Quarter
Ending:
|
High
|
Low
|
||||||
Fiscal
Year 2008
|
||||||||
First
Quarter
|
5.50
|
4.10
|
||||||
Second
Quarter
|
9.00
|
4.50
|
||||||
Third
Quarter
|
9.00
|
5.50
|
||||||
Fourth
Quarter
|
5.50
|
3.40
|
||||||
Fiscal
Year 2009
|
||||||||
First
Quarter
|
4.50
|
2.75
|
||||||
Second
Quarter (through June 26)
|
6.00
|
3.50
|
||||||
Second
Quarter (June 26 through June 3)
|
6.00
|
5.00
|
||||||
Third
Quarter
|
8.19
|
4.80
|
||||||
Fourth
Quarter
|
8.05
|
5.75
|
||||||
Fiscal
Year 2009
|
||||||||
First
Quarter (through March 22, 2010)
|
10.28
|
6.78
|
Holders
of Record
As of
March 22, 2010, there were 240 holders of record of our common
stock. This number does not include beneficial holders of our common
stock, who hold their shares in accounts through brokers or banks.
Unregistered
Sales of Equity Securities
There
were no unregistered sales of equity securities that were not reported on a
Current Report on Form 8-K or in a Quarterly Report on Form 10-Q.
Use
of Proceeds from Registered Offering
On November 4, 2009, we consummated a
public offering of 5,000,000 shares of common stock at a public offering price
of $5.75 per share, and subsequently on November 18, 2009, we consummated a
public offering of an additional 750,000 shares of common stock at the same
price as a result of the exercise of the over-allotment
option. Aggregate gross proceeds were approximately $33.1 million and
we received net proceeds of approximately $30.7 million from the offering, after
deducting underwriting discounts and estimated offering expenses of
approximately $2.4 million. There were no payments, direct or indirect, made to
any directors, officers, or their associates; to persons owning 10% percent or
more of any class of our equity securities of the issuer; or our affiliates of
the issuer, or direct or indirect payments to others.
We offered the shares sold in the
offering pursuant to a Registration Statement on Form S-1 (File No. 333 -
161831), which was declared effective by the SEC on October 29,
2009. We used approximately $15 million of the net proceeds from the
offering to begin construction of a new bio-diesel facility, and the remaining
$16 million will be used to expand our wholesale distribution and retail gas
station businesses through both organic growth and potential acquisitions and
for working capital and general corporate purposes.
The offering was underwritten by
Oppenheimer & Co., Cowen and Company and Roth Capital Partners,
LLC. Oppenheimer & Co. acted as sole book-running manager for the
offering. Cowen and Company and Roth Capital Partners, LLC served as
co-managers.
39
Dividends
We have
never paid any dividends and we plan to retain earnings, if any, for use in the
development of our business.
Under
current PRC regulations, wholly foreign-owned enterprises and Sino-foreign
equity joint ventures in the PRC may pay dividends only out of their accumulated
profits, if any, determined in accordance with PRC accounting standards and
regulations. Additionally, these foreign-invested enterprises are required to
set aside certain amounts of their accumulated profits each year, if any, to
fund certain reserve funds. These reserves are not distributable as cash
dividends. Payment of future dividends, if any, will be at the discretion of the
Board of Directors after taking into account various factors, including current
financial condition, operating results and current and anticipated cash
needs.
Equity
Compensation Plan Information
See “Item
11. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters ” for disclosure regarding our Equity Compensation
Plans.
40
Issuer
Purchases of Equity Securities
None.
Item 5.
|
Selected Financial
Data.
|
As a
smaller reporting company we are not required to include this
disclosure.
Item 6.
|
Management’s Discussion and
Analysis of Financial Condition and Results of
Operations.
|
Forward
Looking Statements
This
annual report on Form 10-K and other reports filed by the Company from time to
time with the Securities and Exchange Commission (collectively the “Filings”)
contain or may contain forward-looking statements and information that are based
upon beliefs of, and information currently available to, the Company’s
management as well as estimates and assumptions made by Company’s management.
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.
When used in the Filings, the words “anticipate”, “believe”, “estimate”,
“expect”, “future”, “intend”, “plan”, or the negative of these terms and similar
expressions as they relate to the Company or the Company’s management identify
forward-looking statements. Such statements reflect the current view of the
Company with respect to future events and are subject to risks, uncertainties,
assumptions, and other factors (including the risks contained in the section of
this report entitled “Risk Factors”) relating to the Company’s industry, the
Company’s operations and results of operations, and any businesses that the
Company may acquire. Should one or more of these risks or uncertainties
materialize, or should the underlying assumptions prove incorrect, actual
results may differ significantly from those anticipated, believed, estimated,
expected, intended, or planned.
Although
the Company believes that the expectations reflected in the forward-looking
statements are reasonable, the Company cannot guarantee future results, levels
of activity, performance, or achievements. Except as required by applicable law,
including the securities laws of the United States, the Company does not intend
to update any of the forward-looking statements to conform these statements to
actual results. Readers are urged to carefully review and consider the various
disclosures made throughout the entirety of this annual report, which attempt to
advise interested parties of the risks and factors that may affect our business,
financial condition, results of operations, and prospects.
Our
financial statements are prepared in accordance with accounting principles
generally accepted in the United States (“GAAP”). These accounting principles
require us to make certain estimates, judgments and assumptions. We believe that
the estimates, judgments and assumptions upon which we rely are reasonable based
upon information available to us at the time that these estimates, judgments and
assumptions are made. These estimates, judgments and assumptions can affect the
reported amounts of assets and liabilities as of the date of the financial
statements as well as the reported amounts of revenues and expenses during the
periods presented. Our financial statements would be affected to the extent
there are material differences between these estimates and actual results. In
many cases, the accounting treatment of a particular transaction is specifically
dictated by GAAP and does not require management’s judgment in its application.
There are also areas in which management’s judgment in selecting any available
alternative would not produce a materially different result.
OVERVIEW
The
following Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") is intended to help the reader understand our
operations and our present business environment. MD&A is provided as a
supplement to—and should be read in conjunction with—our consolidated financial
statements and the accompanying notes thereto contained in "Item 1. Financial
Statements of this report. This overview summarizes the MD&A, which includes
the following sections:
• Our Business—a general
overview of our three business segments and the material opportunities and
challenges of our business.
• Critical Accounting Policies and
Estimates—a discussion of accounting policies that require critical
judgments and estimates.
• Results of Operations—an
analysis of our Company's consolidated results of operations for the two years
presented in our consolidated financial statements. Except to the extent that
differences among our operating segments are material to an understanding of our
business as a whole, we present the discussion in the MD&A on a consolidated
basis.
• Liquidity, Capital Resources and
Financial Position—an analysis of cash flows; an overview of financial
position.
41
The
following discussion contains forward-looking statements that involve risks,
uncertainties, and assumptions such as statements of our plans, objectives,
expectations, and intentions. Our actual results may differ materially from
those discussed in these forward-looking statements because of the risks and
uncertainties inherent in future events.
Our
Business
Company
Overview
We are a
leading non-state-owned integrated energy company in China engaged in three
business segments, wholesale distribution of finished oil and heavy oil
products,, production and sale of bio-diesel, and operation of retail gas
stations..
We now
operate four oil depots located in Xi’an, Shaanxi Province, access to a
2.65 kilometer special transportation rail track and one 100,000 ton biodiesel
production plant located in Tongchuan, Shaanxi Province, China. Our major market
is China. Currently, our products are sold in 14 provinces and municipalities of
China covering Shaanxi Province, Henan Province, Hebei Province, Shangdong
Province, Shanxi Province, Hunan Province, Hubei Province, Sichuan Province,
Guizhou Province, Yunnan Province, Fujian Province, Xinjiang Province,
Beijing, and Shanghai.
Fluctuations
in Fuel Prices During 2009
For the
past 9 years, China's fuel prices have been controlled by the National
Development and Reform Commission (NDRC) and not set by market supply and
demand. Effective January 1, 2009, the Chinese government implemented a new
pricing regime for refined oil products, aimed to link domestic oil prices more
closely to changes in the global crude oil prices in a controlled
manner.
In
January 2009, the Chinese government halved sales tax to 5% on purchases of cars
with engines less than 1.6 liters. The tax cut was aimed at boosting domestic
auto purchases which will likely increase overall domestic oil consumption as
well as provide a stimulus for the steel sector. We believe that the sales tax
cut on purchases of vehicles with small engines will drive more fuel
consumption.
In
January 2009, the average sales price for our oil products, which include
gasoline, diesel and heavy oil decreased 22.3% to $641 per ton (equivalent to
approximately $1.77 per gallon of gasoline and $2.04 per gallon of
petro-diesel), compared to an average price of $825 per ton (equivalent to
approximately $2.28 per gallon of gasoline and $2.62 per gallon of
petro-diesel), during 2008. This decrease is substantially less than the drop in
world crude oil prices during the same period because the NDRC had held domestic
prices at lower levels during 2008.
On March
25, 2009, the NDRC increased the prices of gasoline and diesel by RMB 290 or $42
per ton or 5.33% and RMB 180 or $26 per ton or 3.74%, respectively, to reflect a
rebound of global oil prices. As a result of this oil price increase, the retail
prices of gasoline and diesel have increased accordingly. In April
2009, the average sales price for our oil products was approximately $745 per
ton (equivalent to approximately $2.55 per gallon of gasoline and $2.83 per
gallon of petro-diesel)
On June
1, 2009, the NDRC increased the prices of gasoline and diesel by RMB 400 or $59
per ton or 7.0% and RMB 400 or $59 per ton or 8.0%, respectively, to reflect the
continued climb of global oil prices. As a result of this oil price increase,
the retail prices of gasoline and diesel have increased
accordingly. In June 2009, the average sales price for our oil
products was approximately $815 per ton (equivalent to approximately $2.72 per
gallon of gasoline and $3.01 per gallon of petro-diesel)
On June
30, 2009, NDRC subsequently increased the prices of gasoline and diesel by RMB
600 or $88 per ton or 9.8% and RMB 600 or $88 per ton or 11.1%,
respectively.
On July
29, 2009 NDRC decreased the prices of gasoline and diesel by RMB 220 or $32 per
ton for each petroleum products.
On
September 2, 2009, the NDRC decreased the prices of gasoline and diesel by RMB
300 or $44 per ton.
On
September 30, 2009, the NDRC decreased the prices of gasoline and diesel by RMB
190 or $27.80 per ton.
On
November 10, 2009, the NDRC increased the prices of gasoline and diesel by RMB
480 or $70.32 per ton.
Price
increase and decrease reflect the fluctuation of global oil market
prices.
From 2006
to 2008, there were only two oil price adjustments in each
year. However, there were eight oil price adjustments to date in
2009. We expect that oil prices in China will be adjusted more
frequently fluctuating in line with global oil prices.
42
Tax
Exemptions
NDRC, the
Ministry of Finance and other governmental departments are formulating relevant
policies such as subsidies, refunds of Value Added Taxes (“VAT”) and relief on
consumption tax, corporate tax and fuel tax to encourage bio-diesel consumption.
As a result, we are exempt from corporate income tax through the end of calendar
year 2010 and also from the fuel tax.
Growth
and Expansion Plans
Management
plans to focus on growing its biodiesel production, its distribution business,
and expanding the footprint of its retail gas stations. On the distribution and
retail sides, we benefit from our advantageous location, well-established
supplier relationships, as well as an extensive distribution network that has
valuable railway access to reach remote parts of China that other distribution
companies located in Shaanxi Province cannot currently reach. We plan to
strengthen our outreach in certain key distribution areas. We also plan to add
another three retail gas stations through acquisition or lease, which we believe
will benefit our overall distribution profit margins.
We also
plan to expand our current biodiesel production capacity of 100,000 tons to
150,000 tons, and have begun constructions to increase this capacity in
the fourth quarter of 2009. We anticipate $15 million in capital
expenditures in 2009 and 2010 to accomplish this 50,000 ton of biodiesel
production facility. We have secured enough raw materials to supply 150,000 tons
of capacity, but will also continue to work towards securing more long-term
sources of raw materials and new technology in the bio-energy field. We continue
pursuing strategic acquisition that will quickly provide financial benefits to
us.
Management
believes the increase in sales volume from these initiatives will not only
offset the impact from fluctuation in fuel pricing, but also favorably impact
overall profits and cash flow.
Public
Equity Financing
On
November 4, 2009, the Company completed a public equity offering issuing
5,000,000 shares of common stock at a public offering price of $5.75 per share.
On November 18, the Company issued additional 750,000 shares upon the exercise
of over-allotment option granted to the underwriters in the public offering.
Aggregate gross proceeds were approximately $33.0 million and the Company paid
approximately $2.4 million in underwriting commissions, legal fees, accounting
fees, and others offering expenses. The Company raised approximately $30.7
million in net proceeds. The net proceeds will be used for acquisitions, leasing
of gas stations, working capital, and other general corporate
purposes.
Basis
of Presentations
Our
financial statements are prepared in accordance with GAAP and the requirements
of Regulation S-X promulgated by the Securities and Exchange
Commission.
Critical
Accounting Policies and Estimates
Accounts
Receivable
Our
policy is to maintain reserves for potential credit losses on accounts
receivable. Management reviews the composition of accounts receivable and
analyzes historical bad debts, customer concentrations, customer credit
worthiness, current economic trends and changes in customer payment patterns to
evaluate the adequacy of these reserves. Based on historical
collections, no allowance was deemed necessary at December 31, 2009 and 2008, as
the Company did not experience any uncollectible accounts receivable and bad
debt write-off over the past years.
Inventories
Inventories
are valued at the lower of cost or market with cost determined on a moving
weighted average basis. Cost of work in progress and finished goods
comprises direct material, direct labor, and an allocated portion of production
overheads.
Property,
Plant and Equipment
Plant,
property, and equipment are stated at the actual cost on acquisition less
accumulated depreciation and amortization. Depreciation and amortization are
provided for in amounts sufficient to relate the cost of depreciation assets to
operations over their estimated service lives, principally on a straight-line
basis. Most property, plant and equipment have a residual value of 5% of actual
cost. The estimated lives used in determining depreciation are:
43
Building
|
20
years
|
Vehicle
|
5
years
|
Office
Equipment
|
5
years
|
Production
Equipment
|
10
years
|
In
accordance with accounting standards codification, “Accounting for the
Impairment or Disposal of Long-Lived Assets”, we examine the possibility of
decreases in the value of fixed assets when events or changes in circumstances
reflect the fact that their recorded value may not be recoverable.
Revenue
Recognition
Our
revenue recognition policies are in compliance with Securities and Exchange
Commission Staff Accounting Bulletin. Sales revenue is recognized at the date of
shipment to customers when a formal arrangement exists, the price is fixed or
determinable, the delivery is completed, no other significant obligations of the
Company exist and collectability is reasonably assured. Payments
received prior to meeting all relevant criteria for revenue recognition are
recorded as unearned revenue. For retail gas station sales, revenue
is recognized and cash is collected upon completion of fuel sales to
customers.
Foreign
Currency Translation
Our
functional currency is the Renminbi (“RMB”). For financial reporting purposes,
RMB has been translated into United States Dollars (“USD”) as the reporting
currency. Assets and liabilities are translated at the exchange rate in effect
at the balance sheet date. Revenues and expenses are translated at the average
rate of exchange prevailing during the reporting period. Translation adjustments
caused by different exchange rates from period to period are included as a
component of stockholders’ equity as “Accumulated other comprehensive income.”
Gains and losses resulting from foreign currency transactions are included in
income. There has been no significant fluctuation in exchange rate for the
conversion of RMB to USD after the balance sheet date.
Income
Tax Recognition
We
account for income taxes under accounting standards codification, “Accounting
for Income Taxes”. “Accounting for Income Taxes” requires the recognition of
deferred tax assets and liabilities for both the expected impact of differences
between the financial statements and the tax basis of assets and liabilities,
and for the expected future tax benefit to be derived from tax losses and
tax credit carry forwards. “Accounting for Income Taxes” additionally requires
the establishment of a valuation allowance to reflect the likelihood of
realization of deferred tax assets.
Xi’an
Baorun Industrial has obtained income tax exemption for the years from 2004 to
the end of 2010, due to the fact that it uses waste gas, water and residue in
the production of its products. We believe that this exemption is in effect for
all periods presented. Currently, the PRC is in a period of growth and is
openly promoting business development in order to bring more business into the
PRC. Tax exemption is one of the many methods used to promote such business
development. If the exemption should be rescinded for future periods, Xi’an
Baorun Industrial would be subjected to tax liabilities. Had the abatement for
income taxes not been in effect for Baorun Industrial, we estimate that the pro
forma financial impact would be as follows:
For
the Years Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
(pro
forma)
|
(pro
forma)
|
|||||||
Net
income before income taxes
|
$ | 37,870,963 | $ | 18,724,367 | ||||
Tax
provision
|
(9,696,897 | ) | (7,208,710 | ) | ||||
Net
income
|
$ | 28,174,066 | $ | 11,515,657 | ||||
Earnings
per share (diluted)
|
$ | 0.78 | $ | 0.35 |
In
connection with the Share Exchange Agreement dated October 23, 2007, Redsky
Industrial and Xi’an Baorun Industrial, two PRC companies, entered into a series
of contracts whereby Redsky Industrial exercises significant control over Xi’an
Baorun Industrial, including the right to receive 100% of the net income
generated by Xi’an Baorun Industrial. While, as noted above, Xi’an Baorun
Industrial is exempt from income tax for the years from 2004 through 2010,
Redsky Industrial is not exempt from tax in those periods and is obligated for
applicable PRC taxes under PRC tax laws. We account for all income taxes in
accordance with “Accounting for Income Taxes” and “Accounting for Uncertainty in
Income Taxes,”
44
We
believe that the series of contracts entered into between Xi’an Baorun
Industrial and Redsky Industrial do not constitute taxable income for the
purposes of Redsky Industrial. Since commencement of these series of contracts,
Xi’an Baorun Industrial has not remitted any income to Redsky Industrial, nor
has Redsky Industrial demanded any remittance of income, nor is remittance
expected in the future, as Xi’an Baorun Industrial is anticipating to use its
undistributed earnings for future bio energy development as was anticipated when
it obtained its original tax exemption. We have examined our tax position
and have determined that our tax position with regards to both these entities is
in compliance with applicable PRC tax laws. Pursuant to the Accounting standards
codification, we have determined that we will reinvest indefinitely our
earnings to the biodiesel production facility and biodiesel production
technology, and accordingly no accrual of deferred tax liabilities was required
as of December 31, 2009 and 2008. We have also analyzed the status of Redsky
Industrial and have determined that based on the aforementioned series of
contracts, if Redsky Industrial should be sold, dissolved or otherwise disposed
of, the obligations of Xi’an Baorun Industrial would be terminated under the
series of contracts, including Redsky Industrial’s right to 100% of Xi’an Baorun
Industrial’s net income. In addition, in accordance with “Accounting for
Uncertainty in Income Taxes”, we have examined our tax position in the context
of “Accounting for Contingencies.” Accounting for Uncertainty in
Income Taxes is an accounting requirement that discusses tax issues that have an
element of uncertainty. In accordance with “Accounting for Contingencies”, we
have determined that it is probable that our tax position with regards to both
Redsky Industrial and Xi’an Baorun Industrial is correct. Accordingly, no
deferred tax liability has been provided for
Consolidation
of Variable Interest Entities
VIE’s are
entities that lack one or more voting interest entity characteristics. The
Company consolidates VIEs in which it is the primary beneficiary of its economic
gains or losses. The FASB has issued a Accounting standards codification
(Revised December 2004), Consolidation of Variable Interest Entities.
Consolidation of Variable Interest Entities clarifies the application of
accounting Research Bulletin, Consolidated Financial Statements, to certain
entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. It separates entities into two groups: (1) those for
which voting interests are used to determine consolidation and (2) those for
which variable interests are used to determine consolidation. Consolidation of
Variable Interest Entities clarifies how to identify a variable interest entity
and how to determine when a business enterprise should include the assets,
liabilities, non-controlling interests and results of activities of a variable
interest entity in its consolidated financial statements.
In
December 2009, the FASB issued guidance for Consolidations – Improvements to
Financial Reporting by Enterprises Involved with Variable Interest Entities (
Topic 810 ). The amendments in this update are a result of incorporating the
provisions of accounting standards codification, “Consolidation of Variable
Interest Entities”, Amendments to accounting standards codification, “, and
accounting standards codification, “Interpretation of Consolidation of Variable
Interest Entities, revised December 2004”. Management believes this Statement
will have immaterial impact on the financial statements of the Company once
adopted.
Contingencies
Management
assesses the probability of loss for certain contingencies and accrues a
liability and/or discloses the relevant circumstances, as appropriate when
Management believes that any liability to the Company that may arise as a result
of having to pay out additional expenses that may have a material adverse effect
on the financial condition of the Company taken as a whole.
Results
of Operations
Comparison
of Results of Operations for the Years Ended December 31, 2009 and
2008
Wholesale Distribution
of
Finished
Oil and Heavy Oil
|
Production
and Sale of Biodiesel
|
Operation
of
Retail
Gas
Stations
|
Total
|
|||||||||||||
2009
|
||||||||||||||||
Sales
|
$ | 195,864,501 | $ | 55,794,525 | $ | 37,913,027 | $ | 289,572,053 | ||||||||
Cost
of goods sold
|
175,325,275 | 39,964,368 | 32,811,696 | 248,101,339 | ||||||||||||
Gross
profit
|
20,539,226 | 15,830,157 | 5,101,331 | 41,470,714 | ||||||||||||
Selling,
general and administrative expenses
|
3,820,173 | |||||||||||||||
Income
from operations
|
37,650,541 | |||||||||||||||
Non-operating
income (expenses)
|
220,422 | |||||||||||||||
Net
income
|
37,870,963 | |||||||||||||||
Segment
assets
|
111,795,742 | 16,407,301 | 35,370,619 | 163,573,661 | ||||||||||||
Capital
expenditures
|
370,564 | - | - | 370,564 | ||||||||||||
2008
|
||||||||||||||||
Sales
|
$ | 143,498,550 | $ | 50,052,524 | $ | 22,955,895 | $ | 216,506,969 | ||||||||
Cost
of goods sold
|
129,846,614 | 35,527,828 | 20,484,060 | 185,858,502 | ||||||||||||
Gross
profit
|
13,651,936 | 14,524,696 | 2,471,835 | 30,648,467 | ||||||||||||
Selling,
general and administrative expenses
|
1,997,818 | |||||||||||||||
Income
from operations
|
28,650,649 | |||||||||||||||
Non-operating
income (expenses)
|
(9,926,282 | ) | ||||||||||||||
Net
income
|
18,724,367 | |||||||||||||||
Segment
assets
|
55,998,069 | 29,075,363 | 9,620,985 | 94,694,417 | ||||||||||||
Capital
expenditures
|
155,769 | 1,095,462 | - | 1,251,231 |
45
The
following table sets forth the results of our operations for the periods
indicated as a percentage of net sales:
2009
|
2008
|
|||||||||||||||
$
|
%
of
Sales
|
$
|
%
of
Sales
|
|||||||||||||
Sales
|
289,572,053 |
100.0
|
% | 216,506,969 | 100.0 | % | ||||||||||
Cost
of Sales
|
248,101,339 | 85.7 | % | 185,858,502 | 85.8 | % | ||||||||||
Gross
Profit
|
41,470,714 | 14.3 | % | 30,648,467 | 14.2 | % | ||||||||||
Total
Operating Expenses
|
3,820,173 | 1.3 | % | 1,997,818 | 0.9 | % | ||||||||||
Income
from Operation
|
37,650,541 | 13.0 | % | 28,650,649 | 13.3 | % | ||||||||||
Other
Income (expenses), net
|
220,422 | 0.0 | % | (9,926,282 | ) | (4.6 | ) % | |||||||||
Net
Income
|
37,870,963 | 13.1 | % | 18,724,367 | 8.7 | % |
Sales. Net sales for the year
ended December 31, 2009 were approximately $289.6 million compared to $216.5
million in the same period in 2008, an increase of $73.1 million, or 33.8%. The
increase was mainly attributable to the growth in wholesale distribution and
retail gas station segments. We have continued to expand new sales channels and
territories. We are conducting business in fourteen provinces and special
districts compared to nine provinces in the same period of 2008. We
have also increased in-depth penetration to the existing sales territories and
our existing customers. The number of customer in our wholesale distribution
segment has grown from 936 in 2008 to over 1,180 in 2009. For the
year ended December 31, 2009, sales from wholesale distribution of finished
oil and heavy oil products was $195.9 million compared to $143.5 million in the
same period of 2008, an increase of $52.4 million or 37.0%. The sales volume of
wholesale distribution of finished oil and heavy oil products increased by
126,000 tons or 82.3% from the same period in 2008. For the year
ended December 31, 2009, sales from our retail gas station segment was $37.9
million, compared to $23.0 million in the same period of 2008, an increase of
$14.9 million or 64.8% as a result of four additional fully operational gas
stations and an increase in sale volume per gas station. For the year
ended December 31, 2009, sales from production and sales of biodiesel was $55.8
million compared to $50.0 million in the same period of 2008. The
sales volume of production and sales of biodiesel increased by 9,700 ton or
13.9% from the same period in 2008 .
Cost of goods
sold. Cost of sales for
the year ended December 31, 2009 was approximately $248.1 million compared to
$185.9 million in the same
period of 2008, an increase of $62.2 million, or 33.5%. The increase
in cost of sales was attributable to and in line with an increase in production
and sales activities during the year of 2009. Cost of sales as a percentage of
sales was approximately 85.7% for the year of 2009,
compared to 85.8% for the same period in 2008. For wholesale distribution of
finished oil and heavy oil products, cost of goods sold as a percentage of sales
for the years ended December 31, 2009 and 2008 were 89.5% and 90.5%, respectively. For
production and sale of biodiesel, cost of goods sold as a percentage of sales
for the years ended December 31, 2009 and 2008 were 71.6% and 71.0%,
respectively. The increase as a percentage of sales in production and sale of
biodiesel was attributable to lower
average selling price in 2009. For our retail gas station operation, cost of
goods sold as a percentage of sales for the years ended December 31, 2009 and
2008 were 86.5% and 89.2%, respectively. The decrease as a percentage of sales of our retail gas station
was attributable to operational efficiency improvements and sales volume
increase per gas station.
46
Gross profit. Gross profit
was approximately $41.5 million for the year ended December 31, 2009 as compared
to approximately $30.6 million in the same period of 2008, representing gross
margins of approximately 14.3% and 14.2%, respectively. For the year
ended December 31, 2009, the gross profit margin of wholesale distribution of
finished oil and heavy oil products was 10.5%, production and sale of biodiesel
was 28.4%, and operation of retail station was 13.5%, compared 9.5%, 29.0%, and
10.8%, respectively, in the same period of 2008. The increase in
gross margin of wholesale distribution and retail gas station was attributed to
favorable frequent pricing adjustments by the NDRC reflecting global oil
pricing. The decrease in the gross margin of biodiesel was attributed
to the lower selling price of diesel oil compared to the same period in
2008. We expect our overall gross margin to improve with upwards
pricing adjustments in the China domestic market.
Selling, general and administrative
expenses. Selling, general and administrative expenses for the year ended
December 31, 2009 were approximately $3.6 million compared to $2.0 million for
the same period in 2008, an increase of $1.6 million or 80.0%. This increase was
mainly attributable to approximately $1.0 million of legal, consulting fees,
stock option expenses for our independent directors and employees, and filing
expenses in connection with the Company becoming public in the
U.S. Payroll and related expenses of sales and administrative staff
increased by approximately $439,000 as a result of business growth and expansion
of distribution channels and territories. Total operating expenses as
a percentage of sales was 1.3% and 0.9% for the years ended December 31, 2009
and 2008, respectively. We expect our professional fees to continue to increase
in 2010, as we have hired an outside consulting firm to work on our Sarbanes
Oxley compliance, financial advisory services, and employee stock options. We
also expect to have an increase in other general and administrative expenses in
future reporting periods, as our business expands.
Income from Operations.
Income from operations for the year ended December 31, 2009 was $37.9
million compared to $28.7 million in the same period of 2008. Income from
operations as a percentage of sales for the years ended December 31, 2009 and
2008 were 13.1% and 13.2%, respectively. The decrease as a percentage of sales
was attributable to additional selling, general and administrative expenses
related to us being a public company in the U.S..
Non-operating income
(expenses). Non-operating income consists mainly of governmental
subsidies received in respect of our biodiesel production. For the year ended
December 31, 2009, we received $0.5 million of government subsidy, compared to
receipt of $0.1 million of government subsidy in the same period of 2008. There
was a $9.8 million of non-cash stock based compensation expense for the make
good provision related to the 2008 financing agreement with the
investor..Non-operating expenses mainly consist of interest expenses, and bank
service charges.
Net income. The net income
for the year ended December 31, 2009 was $37.9 million compared to $18.7 million
in the same period in 2008, an increase of $19.4 million or 102.7%. The
significant increase in net income from the year of 2008 to 2009 was
attributable to the $9.8 million of one-time non-cash stock based compensation
expense related to the make good provision in 2008. Our net margin
for the years ended December 31, 2009 and 2008 were 13.1% and 8.7%,
respectively.
Liquidity
and Capital Resources
As of
December 31, 2009 and December 31, 2008, we had cash and cash equivalents of
approximately $62.4 million and $23.1 million, respectively. At December 31
2009, current assets were approximately $131.4 million and current liabilities
were approximately $10.2 million, as compared to current assets of approximately
$78.3 million and current liabilities of approximately $10.8 million at December
31, 2008. Working capital equaled approximately $121.2 million at December 31,
2009, compared to $67.5 million at December 31, 2008, an increase of 79.6%. The
ratio of current assets to current liabilities was 12.9-to-1 at December 31,
2009, compared to 7.3-to-1 at the December 31, 2008. The increase in working
capital as of December 31, 2009 was primarily due to the increased sales volume
and net income. The increase in the current ratio as of December 31, 2009
was primarily related to an increase in cash, and advances to suppliers. At
December 31, 2009 our cash and cash equivalents included approximately $30.7
million of net proceeds from the public offering completed in November
2009. Approximately $15 million in proceeds from the funding will be used
to construct a 50,000 ton biodiesel manufacturing facility adjacent to the
existing plant. Construction of the new facility began in the
fourth quarter of 2009 and is expected to be completed by the third quarter
of 2010. The available cash will be used for a potential acquisition of a 50,000
ton of biodiesel production plant, leasing additional gas stations, and working
capital to support growth of the Company.
47
The
following is a summary of cash provided by or used in each of the indicated
types of activities during the years ended December 31, 2009 and
2008.
For
Years Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Cash
provided by (used in):
|
||||||||
Operating
Activities
|
$ | 4,360,998 | $ | 8,705,385 | ||||
Investing
Activities
|
1,145,386 | (1,251,231 | ) | |||||
Financing
Activities
|
33,748,098 | 14,060,434 |
Net cash
provided by operating activities was $4,360,998 for the year ended December 31,
2009, compared to $8,705,385 of cash provided by operating activities in the
same period of 2008. The net cash inflow decreased in 2009 compared to the same
period of 2008 was primarily due to an increase in current assets amounting of
$32.8 million and a decrease of $2.7 million in current liabilities, offset by
net income of $37.9 million. The increase in current assets was mainly
attributable to the increase in advance to suppliers amounting to $16.6 million
and in prepaid rental expense for the newly leased gas stations amount to $19.5
million.
Net cash
provided by investing activities was $1,145,386 for the year ended December 31,
2009, as compared to net cash used in investing activities of $1,251,231 in the
same period of 2008. In the year of 2009, the Company disposed of three
non-edible seeds crushing plants due to inefficient operation and received $1.5
million of proceeds from sales of the three facilities. During the year ended
December 31, 2008, we spent approximately $1.3 million to add our biodiesel
manufacturing related facilities.
Net cash
provided by financing activities for the years ended December 31, 2009 and 2008
were $33.6 million and $14.1 million, respectively. In September 2009, the
Company paid off approximately $2.2 million of revolving credit facilities with
local banks. In October2009, the Company received $4.4 million of
proceeds by renewal of revolving credit facility with a local bank. For the
period ended December 31 , 2009, we received approximately $0.9 million released
from the escrow agreement as a result of us having satisfied the escrow
requirements. In the same period of 2008, we received approximately $0.7 million
of proceeds from a short term loan.
In
October 2008, the Company received $14.1 million of proceeds from a private
placement with an accredited investor. We received $9 million in proceeds from
the consummation of a Series B Preferred Stock financing with the investor. The
investor also exercised 1,704,545 shares of Series A-1 warrant at the exercise
price of $3.00 per share with a total of $5.1 million of proceeds.
By
November 18, 2009, we completed a public offering of 5,000,000 shares of our
common stock and issued additional 750,000 shares of common stock through
exercise of over-allotment by the underwriter, raising net proceeds of
approximately $30.5 million. As a result of the public offering and cash
provided by operating activities, we believe we have sufficient working capital
to sustain our current business for the next 12 months due to expected increased
sales volume and net income from operations. We continue the expansion of our
current operations by spending approximately $15 million from the proceeds of
the offering to expand our biodiesel manufacturing facility by 50,000 ton
through construction of a new facility, which began in the fourth quarter of
2009. We also anticipate to spend $15 million to acquire a 50,000 ton of
biodiesel production plant. We continue to expand our wholesale distribution and
retail gas station businesses through both organic growth and potential
acquisition. We expect to finance such expansions through the net proceeds from
the public offering that was just completed.
Our
future capital requirements will depend on a number of factors,
including:
|
·
|
Development of new sales territories,
sales offices, and sales force for our wholesale distribution of finished
oil and heavy oil products and required working capital to sustain our
existing market share and support the growth in this business segment.
This development can be achieved by
organic growth or through
acquisition;
|
|
·
|
Expanding of market share for our
retail gas stations both in terms of quantity and geographic location and
required working capital to support the
growth;
|
|
·
|
our ability to maintain our
existing oil suppliers and establish collaborative relationships with new
suppliers;
|
|
·
|
Increase our biodiesel production
capacity through strategic acquisitions or construction of a new facility;
and
|
|
·
|
Development and commercialization
of new technology in biodiesel production
capacity.
|
We
anticipate incurring some research and development expenses during the next 12
months.
48
Off-Balance
Sheet Arrangements
We have
not entered into any other financial guarantees or other commitments to
guarantee the payment obligations of any third parties. We have not entered into
any derivative contracts that are indexed to our shares and classified as
stockholders’ equity or that are not reflected in our consolidated financial
statements. Furthermore, we do not have any retained or contingent interest in
assets transferred to an unconsolidated entity that serves as credit,
liquidity or market risk support to such entity. We do not have any variable
interest in any unconsolidated entity that provides financing, liquidity, market
risk or credit support to us or engages in leasing, hedging or research and
development services with us.
Contractual
Obligations and Commitments
As a smaller reporting company we are
not required to to provide information required by this Item.
Quantitative
and Qualitative Disclosures About Market Risks
As a smaller reporting company we are
not required to to provide information required by this Item
Recently
Issued Accounting Pronouncements
Refer to Note 2 of Notes to
Consolidated Financial Statements for a discussion of recent accounting
standards and pronouncements.
Item 6A.
|
Quantitative and Qualitative
Disclosures About Market
Risk.
|
As a
smaller reporting company we are not required to include this
disclosure.
Item 7.
|
Financial Statements and
Supplementary Data.
|
Our
consolidated financial statements and the notes thereto begin on page F-1 of
this Annual Report on Form 10-K.
Item 8.
|
Changes in and Disagreements with
Accountants on Accounting and Financial
Disclosure.
|
None.
Item
8A(T).
|
Controls and
Procedures.
|
Evaluation
of Disclosure Controls and Procedures
Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of our disclosure controls and procedures as of December 31, 2009, as
such term is defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based on
this evaluation, our principal executive officer and principal financial officer
have concluded that during the period covered by this report, the Company’s
disclosure controls and procedures were effective as of such date to ensure that
information required to be disclosed by us in our Exchange Act reports is
recorded, processed, summarized, and reported within the time periods specified
in the SEC’s rules and forms, and that such information is accumulated and
communicated to our management, including our principal executive officer and
principal financial officer, as appropriate to allow timely decisions regarding
required disclosure.
Even
though management concluded that the disclosure controls and procedures were
effective, management determined, when performing its evaluation that there are
additional measures that could be implemented to strengthen such controls and
procedures now that the Company is a public company. This determination was made
by personnel in the Company’s finance and accounting department under the
supervision of the Company’s Chief Financial Officer. We are developing a plan
to strengthen our disclosure controls and procedures including engagement with
external consulting firm to assist the Company to comply with the requirements
of Sarbanes-Oxley Act, section 404 and hiring new personnel, who will be tasked
to ensure that all information will be recorded, processed, summarized and
communicated to management to allow for reporting on a timely basis and in
compliance with the U.S GAAP and reporting requirements. We expect to complete
implementation of our plan in the first two quarters of 2010. The costs
associated with the plan would primarily be the investment by the Company in
consulting fees and hiring new personnel to handle the financial reporting
responsibility.
49
Management’s
Report on Internal Control over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f) and 15d-15(f). Internal control over financial reporting refers to the
process designed by, or under the supervision of, our principal executive and
principal financial officers, and effected by the Board of Directors, management
and other personnel, 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 and
includes those policies and procedures that:
1. Pertain
to the maintenance of records that in reasonable detail accurately and fairly
reflect the transactions and dispositions of our assets;
2.
Provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that our receipts and expenditures are being made
only in accordance with authorization of our management and directors;
and
3.
Provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisitions, use or disposition of our assets that could have a
material effect on the financial statements.
Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of our internal control over financial reporting
based on the framework in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on our
evaluation, our principal executive officer and principal financial officer have
concluded that during the period covered by this report, our internal controls
over financial reporting were effective.
This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by our registered public
accounting firm pursuant to temporary rules of the Securities and Exchange
Commission that permit us to provide only management’s report in this annual
report.
Changes
in Internal Control over Financial Reporting
There was
no change in our internal control over financial reporting that occurred during
the fourth fiscal quarter of the fiscal year covered by this Annual Report on
Form 10-K that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
Item 8B.
|
Other
Information.
|
None.
PART
III
Item 9.
|
Directors, Executive Officers and
Corporate Governance.
|
As of the
date hereof our directors, executive officers and significant employees are as
follows:
Name
|
Age
|
Position
|
||
Xincheng
Gao
|
47
|
Chairman
of the Board of Directors, Chief Executive Officer and
President
|
||
Albert
C. Pu
|
50
|
Chief
Financial Officer
|
||
Gaihong
Li
|
33
|
Executive
Vice President, Controller and Director
|
||
Larry
Goldman
|
53
|
Independent
Director
|
||
Wenbing
Christopher Wang
|
39
|
Independent
Director
|
||
Junrong
Guo
|
46
|
Independent
Director
|
50
Xincheng Gao, Chairman, Chief
Executive Officer and President. Mr. Gao has served as our
Chairman, Chief Executive Officer and President since October 23, 2007. Mr. Gao
has extensive experience in the research and marketing of oil products. In
November 1999, Mr. Gao founded Xi’an Baorun Industrial Development Co., Ltd.
(Xi’an Baorun Industrial) to produce and sell finished oil products and
biodiesel. Prior to founding of Xi’an Baorun Industrial, Mr Gao worked in the
Oil and Chemical Department of Shaanxi Province that oversaw the oil industry;
and worked in Zhongtian Oil and Chemical Group in charge of R&D and
marketing. Mr. Gao received a B.S. in Mechanical Engineering from Xi’an
University of Technology in 1985 and an E.M.B.A. from Xi’an Jiaotong University
in 2004.
Albert C. Pu, Chief Financial
Officer. Mr. Pu has served as our Chief Financial Officer
since May 12, 2009. Mr. Pu joined the Company in February 2009 as the vice
president of finance. Prior to joining the Company, from 2005 through 2009, Mr.
Pu served as global controller of Amphenol Corporation Industrial Operations, a
division of Amphenol Corporation (NYSE:APH), a U.S. based multi-national
manufacturing company specializing in interconnect systems, where he was in
charge of facilities in the U.S., Mexico and China. From 2004 through 2005, Mr.
Pu was the director of finance of Endicott Interconnect Technologies, Inc., a
U.S.-based company specializing in high-end interconnect technologies for
industrial and military applications. Mr. Pu also serves as an independent
director and audit committee chairman of Sino Clean Energy, Inc. (OTCBB: SCLX),
a China based manufacturer and distributor of coal-water mixture. Mr. Pu has
over 19 years of accounting and audit experience. Mr. Pu has a B.S. in
Accounting from the State University of New York, Institute of Technology in
1990. He is a New York State Certified Public Accountant.
Gaihong Li, Executive Vice President,
Controller and Director. Ms. Li has served as our Executive
Vice President since June 2009, and as Controller since May 12, 2009. Ms. Li
served as our Chief Financial Officer from October 23, 2007 until May 12, 2009,
and has served as a member of our board of directors since December 9, 2007. Ms.
Li has also served as Chief Financial Officer of Xi’an Baorun Industrial since
September 2005 until May 12, 2009. Ms. Li has more than ten years of experience
in the oil industry. From August 2000 until Ms. Li joined Xi’an Baorun
Industrial in September 2005, Ms. Li served as Chief Financial Officer of Xi’an
Dongfang Oil Group Co., Ltd., which is located in China and engages in the
business of oil production. Ms. Li obtained a B.S. degree in Accounting from
Xi’an Northwest University in 1997, and is currently studying to obtain an
E.M.B.A. degree in Business Administration from Xi’an Jiaotong
University.
Larry Goldman, Independent Director. Mr. Goldman has served
as an independent director since November 17, 2008. Mr. Goldman is a
certified public accountant with over 25 years of auditing, consulting and
technical experience and from October 2007 to the present time works as a
consultant providing CFO support to various US listed public
companies. Mr. Goldman served from May 2006 to October 2007 as the
Treasurer and Acting Chief Financial Officer of Thorium Power, Ltd. (NASDAQ:
THPW). Prior to joining Thorium Power, Ltd. Mr. Goldman worked as the Chief
Financial Officer, Treasurer and Vice President of Finance of WinWin Gaming,
Inc. (OTCBB: WNWN), a multi-media developer and publisher of sports, lottery and
other games. Prior to joining WinWin in October 2004, Mr. Goldman was a partner
at Livingston Wachtell & Co., LLP and had been with that firm for the past
19 years auditing public companies. Mr. Goldman is also an independent director
and audit committee chairman of Winner Medical Group Inc. (AMEX: WWIN), a China
based manufacturer of medical disposable products and surgical dressings; Wonder
Auto Tech, Inc. (NASDAQ:WATG), a leading manufacturer of automotive electrics,
suspension products and engine accessories in China; China Advanced Construction
Material (NASDAQ:CADC), a leading producer and supplier of ready mix cement and
China GengSheng Minerals Inc.(AMEX:CHGS) a developer and manufacturer of mineral
based industrial material products. Mr. Goldman has extensive experience in both
auditing and consulting with public companies, and has experience providing
accounting and consulting services to the Asian marketplace for almost 10 years,
having also audited several US listed Chinese public companies.
Wenbing (Christopher) Wang, Independent Director. Mr. Wang has served as
an independent director since November 17, 2008. Mr. Wang currently
serves as Interim Chief Financial Officer, President and a director of Fushi
Copperweld, Inc. Prior to joining Fushi, from November 2004 to March 2005, Mr.
Wang served as an Executive Vice President of Redwood Capital, Inc., with a
specific focus on providing strategic and financial advisory services to China
based clients seeking access to the U.S. capital markets. From October 2002 to
September 2004, Mr. Wang served as Assistant VP of Portfolio Management at China
Century Investment Corporation. Mr. Wang began his investment banking career at
Credit Suisse First Boston (HK) Ltd in 2001. From 1999 to 2000, Mr. Wang worked
for VCChina as Management Analyst. Mr. Wang is also an independent director of
General Steel Holding Inc. (NYSE: GSI), through its subsidiaries engages in the
manufacture and sales of steel products in the People’s Republic of China;
Orient Paper, Inc. (NYSE AMEX: ONP), engages in the production and distribution
of paper and paper products in the People’s Republic of China; and
Energroup Holdings Corporation (OTCBB:ENHD), which engages in the production,
packaging, sales, marketing and distribution of fresh and processed meat
products in the People’s Republic of China. Fluent in both English and
Chinese, Mr. Wang holds an MBA in Finance and Corporate Accounting from Simon
Business School of University of Rochester. Mr. Wang
offers the Company significant financial, strategic and management expertise. He
also brings a wealth of knowledge having served as an independent director of
various public companies with operation in the PRC.
Junrong Guo, Independent
Director.
Mr. Guo has served as an independent director since November 17,
2008. Mr. Guo is a professional researcher in the forestry field.
Since June 2003, Mr. Guo has engaged in research and development in the forestry
resources with Shaanxi Forest Researching & Planning Institute, Mr. Guo
served as director of Shaanxi Forest Institute from 1999 to 2000, and director
of Shaanxi Ginkgo Research Institute from 1997 to 1999. Through his work
experience Mr. Guo participated in the projects such like National Key
Scientific & Technological Projects, Shaanxi Government Key Scientific &
Technological Projects, Shaanxi Forest & Agricultural Key Projects, Yanglin
Youth Scientific & Technological Projects, among of which gained Shaanxi
Scientific & Technological Progress Awards. Mr. Guo has been granted honors
and awards including Shaanxi New Century Talent, Specialist to Enjoy the State
Subsidies’ in 2004, Evaluation Committee of Shaanxi Scientific &
Technological Progress Award from 2005 to 2008 and Professional Researcher in
2006, Shaanxi Agricultural Expert in 2008. With his expertise in forestry, Mr.
Guo continues working with the Company to explore various feedstocks for the
Company’s biodiesel production.
51
All
directors hold office until the next annual stockholders’ meeting or until their
death, resignation, retirement, removal, disqualification, or until their
successors have been elected and are qualified. Our officers serve at the will
of the Board of Directors.
No
director or executive officer is related to any other director or executive
officer.
Section
16(a) Beneficial Ownership Reporting Compliance
Section
16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”),
requires the executive officers and directors of the Company and every person
who is directly or indirectly the beneficial owner of more than 10% of any class
of security of the Company to file reports of ownership and changes in ownership
with the Securities and Exchange Commission. Such persons also are required to
furnish our company with copies of all Section 16(a) forms they
file.
Based
solely on our review of copies of such forms received by us, we believe that
during the fiscal year 2009, the executive officers and directors of the Company
and every person who is directly or indirectly the beneficial owner of more than
10% of any class of security of the Company complied with the filing
requirements of Section 16(a) of the Exchange Act, except that Redsky Group
Limited and Mr. Gao did not file a Form 4 reflecting the private sale of 517,200
shares of Redsky Group’s common stock, which occurred on September 10,
2009.
CORPORATE
GOVERNANCE
Board
of Directors
We have
five members serving on our Board of Directors, of which a majority are
independent directors . All actions of the Board of Directors require the
approval of a majority of the directors in attendance at a meeting at which a
quorum is present or by unanimous written consent.
Audit
Committee
We have a
separately-designated standing audit committee established in accordance with
Section 3(a)(58)(A) of the Securities and Exchange Act of 1934, as
amended. The audit committee consists of Larry Goldman,
Wenbing (Christopher) Wang and Junrong Guo. Each of these members are
“independent” as defined by Rule 5605(a)(2) of the Marketplace Rules of The
Nasdaq Stock Market, LLC as determined by our board of directors. The audit
committee recommends to the board of directors the annual engagement of a firm
of independent accountants and reviews with the independent accountants the
scope and results of audits, our internal accounting controls and audit
practices and professional services rendered to us by our independent
accountants. The Audit Committee operates under a written charter. Mr.Goldman is
the Chairman of our Audit Committee.
Our board
of directors has determined that we have at least one audit committee financial
expert, as defined by the rules and regulations of the SEC, serving on our audit
committee, and that Larry Goldman is the “audit committee financial
expert.” Mr. Goldman is “independent” as defined by Rule 5605(a)(2)
of the Marketplace Rules of The Nasdaq Stock Market, LLC.
Security
Holder Recommendations for Board Nominees
There
have been no changes to the procedures by which our stockholders may recommend
nominees to the Board of Directors since the filing of the Company’s Annual
Report on Form 10-K on March 25, 2009.
Code
of Ethics
We
adopted a Code of Business Conduct and Ethics on March 28, 2008. The Code of
Ethics constitutes our Code of Ethics for our principal executive officer, our
principal financial and accounting officer and our other senior financial
officers. The Code of Ethics is intended to promote honest and ethical conduct,
full and accurate reporting, and compliance with laws as well as other
matters. A copy of Code of Ethics is filed as an exhibit to our
Annual Report on Form 10-K filed on March 31, 2008. A printed copy of
the Code of Ethics may be obtained free of charge by writing to China
Integrated Energy, Inc., Dongxin Century Square, 7th Floor, Hi-Tech Development
District, Xi’an, Shaanxi Province, PRC 710043.
52
Item
11.
|
Executive
Compensation.
|
It is not
uncommon for companies with operations primarily in China to have base salaries
and bonuses as the sole form of compensation. The base salary level is
established and reviewed based on the level of responsibilities, the experience
and tenure of the individual and the current and potential contributions of the
individual. The base salary is compared to similar positions within comparable
peer companies and with consideration of the executive’s relative experience in
his or her position. Based on an evaluation of available information with
respect to the base salaries of executives of our competitors located in China,
the base salary and bonus paid to our named executive officers is in line with
our domestic competitors, such as Shaanxi Dongda Oil and Chemical Co., Ltd. Base
salaries are reviewed periodically and at the time of promotion or other changes
in responsibilities.
Our 2003
Equity Incentive Program provides for the grant of incentive stock options,
nonqualified stock options and restricted stock awards. Certain awards are
intended to qualify as “incentive stock options” within the meaning of the
Internal Revenue Code of 1986, as amended. The incentive plan was approved by
our stockholders on August 11, 2003.
We will
consider other elements of compensation, including without limitation, short-
and long-term compensation, cash and non-cash, and other equity-based
compensation. We believe our current compensation package is comparable to our
peers in the industry and is aimed to retain and attract talented
individuals.
Summary
Compensation Table
The
following tables reflects the cash compensation we paid, as well as certain
other compensation paid or accrued, during the fiscal years ended December 31,
2009 and 2008 to the identified persons (the “Named Executive
Officers”).
Name
and Principal Position
|
Year
|
Salary
($)
|
Bonus
($)
|
All
Other
Compensation
($)
|
Total
($)
|
|||||||||||||
Xincheng
Gao (1)
|
2008
|
40,000
|
10,000
|
-
|
50,000
|
|||||||||||||
Chairman, President, and Chief
Executive Officer
|
||||||||||||||||||
2009
|
44,000
|
10,000
|
-
|
54,000
|
(1)
Reflects compensation received by our named executive officer in his capacity as
an executive officer of Xi’an Baorun Industrial.
During
each of the last two fiscal years, none of our other executive officers had
total compensation greater than $100,000. Our executive officers are reimbursed
by us for any out-of-pocket expenses incurred in connection with activities
conducted on our behalf. There is no limit on the amount of these out-of-pocket
expenses and there will be no review of the reasonableness of such expenses by
anyone other than our board of directors, which includes persons who may seek
reimbursement, or a court of competent jurisdiction if such reimbursement is
challenged.
Employment
Contracts and Termination of Employment
The
following employment agreements were entered into by Xi’an Baorun Industrial and
the following executive officers:
Xincheng
Gao
Xi’an
Baorun Industrial entered into an employment agreement with Mr. Xincheng Gao to
employ him as its chairman, effective as of October 23, 2007. The agreement will
expire on October 22, 2010, and may be renewed for an additional term of three
years. Mr. Gao is entitled to a base monthly salary in an amount of $800. Xi’an
Baorun Industrial also pays premiums for Mr. Gao for pension, unemployment,
medical insurance and other social insurance coverage in accordance with
relevant PRC laws and regulations. Xi’an Baorun Industrial has a right to adjust
the salary and welfare benefits of Mr. Gao appropriately based on his
capability, experience, attitude, performance, achievement, working-age and
position as well as its salary and position adjustment policies and business
conditions. Either party to the agreement has a right to terminate the
agreement, subject to the terms and conditions therein. In connection with the
agreement, Mr. Gao also executed a confidentiality and non-competition
agreement. In the event of a major change in the objective situation, which
includes the merger of Xi’an Baorun Industrial into another business entity, or
the sale, or transfer by Xi’an Baorun Industrial of a substantial portion of its
assets to others, Xi’an Baorun Industrial may terminate this agreement by giving
a 30-day notice, or giving one month’s salary in lieu of a notice, if the
parties cannot agree to a modification of terms of the agreement.
53
Gaihong
Li
Xi’an
Baorun Industrial entered into an employment agreement with Ms. Gaihong Li to
employ her as its chief financial officer, effective as of October 23, 2007. The
current term of the agreement will expire on October 22, 2010, and may be
renewed for an additional term of three years. Ms. Li receives a base monthly
salary in an amount of $500. Xi’an Baorun Industrial also pays premiums for Ms.
Li for pension, unemployment, medical insurance and other social insurance
coverage in accordance with relevant PRC laws and regulations. Xi’an Baorun
Industrial has a right to adjust the salary and welfare benefits of Ms. Li
appropriately based on her capability, experience, attitude, performance,
achievement, working-age and position as well as its salary and position
adjustment policies and business conditions. Either party to the agreement has a
right to terminate the agreement, subject to the terms and conditions therein.
In connection with the agreement, Ms. Li also executed a confidentiality and
non-competition agreement. In the event of a major change in the objective
situation, which includes the merger of Xi’an Baorun Industrial into another
business entity, or the sale, or transfer by Xi’an Baorun Industrial of a
substantial portion of its assets to others, Xi’an Baorun Industrial may
terminate this agreement by giving a 30-day notice or giving one month’s salary
in lieu of a notice, if the parties cannot agree to a modification of terms of
the agreement. Ms. Li resigned as our chief financial officer as of May 12, 2009
and now acts as executive vice president and controller. ‘
Albert
C. Pu
Xi’an
Baorun Industrial entered into an employment agreement with Mr. Pu on January
22, 2009 whereby the Company employed Mr. Pu as chief financial officer. The
term of Mr. Pu’s employment is two years commencing from February 2, 2009. Mr.
Pu receives an annual salary of $70,000, including an allowance for housing and
social insurance, as well as reimbursement of reasonable out-of-pocket expenses
and travel for business purposes. Mr. Pu also executed a confidentiality and
non-competition agreement. In the event of a major change in the objective
situation, which includes the merger of Xi’an Baorun Industrial into another
business entity, or the sale, or transfer by Xi’an Baorun Industrial of a
substantial portion of its assets to others, Xi’an Baorun Industrial may
terminate this agreement by giving a 30-day notice, or giving one month’s salary
in lieu of a notice, if the parties cannot agree to a modification of terms of
the agreement.
Grants
of Plan-Based Awards
This
information has been omitted based on the Company’s status as a smaller
reporting company.
Outstanding
Equity Awards at Fiscal Year-End
None.
Pension
Benefits
We do not
sponsor any qualified or non-qualified defined benefit plans.
Nonqualified
Deferred Compensation
We do not
maintain any non-qualified defined contribution or deferred compensation
plans.
Compensation
Of Directors
Compensation
paid to our independent directors as of December 31, 2009 is as
follows
Name
|
Fees
earned or
paid
in cash
($)
|
Option
awards
($)
|
All
other
compensation
($)
|
Total
($)
|
||||||||||||
Larry
Goldman
|
$
|
20,000
|
$
|
-
|
$
|
-
|
$
|
20,000
|
||||||||
Wenbing
(Christopher) Wang
|
$
|
15,000
|
$
|
-
|
$
|
-
|
$
|
15,000
|
||||||||
Junrong
Guo
|
$
|
2,930
|
$
|
-
|
$
|
-
|
$
|
2,930
|
54
Each of
Messrs. Goldman, Wang and Guo entered into Independent Director Agreements with
the Company on November , 2008. Pursuant to the
terms of those agreements, Mr. Goldman shall receive $20,000 in cash annually
and an annual option grant to purchase 20,000 shares of common stock of the
Company, Mr. Wang shall receive $15,000 in cash annually and an annual option to
purchase 20,000 shares of common stock of the Company, and Mr. Guo shall receive
RMB20,000 in cash annually. In addition, each of Mr. Goldman and Mr. Wang shall
receive $1,000 for each director meeting attended by phone and $5,000 for each
director meeting attended in person. The exercise price of the annual
option grants shall be equal to the fair market value of a share of the
Company’s common stock on the date of the grant of the option and such options
vest quarterly, in equal installments over the 12 months period from date of
grant.
Item 11.
|
Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder
Matters.
|
The
following table sets forth as of March 22, 2010 the number of shares of our
common stock beneficially owned by (i) each person who is known by us to be the
beneficial owner of more than five percent of the Company’s common stock; (ii)
each director; (iii) each of the named executive officers in the Summary
Compensation Table; and (iv) all directors and executive officers as a group. As
of March 22 , 2010, we had 36,321,091 shares of common stock issued and
outstanding.
Beneficial
ownership is determined in accordance with Securities and Exchange Commission
rules and generally includes voting or investment power with respect to
securities. Unless otherwise indicated, the stockholders listed in the table
have sole voting and investment power with respect to the shares indicated.
Unless otherwise noted, the principal address of each of the stockholders,
directors and officers listed below is Dongxin Century Square 7F, Xi’an Hi-tech
Development District, Xi’an, China.
All share
ownership figures include shares of our common stock issuable upon securities
convertible or exchangeable into shares of our common stock within sixty (60)
days of March 22, 2010, which are deemed outstanding and beneficially owned by
such person for purposes of computing his or her percentage ownership, but not
for purposes of computing the percentage ownership of any other
person
Shares
Beneficially
Owned
(1)
|
Percent
of Class
(2)(3)
|
|||||||
Redsky
Group Limited (4)
|
21,997,345
|
60.6
|
%
|
|||||
Xincheng
Gao (5)
|
21,997,345
|
60.6
|
%
|
|||||
Albert
C. Pu (6)
|
15,000
|
*
|
||||||
Gaihong
Li (7)
|
20,100
|
*
|
||||||
Larry
Goldman (8)
|
25,000
|
*
|
||||||
Wenbing
Christopher Wang (8)
|
25,000
|
*
|
||||||
Junrong
Guo
|
---
|
--
|
||||||
Vision
Capital Advisors, LLC (9)
|
3,411,652
|
9.4
|
%
|
|||||
All
Directors and Executive Officers, as a group (6 persons)
|
22,082,445
|
60.8
|
%
|
* Less
than one percent.
(1)
Beneficial ownership is determined in accordance with the rules of the SEC and
generally includes voting or investment power with respect to securities. Shares
of Common Stock subject to securities anticipated to be exercisable or
convertible at or within 60 days of the date hereof, are deemed outstanding for
computing the percentage of the person holding such option or warrant but are
not deemed outstanding for computing the percentage of any other person. The
indication herein that shares are anticipated to be beneficially owned is not an
admission on the part of the listed stockholder that he, she or it is or will be
a direct or indirect beneficial owner of those shares.
55
(2) Based
upon 36,321,091 shares of Common Stock issued and outstanding.
(3) In
determining the percent of our common stock owned by a person or entity on March
22, 2010 (a) the numerator is the number of shares of the class beneficially
owned by such person or entity, including shares which may be acquired within 60
days on exercise of outstanding warrants and conversion of convertible
securities, and (b) the denominator is the sum of (i) the total shares of our
common stock outstanding on that date March 22, 2010, plus (ii) the total number
of shares that the beneficial owner may acquire on conversion of preferred stock
and on exercise of warrants and options.
(4)
Includes options to purchase up to 60,000 shares of common stock which are
exercisable within the next 60 days. The business address of Redsky
Group Limited is P.O. Box 957, Offshore Incorporation Centre, Road Town,
Tortola, British Virgin Islands.
(5)
Includes options to purchase up to 60,000 shares of common stock which are
exercisable within the next 60 days. Mr. Gao Xincheng, as the sole
stockholder of Redksy Group, has dispositive and voting power over the
shares.
(6)
Includes an option to purchase up to 15,000 shares of common stock which is
exercisable within the next 60 days.
(7)
Includes 100 shares of common stock and an option to purchase up to 20,000
shares of common stock which is exercisable within the next 60
days.
(8)
Includes options to purchase up to 25,000 shares of common stock, of which
20,000 are fully vested and exercisable and 5,000 are exercisable within the
next 60 days.
(9)
Includes 1,631,578 shares issuable upon conversion or exercise of derivative
securities within the next 60 days. Derived from a Schedule 13G/A
group filing by Vision Capital Advisors, LLC, which included Vision Opportunity
Master Fund, Ltd. (VOMF) and Vision Capital Advantage Fund, L.P. (VCAF), with
the SEC on February 17, 2010. VOMF and VCAF are deemed to be affiliates of each
other and Vision Capital Advisors and beneficially own, in the aggregate,
approximately 9.9% of the shares of the Company’s common stock, which includes
securities exercisable and convertible into shares of common
stock. The principal business office of VCAF is 20 West 55th Street,
5th
Floor, New York, New York 10019. The principal business office of VOMF is Ogier
Fiduciary Services (Cayman) Limited, 89 Nexus Way, Camana Bay, Grand Cayman,
KY1-9007, Cayman Islands. Mr. Adam Benowitz and Vision Capital Advisors, LLC may
be deemed to share with Vision Opportunity Master Fund, Ltd. and Vision Capital
Advantage Fund, L.P. voting and dispositive power with respect to the shares.
Pursuant to the terms of the Series A-1 and A-2 Warrants and the Certificate of
Designation for each of the series A and series B preferred stock, at no time
may VOMF and VCAF convert their shares of preferred stock into shares of common
stock if the conversion would result in VOMF and VCAF together beneficially
owning (as determined in accordance with Section 13(d) of the Exchange Act and
the rules thereunder) more than 9.9% of our then issued and outstanding shares
of common stock; provided, however, that upon providing us with sixty-one days’
notice that VOMF and VCAF wish to waive the cap, then the cap will be of no
force or effect with regard to all or a portion of the series A or series B
preferred stock referenced in the waiver notice. Similarly under the terms of
the Series A-1 and Series A-2 Warrants, at no time may VOMF and VCAF exercise
the warrant if the exercise would result in VOMF and VCAF together beneficially
owning (as determined in accordance with Section 13(d) of the Exchange Act and
the rules thereunder) more than 9.9% of our then issued and outstanding shares
of common stock; provided, however, that upon providing us with sixty-one days’
notice that VOMF and VCAF wish to waive the cap, then the cap will be of no
force or effect with regard to all or a portion of the shares referenced in the
waiver notice. The 9.9% beneficial ownership limitation does not prevent VOMF
and VCAF from selling some of their holdings and then receiving additional
shares. Accordingly, each of VOMF and VCAF could exercise and sell more than
9.9% of our common stock without ever at any one time holding more than this
limit
Change
in Control
There were no arrangements, known to
the Company, including any pledge by any person of securities of the Company the
operation of which may at a subsequent date result in a change in control of the
Company.
56
Equity
Compensation Plan Information
The
following table sets forth aggregate information regarding our equity
compensation plans in effect as of December 31, 2009:
Equity Compensation Plan
Information
Number
of securities to be issued upon exercise of outstanding options, warrants and rights
|
Weighted-
average exercise price of outstanding options,warrants
and rights
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in column (a))
|
||||||||||
Plan category
|
(a)
|
(b)
|
(c)
|
|||||||||
Equity
compensation plans approved by security holders
|
60,000 | $ | 5.03 | 5,187,500 | ||||||||
Equity
compensation plans not approved by security holders
|
30,000 | 6.00 | -0- | |||||||||
Total
|
90,000 | 5.35 | 5,187,500 |
Equity
compensation plans approved by security holders
Our 2003 Equity Incentive Program (the
“Plan”) provides for the grant of incentive stock options, nonqualified stock
options and restricted stock awards (the “Awards”). Certain Awards are intended
to qualify as “incentive stock options” within the meaning of the Internal
Revenue Code (the “Code”). The Plan was approved by our stockholders on August
11, 2003. The shares of common stock underlying Awards that can be granted under
our Plan were registered on a Form S-8 with the Securities and Exchange
Commission on November 24, 2003.
The total number of shares of our
common stock that may be issued under the Plan may not exceed 6,000,000, of
which 1,000,000 will be available for issuance as incentive stock option grants
and 5,000,000 will be available for issuance as nonqualified stock option grants
and/or restricted stock awards. The total number of shares may be
increased annually based upon the total number of common stock outstanding in
subsequent years. In connection with our private placement in 2008,
we agreed to limit the number of awards we grant under the Plan to no more than
10% of the total number of shares of Common Stock issued and outstanding at any
time.
Equity
compensation plans not approved by security holders
In February 2009, the Company retained
an investor relations consulting firm for the investor relations services. As a
part of investor relations consulting fee, the Company issued the investor
relations consulting firm warrants to purchase 30,000 shares of the Company’s
common stock with a strike price at $6.00 per share. The warrants will be vested
on the one year anniversary of the contract signature date and exercisable only
for cash; and will expire 18 months from the date of vesting.
Item 12.
|
Certain Relationships and Related Transactions,
and Director Independence
|
Related
Party Transaction
As of
December 31, 2007, there was an advance of $593,696 to a related party that is
40% owned by one of the shareholders of Baorun Industrial. In 2008, the advance
was fully repaid. The Company has also periodically purchased oil supplies at
the fair market value from this related party. There has been no purchase from
this related party since 2008.
Director
Independence
A
majority of the directors serving on our Board must be independent directors
under Rule 5605(b)(1) of the Marketplace Rules of The NASDAQ Stock Market, Inc.
(“NASDAQ”). The Board of Directors has a responsibility to make an affirmative
determination whether a directors has a material relationships with the listed
company through the application of Rule 5605(a)(2) of the Marketplace Rules of
NASDAQ, which provides the definition of an independent director.
57
Based on
the application of the independence standards and the examination of all of the
relevant facts and circumstances, the Board determined that none of the
following directors had any material relationship with the Company and, thus,
are independent under Rule 5605(a)(2) of the Marketplace Rules of NASDAQ: Larry
Goldman, Wenbing Christopher Wang and Junrong Guo. In accordance with the
Marketplace Rules of NASDAQ a majority of our Board of Directors is
independent.
The Board
of Directors has determined that none of Messrs. Goldman, Wang or Guo has a
relationship that, in the opinion of the Board of Directors, would interfere
with the exercise of independent judgment in carrying out the responsibilities
of an independent director . In determining the independence of our
directors, the Board of Directors has adopted independence standards that follow
the criteria specified by applicable laws and regulations of the SEC and the
Marketplace Rules of NASDAQ. In determining the independence of our directors,
the Board of Directors considered all transactions in which the Company and any
director had any interest, including those discussed under “Related Party
Transactions” above.
Review,
Approval or Ratification of Transactions with Related Parties
The
transactions with related parties described above by Baorun Industrial were
entered into prior to the consummation of the Share Exchange and the formation
of an Audit Committee of the Board of Directors. Baorun Industrial did not have
any policies or procedures in place with respect to the review and approval or
ratification of the related party transactions that have been described. Our
Audit Committee under its charter is responsible reviewing and approving any
related party transactions. It is the Company’s policy that the
Company will not enter into any related party transactions unless the Audit
Committee or another independent body of the Board of Directors first reviews
and approves the transactions.
Item 13.
|
Principal Accountant Fees and
Services.
|
Our
independent accountants for the audit of our annual financial statements for our
fiscal years ended December 31, 2009 and 2008, was Sherb & Co.,
LLP. The following table shows the fees paid or accrued by us to
Sherb & Co., LLP during the periods indicated.
2009
|
2008
|
|||||||
Audit
Fees
|
$
|
107,800
|
$
|
84,500
|
||||
Audit-Related
Fees
|
$
|
-
|
$
|
-
|
||||
Tax
Fees
|
$
|
-
|
$
|
-
|
||||
All
other fees
|
$
|
80,000
|
$
|
-
|
Audit
Fees were for professional services rendered for the audit of our company’s
annual financial statements, the review of quarterly financial statements and
the preparation of statutory and regulatory filings. Other fees were
for professional services rendered for the public equity offering that was
completed November 4, 2009, and the underwriters’
exercise of the over-allotment that was completed November 18,
2009.
Pre-Approval
of Services.
Following
the establishment of our Audit Committee, the Audit Committee must pre-approve
all audit and permissible non-audit services performed by the independent
registered public accounting firm. These services may include audit services,
audit-related services, tax services and other services. All of the services
described herein were approved by the Audit Committee pursuant to its
pre-approval policies. None of the hours expended on the principal accountant’s
engagement to audit the Company’s financial statements for the most recent
fiscal year were attributed to work performed by persons other than the
principal accountant’s full-time permanent employees.
58
PART
IV
Item
14.
|
Exhibits,
Financial Statement
Schedules.
|
(a) The
following are filed with this Annual Report:
(1)
|
(i)
Consolidated Balance Sheets
|
(ii)
|
Consolidated
Statements of Income and Comprehensive
Income
|
(iii)
|
Consolidated
Statement of Stockholders' Equity
|
(iv)
|
Consolidated
Statements of Cash Flows
|
(2)
|
Not
applicable.
|
(3)
|
Exhibits
required by Item 601 of Regulation S-K are as
follows:
|
Exhibits
Exhibit
Number
|
Description
|
|
2.1
|
Share
Exchange Agreement dated as of October 23, 2007. (1)
|
|
2.2
|
Agreement
and Plan of Merger, dated November 15, 2007. (2)
|
|
3.1
|
Certificate
of Correction filed on July 24, 2007. (3)
|
|
3.1
|
Certificate
of Amendment filed on June 11, 2007. (4)
|
|
3.1
|
Articles
of Incorporation. (5)
|
|
3.1
|
Certificate
of Amendment to Articles of Incorporation. (6)
|
|
3.1
|
Certificate
of Ownership and Merger, dated November 15, 2007. (2)
|
|
3.1
|
Certificate
of Incorporation of China Integrated Energy, Inc. (7)
|
|
3.2
|
By-laws.
(5)
|
|
4.1
|
Form
of Warrant. (1)
|
|
4.2
|
Amended
and Restated Certificate of Designation of the Relative Rights and
Preferences of the Series A Convertible Preferred Stock.
(1)
|
|
4.3
|
Amended
and Restated Certificate of Designation of the Relative Rights and
Preferences of Series B Convertible Preferred Stock
(10)
|
|
4.4
|
Form
of Debenture (9)
|
|
4.5
|
Series
A-1 Warrant Amendment, dated January 22, 2010(15)
|
|
4.6
|
Series
A-2 Warrant Amendment, dated January 22, 2010 (15)
|
|
10.1
|
Exclusive
Business Cooperation Agreement by and between Redsky China and Baorun
Industrial , dated as of October 19, 2007. (7)
|
|
10.2
|
Exclusive
Option Agreement by and between Gao Xincheng and Baorun Industrial, dated
as of October 19, 2007. (7)
|
|
10.3
|
Exclusive
Option Agreement by and between Gao Huiling and Baorun Industrial, dated
as of October 19, 2007. (7)
|
|
10.4
|
Exclusive
Option Agreement by and between Liu Yunlong and Baorun Industrial, dated
as of October 19, 2007. (7)
|
|
10.5
|
Equity
Pledge Agreement by and among Redsky China, Baorun Industrial and Gao
Xincheng, dated as of October 19, 2007. (7)
|
|
10.6
|
Equity
Pledge Agreement by and among Redsky China, Baorun Industrial and Gao
Huiling, dated as of October 19, 2007. (7)
|
|
10.7
|
Equity
Pledge Agreement by and among Redsky China, Baorun Industrial and Liu
Yunlong, dated as of October 19, 2007. (7)
|
|
10.8
|
Power
of Attorney of Gao Xincheng. (8)
|
|
10.9
|
Power
of Attorney of Gao Huiling. (8)
|
|
10.10
|
Power
of Attorney of Liu Yunlong. (8)
|
|
10.11
|
Nominee
Letter between Redsky China and Gao Xincheng. (8)
|
|
10.12
|
Nominee
Letter between Redsky China and Gao Huiling. (8)
|
|
10.13
|
Nominee
Letter between Redsky China and Liu Yunlong. (8)
|
|
10.14*
|
Employment
Agreement between Baorun Industrial and Gao Xincheng, dated as of October
23, 2007. (8)
|
|
10.15*
|
Employment
Agreement between Baorun Industrial and Li Gaihong, dated as of October
23, 2007. (8)
|
|
10.16
|
Amendment
to Exclusive Business Cooperation Agreement, dated March 24, 2008.
(8)
|
|
10.17
|
Securities
Purchase Agreement, dated as of October 14, 2008. (9)
|
|
10.18
|
Registration
Rights Agreement, dated as of October 14, 2008. (9)
|
|
10.19
|
Share
Escrow Agreement, dated as of October 14, 2008.
(9)
|
59
10.20
|
Management
Escrow Agreement, dated as of October 14, 2008. (9)
|
|
10.21
|
Form
of Warrant Exercise Agreement. (9)
|
|
10.22
|
Gas
Station Lease Agreement, dated as of May 20, 2008. (10)
|
|
10.23
|
Employment
Agreement with Albert C. Pu, dated as of January 22, 2009
(11)
|
|
10.24
|
Gas
Station Leasing Business Contract, dated as of May 28, 2009
(12)
|
|
10.25
|
Gas
Station Lease Agreement, dated as of February 1, 2007
(13)
|
|
10.26
|
Gas
Station Lease Agreement, dated as of July 27, 2009 (13)
|
|
10.27
|
Land
Lease Agreement, dated as of April 20, 2006 (13)
|
|
10.28
|
Oil
Storage Service Agreement, effective as of January 1, 2009
(13)
|
|
10.29
|
Oil
Storage Service Agreement, dated as of August 26, 2008
(13)
|
|
10.30
|
Finished
Oil Sales Contract by and between Yanchang Petroleum Oil (Group) Co., Ltd.
and Xi’an Baorun Industrial, effective as of December 23, 2008
(13)
|
|
10.31
|
Finished
Oil Sales Contract by and between China Petroleum & Chemical
Corporation Chuanyu Trading Co., Ltd. and Xi’an Baorun Industrial, dated
as of January 25, 2009 (13)
|
|
10.32
|
Registration
Rights Agreement, dated September 10, 2009, by and between the Company and
Longgen Zhang and Yuan Gong (14)
|
|
10.33
|
Lease
Contract, dated April 30, 2008, amending the terms of the Land Lease
Agreement, dated April 20, 2006 (14)
|
|
10.34
|
2003
Equity Incentive Program (6)
|
|
10.35+ |
Finished
Oil Products Sales Contract by and between Yanchang Petroleum (Group)
Corp. Ltd. and Xi’an Baorun Industrial Development
Co.
|
|
10.36+ |
Finished
Oil Products Sales Contract by and between Yanchang Petroleum (Group)
Corp. Ltd. and Xi’an Baorun Industrial Development
Co.
|
|
10.37+ |
Gas
Station Lease Agreement with Andong Gas Station, dated December 17,
2009
|
|
10.38 |
Gas
Station Lease Agreement with Xi’an Jindou Gas Station, dated
December 15, 2009
|
|
10.39+ |
Finished
Oil Sales Contract by and between Chongqing Oil Subsidiary Company of
China Petroleum & Chemical Corporation, dated as of January 6,
2010
|
|
10.40+ | Equity Transfer Agreement for Hanyang Jinzheng Petroleum Sales Co., Ltd, dated December 13, 2009 | |
14
|
Code
of Business Conduct and Ethics. (8)
|
|
21
|
List
of Subsidiaries. (7)
|
|
23.1+
|
Consent
of Sherb & Co.
|
|
31.1+
|
Certification
of Chief Executive Officer pursuant to Rule 13A-14(A)/15D-14(A) of the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
31.2+
|
Certification
of the Principal Financial Officer pursuant to Rule 13A-14(A)/15D-14(A) of
the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
|
|
32+
|
Certification
of Chief Executive Officer and Chief Financial Officer Pursuant to 18
U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of
2002).
|
_________________
+ Filed
herewith.
*
Management Contract or Compensatory Arrangement
(1)
|
Incorporated
by reference to the Company’s Form 8-K filed on October 29,
2007.
|
(2)
|
Incorporated
by reference to the Company’s Form 8-K filed on November 23,
2007.
|
(3)
|
Incorporated
by reference to the Company’s Form 10-QSB filed on November 13,
2007.
|
(4)
|
Incorporated
by reference to the Company’s Form 10-QSB filed on August 3,
2007.
|
(5)
|
Incorporated
by reference to the Company’s Registration Statement on Form
10-SB.
|
(6)
|
Incorporated
by reference to the Company’s Definitive Information Statement filed on
September 19, 2003.
|
(7)
|
Incorporated
by reference to the Company’s Registration Statement on Form S-1 initially
filed on December 7, 2007.
|
(8)
|
Incorporated
by reference to the Company’s Form 10-K filed on March 31,
2008.
|
(9)
|
Incorporated
by reference to the Company’s Form 8-K filed on October 20,
2008.
|
(10)
|
Incorporated
by reference to the Company’s Form 10-K filed on March 25,
2009.
|
(11)
|
Incorporated
by reference to the Company’s Form 10-Q filed on May 13,
2009
|
(12)
|
Incorporated
by reference to the Company’s Form 10-Q filed on August 11,
2009
|
(13)
|
Incorporated
by reference to the Company’s Registration Statement on Form S-1 filed on
September 10, 2009
|
(14)
|
Incorporated
by reference to the Company’s Registration Statement on Form S-1/A filed
on October 5, 2009
|
(15)
|
Incorporated
by reference to the Company’s Form 8-K filed on January 28,
2010.
|
(b)
Exhibits
required by Item 601 of Regulation S-K are listed above and filed
herewith.
(c)
None
60
CHINA
INTEGRATED ENERGY, INC..
AND
SUBSIDIARIES
TABLE
OF CONTENTS
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
|
F-2
|
CONSOLIDATED
BALANCE SHEETS.
|
F-3
|
CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME.
|
F-4
|
CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ EQUITY.
|
F-5
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS.
|
F-6
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS.
|
F-7
|
F-1
SHERB
& CO., LLP
|
1900
NW Corporate Blvd., Suite East 210
Boca
Raton, Florida 33431
Tel.
561-886-4200
Fax.
561-886-3330
E-mail:
info@sherbcpa.com
Offices
in New York, Florida
|
Certified
Public Accountants
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Stockholders of China Integrated Energy,
Inc.
We have
audited the accompanying consolidated balance sheets of China Integrated Energy,
Inc. and subsidiaries as of December 31, 2008 and 2009, and the related
consolidated statements of income, stockholders’ equity and comprehensive
income, and cash flows for each of the years in the two-year period ended
December 31, 2009. China Integrated Energy, Inc.’s management is responsible for
these financial statements. Our responsibility is to express an opinion on these
financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of China Integrated Energy, Inc. and
subsidiaries as of December 31, 2008 and 2009, and the results of its operations
and its cash flows for each of the years in the two-year period ended December
31, 2009 in conformity with accounting principles generally accepted in the
United States of America.
/s/ Sherb
& Co., LLP
Boca
Raton, Florida
March 30,
2010
F-2
CHINA
INTEGRATED ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
December
31,
|
December
31,
|
|||||||
2009
|
2008
|
|||||||
ASSETS
|
||||||||
CURRENT
ASSETS
|
||||||||
Cash
and cash equivalents
|
$ | 62,415,443 | $ | 23,119,028 | ||||
Restricted
cash
|
- | 919,351 | ||||||
Accounts
receivable
|
3,099,587 | 8,164,320 | ||||||
Other
receivables and deposits
|
7,231,586 | 3,986,984 | ||||||
Prepaid
expenses
|
3,145,502 | 1,884,102 | ||||||
Advance
to suppliers
|
34,544,100 | 17,945,487 | ||||||
Inventories,
net
|
20,954,851 | 22,268,903 | ||||||
Total
current assets
|
131,391,069 | 78,288,175 | ||||||
Prepaid
rents
|
24,620,685 | 6,408,568 | ||||||
Property
and equipment, net
|
7,561,907 | 9,997,674 | ||||||
Total
noncurrent assets
|
32,182,592 | 16,406,242 | ||||||
TOTAL
ASSETS
|
$ | 163,573,661 | $ | 94,694,417 | ||||
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
||||||||
CURRENT
LIABILITIES
|
||||||||
Advance
from customers
|
$ | 1,903,124 | $ | 4,580,462 | ||||
Taxes
payable
|
1,242,931 | 735,461 | ||||||
Other
payables
|
2,700,988 | 3,232,088 | ||||||
Loans
payable
|
4,395,025 | 2,247,197 | ||||||
Total
current liabilities
|
10,242,068 | 10,795,208 | ||||||
TOTAL
LIABILITIES
|
10,242,068 | 10,795,208 | ||||||
STOCKHOLDERS'
EQUITY
|
||||||||
Preferred
stock, $.001 par value; authorized
shares
|
||||||||
10,000,000;
issued and ourstanding 3,115,753 and
|
||||||||
3,465,753
shares at December 31, 2009 and December 31 2008,
respectively
|
3,115 | 3,465 | ||||||
Common
stock, $.0001 par value; authorized
shares
|
||||||||
79,000,000; issued
and outstanding 33,269,091 and
|
||||||||
27,169,091
shares at December 31, 2009 and December 31, 2008,
respectively
|
3,326 | 2,716 | ||||||
Additional
paid in capital
|
75,858,994 | 44,434,250 | ||||||
Statutory
reserve
|
4,920,114 | 4,920,114 | ||||||
Accumulated
other comprehensive income
|
5,473,420 | 5,337,003 | ||||||
Retained
earnings
|
67,072,624 | 29,201,661 | ||||||
Total
stockholders' equity
|
153,331,593 | 83,899,209 | ||||||
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
$ | 163,573,661 | $ | 94,694,417 |
F-3
CHINA
INTEGRATED ENERGY, INC. AND SUBSIDIARIES
|
||||||||
CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
|
||||||||
For
The Years Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Sales
|
$ | 289,572,053 | $ | 216,506,969 | ||||
Cost
of goods sold
|
248,101,339 | 185,858,502 | ||||||
Gross
profit
|
41,470,714 | 30,648,467 | ||||||
Selling,
general and administrative expenses
|
3,820,173 | 1,997,818 | ||||||
Income
from operations
|
37,650,541 | 28,650,649 | ||||||
Non-operating
income (expenses)
|
||||||||
Interest
expenses
|
(121,522 | ) | (125,201 | ) | ||||
Subsidy
income
|
541,059 | 100,792 | ||||||
Other
expense
|
(199,115 | ) | (63,519 | ) | ||||
Stock
based compensation - make good provision (see Note 18)
|
- | (9,838,354 | ) | |||||
Total
non-operating income (expenses)
|
220,422 | (9,926,282 | ) | |||||
Net
income
|
37,870,963 | 18,724,367 | ||||||
Other
comprehensive item
|
||||||||
Foreign
currency translation gain (Loss)
|
64,508 | 3,017,271 | ||||||
Comprehensive
Income
|
$ | 37,935,471 | $ | 21,741,638 | ||||
Net
Income
|
$ | 37,870,963 | $ | 18,724,367 | ||||
Deemed
dividend to preferred stockholders
|
- | (863,014 | ) | |||||
Net
income available to common stockholders
|
$ | 37,870,963 | $ | 17,861,353 | ||||
Basic
and diluted weighted average shares outstanding
|
||||||||
Basic
|
28,230,461 | 25,889,748 | ||||||
Diluted
|
36,254,975 | 32,877,570 | ||||||
Basic
and diluted net earnings per share available to common
stockholders
|
||||||||
Basic
|
$ | 1.34 | $ | 0.69 | ||||
Diluted
|
$ | 1.04 | $ | 0.54 |
F-4
CHINA
INTEGRATED ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENT OF STOCKHOLDERS' EQUITY
Preferred
stock
|
Common
stock
|
|||||||||||||||||||||||||||||||||||
Shares
|
Amount
|
Shares
|
Amount
|
Additional
paid in capital
|
Statutory
reserves
|
Other
comprehensive income
|
Retained
earnings
|
Total
stockholders' equity
|
||||||||||||||||||||||||||||
Balance
at December 31, 2007
|
1,000,000 | $ | 1,000 | 25,454,545 | $ | 2,545 | $ | 19,611,938 | $ | 2,051,030 | $ | 2,319,732 | $ | 14,209,392 | 38,195,637 | |||||||||||||||||||||
Preferred
Shares issued for cash
|
2,465,753 | 2,465 | - | - | 8,997,535 | - | - | - | 9,000,000 | |||||||||||||||||||||||||||
Warrant
exercised
|
- | - | 1,704,546 | 170 | 5,113,465 | - | - | - | 5,113,635 | |||||||||||||||||||||||||||
Shares
issued to employees
|
- | - | 10,000 | 1 | 9,944 | - | - | - | 9,945 | |||||||||||||||||||||||||||
Deemed
dividend
|
- | - | - | - | 863,014 | - | - | (863,014 | ) | - | ||||||||||||||||||||||||||
Make
good provision
|
- | - | - | - | 9,838,354 | - | - | - | 9,838,354 | |||||||||||||||||||||||||||
Net
income for the year
|
- | - | - | - | - | - | - | 18,724,367 | 18,724,367 | |||||||||||||||||||||||||||
Transfer
to statutory reserves
|
- | - | - | - | - | 2,869,084 | - | (2,869,084 | ) | - | ||||||||||||||||||||||||||
Foreign
currency translation gain
|
- | - | - | - | - | - | 3,017,271 | - | 3,017,271 | |||||||||||||||||||||||||||
Balance
at December 31, 2008
|
3,465,753 | 3,465 | 27,169,091 | 2,716 | 44,434,250 | 4,920,114 | 5,337,003 | 29,201,661 | 83,899,209 | |||||||||||||||||||||||||||
Preferred
B conversion
|
-350,000 | -350 | 350,000 | 35 | 315 | - | - | - | - | |||||||||||||||||||||||||||
Shares
issued to employees
|
- | - | - | - | 30,056 | - | - | - | 30,056 | |||||||||||||||||||||||||||
Stock
purchase option - directors
|
- | - | - | - | 155,104 | - | - | - | 155,104 | |||||||||||||||||||||||||||
Stock-based
compensation
|
- | - | - | - | 555,710 | - | - | - | 555,710 | |||||||||||||||||||||||||||
Net
income for the year
|
- | - | - | - | - | - | - | 37,870,963 | 37,870,963 | |||||||||||||||||||||||||||
Issuance
of common stock
|
- | - | 5,750,000 | 575 | 30,683,559 | - | - | - | 30,684,134 | |||||||||||||||||||||||||||
Foreign
currency translation gain (loss)
|
- | - | - | - | - | - | 136,417 | - | 136,417 | |||||||||||||||||||||||||||
Balance
at December 31, 2009
|
3,115,753 | $ | 3,115 | 33,269,091 | $ | 3,326 | $ | 75,858,994 | $ | 4,920,114 | $ | 5,473,420 | $ | 67,072,624 | $ | 153,331,593 |
F-5
CHINA
INTEGRATED ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOW
For
The Years Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
Net
income
|
$ | 37,870,963 | $ | 18,724,367 | ||||
Adjustments
to reconcile net income to net cash
|
||||||||
provided
by (used in) operating activities:
|
||||||||
Loss
on disposal of property and equipment
|
155,866 | - | ||||||
Depreciation
|
1,145,538 | 1,040,924 | ||||||
Stock
based compensation - make good provision
|
- | 9,838,354 | ||||||
Stock
based compensation
|
740,870 | 9,945 | ||||||
(Increase)
decrease in current assets:
|
||||||||
Accounts
receivable
|
5,071,574 | (7,731,421 | ) | |||||
Other
receivables, deposits and prepaid expenses
|
(3,242,271 | ) | (8,466,631 | ) | ||||
Advance
to suppliers
|
(16,564,092 | ) | (280,790 | ) | ||||
Inventories
|
1,341,491 | (9,223,710 | ) | |||||
Prepaid
expenses - Rents, non-current
|
(19,449,270 | ) | - | |||||
Due
from related party
|
- | 623,581 | ||||||
Increase
(decrease) in current liabilities:
|
||||||||
Accounts
payable
|
- | (187,219 | ) | |||||
Advance
from customers
|
(2,681,291 | ) | 3,982,577 | |||||
Taxes
payable
|
506,177 | 592,462 | ||||||
Other
payables and accrued expenses
|
(534,557 | ) | (217,054 | ) | ||||
Net
cash provided by operating activities
|
4,360,998 | 8,705,385 | ||||||
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||
Net
proceeds from sales of property and equipment
|
1,515,950 | - | ||||||
Acquisition
of property and equipment
|
(370,564 | ) | (1,251,231 | ) | ||||
Net
cash provided in (used in) investing activities
|
1,145,386 | (1,251,231 | ) | |||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
Restricted
cash released
|
919,351 | (718,768 | ) | |||||
Proceeds
from short-term loans
|
4,394,252 | 719,942 | ||||||
Repayment
of auto loans and notes payable
|
(2,249,638 | ) | (54,375 | ) | ||||
Proceeds
from issuance of preferred stock
|
- | 9,000,000 | ||||||
Proceeds
from warrants exercised
|
- | 5,113,635 | ||||||
Proceeds
from issuance of common stock
|
30,684,133 | - | ||||||
Net
cash provided by financing activities
|
33,748,098 | 14,060,434 | ||||||
EFFECT
OF EXCHANGE RATE CHANGE ON CASH AND
CASH
EQUIVALENTS
|
41,933 | 222,069 | ||||||
NET
INCREASE IN CASH AND CASH EQUIVALENTS
|
39,296,415 | 21,736,657 | ||||||
CASH
AND CASH EQUIVALENTS, BEGINNING OF YEAR
|
23,119,028 | 1,382,371 | ||||||
CASH
AND CASH EQUIVALENTS, END OF YEAR
|
$ | 62,415,443 | $ | 23,119,028 | ||||
Supplemental
Cash flow data:
|
||||||||
Income
tax paid
|
$ | - | $ | - | ||||
Interest
paid
|
$ | 121,522 | $ | 125,201 | ||||
NON-CASH
INVESTING AND FINANCING ACTIVIES:
|
||||||||
Conversion
of preferred B stock
|
$ | 350 | $ | - |
F-6
CHINA
INTEGRATED ENERGY INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2009 AND 2008
1. ORGANIZATION AND DESCRIPTION OF
BUSINESS
Company
History
We were
incorporated in the State of Delaware in July 1998 under the corporate name “AMS
Marketing Inc.” and in October 2003, we changed our name to “International
Imaging Systems, Inc.” Until January 2007 we were engaged in the business of
marketing pre-owned, brand name photocopy machines and employee
leasing. We then began to pursue an acquisition strategy to acquire
an undervalued business with a history of operating revenues in markets that
provide room for growth.
Pursuant
to our strategy, we acquired Baorun Group pursuant to a Share Exchange
Agreement, dated October 23, 2007, with Baorun Group, Redsky Group Limited, a
British Virgin Islands company, Princeton Capital Group LLP, Castle Bison, Inc.
and Stallion Ventures, LLC. Together, Redsky Group and Princeton Capital Group
owned shares constituting 100% of the issued and outstanding ordinary shares of
Baorun Group. Pursuant to the terms of the Share Exchange Agreement, Redsky
Group and Princeton Capital Group transferred to us all of their shares in
Baorun Group in exchange for the issuance of 22,454,545 shares of our common
stock to Redsky Group and 1,500,000 shares of our common stock to Princeton
Capital Group. As a result of this share exchange, Baorun Group became our
wholly owned subsidiary and Redsky Group and Princeton Capital Group acquired an
aggregate of approximately 94.11% of our common stock.
On
November 15, 2007, through a merger of a wholly owned subsidiary, China Bio
Energy Holding Group Co., Ltd., the Company’s corporate name was changed to
“China Bio Energy Holding Group Co., Ltd.”
On
September 17, 2009, the Company’s corporate name was changed to “China
Integrated Energy, Inc.”
Corporate
Structure
We are
engaged in three business segments, (1) the wholesale distribution of finished
oil and heavy oil products, (2) the production and sales of biodiesel, and (3)
the operation of retail gas stations. We operate our business through
certain contractual agreements between Redsky Industrial and Xi’an Baorun
Industrial. Redsky Industrial is our indirect wholly owned subsidiary
that is a registered wholly foreign owned enterprise in the People’s Republic of
China. Xi’an Baorun Industrial is based in China and wholly owned by
Chinese citizens, including our Chairman and Chief Executive Officer, Mr.
Xincheng Gao, who owns 70% of Xi’an Baorun Industrial.
The
following diagram illustrates our corporate structure
F-7
Contractual
Agreements with Xi’an Baorun Industrial
We do not own an equity interest in
Xi’an Baorun Industrial. In order to meet domestic ownership requirements under
Chinese law, which restricts foreign companies from operating in the finished
oil industry, Redsky Industrial executed a series of exclusive contractual
agreements with Xi’an Baorun Industrial, which allow us, among other things, to
secure significant rights to influence Xi’an Baorun Industrial’s
business operations, policies and management, to approve all matters requiring
shareholder approval, and give us the right to include 100% of the annual net
income earned by Xi’an Baorun Industrial as part of our consolidated financial
statements. In addition, to ensure that Xi’an Baorun Industrial and its
shareholders perform their obligations under these contractual arrangements, the
shareholders have pledged to Redsky Industrial all of their equity interests in
Xi’an Baorun Industrial. At such time that current restrictions under
PRC law on foreign ownership of Chinese companies engaging in the finished oil
industry in China are lifted, Redsky Industrial may exercise its option to
purchase the equity interests in Xi’an Baorun Industrial directly.
Since
Baorun Group owns Redsky Industrial, which effectively controls Xi’an Baorun
Industrial, Xi’an Baorun Industrial is deemed a subsidiary of Baorun Group, our
legal subsidiary. Based on Xi’an Baorun Industrial’s contractual relationship
with Redsky Industrial as set forth in the Exclusive Business Cooperation
Agreement, we have determined that Xi’an Baorun Industrial should be deemed to
be our variable interest entity has been created in accordance with FASB
Interpretations - FIN 46(R): Consolidation of Variable Interest Entities (as
amended) (“FIN 46(R)”). Under FIN 46(R), Xi’an Baorun Industrial is to be
presented as our consolidated subsidiary.
The
contractual agreements Redsky Industrial entered into with Xi’an Baorun
Industrial and its shareholders include the following:
Exclusive
Business Cooperation Agreement
Pursuant
to an Exclusive Business Cooperation Agreement entered into between Redsky
Industrial and Xi’an Baorun Industrial on October 19, 2007, as amended on March
24, 2008, Redsky Industrial has the exclusive right to provide complete
technical support, business support and related consulting services, which
include, among others, technical services, business consultations, equipment or
property leasing, marketing consultancy and product research.
Xi’an Baorun Industrial has agreed to pay the service fee on a
monthly basis to Redsky Industrial equal to 100% of the monthly net income of
Xi’an Baorun Industrial. This agreement is subject to renewal at the option of
both Redsky Industrial and Xi’an Baorun Industrial. Redsky
Industrial has the right to early termination of this agreement for any reason
upon 30 days written notice. Xi’an Baorun Industrial only has the right to early
termination this agreement in the event of the gross negligence of, or
fraudulent acts by Redsky Industrial.
Exclusive
Option Agreements
Under
Exclusive Option Agreements dated October 19, 2007 entered into among Redsky
Industrial, each of the three shareholders of Xi’an Baorun Industrial and Xi’an
Baorun Industrial, the shareholders of Xi’an Baorun Industrial irrevocably
granted to Redsky Industrial or its designated person, an exclusive option to
purchase, to the extent permitted by PRC law, a portion or all of their
respective equity interests in Xi’an Baorun Industrial for a purchase price
either to be designated by Redsky Industrial or to be determined based on the
evaluation of the equity interests required by PRC law. Redsky Industrial or its
designated person has the sole discretion to decide when to exercise the option,
whether in part or in full. Each of these agreements has a ten-year term,
subject to renewal at Redsky Industrial’s election.
Equity
Pledge Agreements
Under the
Equity Pledge Agreements dated October 19, 2007, entered into among Redsky
Industrial, Xi’an Baorun Industrial and each of the three shareholders of Xi’an
Baorun Industrial, the shareholders of Xi’an Baorun Industrial pledged their
equity interests in Xi’an Baorun Industrial to guarantee Xi’an Baorun
Industrial’s performance of its obligations under the Exclusive Business
Cooperation Agreement. If Xi’an Baorun Industrial fails to perform its payment
obligations under the Exclusive Business Cooperation Agreement, or if Xi’an Baorun Industrial
or any of its shareholders breaches his/her respective contractual obligations
under the agreement, or upon the occurrence of an event of default, Redsky
Industrial is entitled to certain rights, including the right to dispose of the
pledged equity interests. The shareholders of Xi’an Baorun Industrial agreed not
to dispose of the pledged equity interests or take any actions that would
prejudice Redsky Industrial’s interest. Each of the Equity Pledge
Agreements will be valid until all the payments due under the Exclusive Business
Cooperation Agreement have been paid by Xi’an Baorun Industrial and
Xi’an Baorun Industrial no longer has any obligations under the Exclusive
Business Cooperation Agreement. Since the Exclusive Business
Cooperation Agreement may be renewed at Redsky Industrial’s option, the equity
pledge will remain in effect with each such renewal of the Exclusive Business
Cooperation Agreement, and until all payments due under the Exclusive Business
Cooperation are paid in full by Xi’an Baorun Industrial.
Irrevocable
Powers of Attorney
Under
irrevocable powers of attorney, each of the three shareholders of Xi’an Baorun
Industrial granted to Redsky Industrial the power to exercise all voting rights
of such shareholder in shareholders’ meetings, including, but not limited to,
the power to determine the sale, pledge or transfer of, or otherwise disposal of
all or part of such shareholder’s equity interest in, and appointing and
electing the directors, the legal representative (chairperson), chief executive
officer and other senior management of Xi’an Baorun Industrial.
F-8
Incentive
Option Agreements
On
October 19, 2007, Redsky Group entered into an Incentive Option Agreement with
Mr. Xincheng Gao, our chairman and chief executive officer, whereby Redsky Group
granted an incentive option to Mr. Gao to purchase 3,000 ordinary shares of
Redsky Group at an exercise price of $1.00 per share for a total aggregate
consideration of $3,000. In connection with the share exchange,
Redsky Group was issued 22,454,545 shares of our common stock. In
August 2008, Mr. Gao exercised the option.
2. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
Basis
of Presentation
The
consolidated financial statements, prepared in accordance with accounting
principles generally accepted in the United States of America,, include the
financial statements of the Company, and its wholly owned or controlled
subsidiaries and all other entities that it has a controlling financial interest
in or are considered to be the primary beneficiary, pursuant to the rules of
accounting standards codification. All significant inter-company transactions
and balances between the Company, its subsidiaries and VIEs are eliminated upon
consolidation. The Company has included the results of operations of its
subsidiaries from the dates of acquisition.
The
Company, its subsidiaries and VIEs referenced above are hereinafter collectively
referred to as the (“Company”).
Principle
of Consolidation
The
accompanying consolidated financial statements include our accounts and the
accounts of our wholly owned subsidiary, Baorun Group and Redsky Industrial, and
its consolidated subsidiary, Baorun Industrial (collectively, the “Company”).
All significant inter-company accounts and transactions have been eliminated in
consolidation.
Use
of Estimates
In
preparing the financial statements in conformity with accounting principles
generally accepted in the United States of America, management makes estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the dates of the financial
statements, as well as the reported amounts of revenues and expenses during the
reporting year. Significant estimates, required by management, include the
recoverability of long-lived assets, allowance for doubtful accounts, and the
reserve for obsolete and slow-moving inventories. Actual results could differ
from those estimates.
Cash
and Cash Equivalents
For
purposes of the statement of cash flows, the Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.
As of
December 31, 2009 and December 31, 2008, the Company maintained restricted cash
of $-0- and $919,351, respectively. Restricted cash was held from the proceeds
of private placements for the purposes of investor relations expenditure and
recruitment of independent board of directors, VP of investor relations, and
chief financial officer (see note number 16, Escrow Agreement).
Accounts
Receivable
The
Company’s policy is to maintain reserves for potential credit losses on accounts
receivable. Management reviews the composition of accounts receivable and
analyzes historical bad debts, customer concentrations, customer credit
worthiness, current economic trends and changes in customer payment patterns to
evaluate the adequacy of these reserves. Based on historical collections, no
allowance was deemed necessary at December 31, 2009 and December 31, 2008 as the
Company did not experience any uncollectible accounts receivable and bad debt
write-off over the past years.
Advance
to Suppliers
Advance
to suppliers consist of prepayments to the suppliers for products that have not
yet been received. Any amount paid to the suppliers prior to the Company’s
acceptance of petroleum products are recorded as advance to suppliers. The
Company will record the prepayment as inventory at the time of accepting
delivery of petroleum products from suppliers. Advance to suppliers as of
December 31, 2009 and 2008 were $34,544,100 and $17,945,487,
respectively.
F-9
Inventories
Inventories
are valued at the lower of cost or market with cost determined on a moving
weighted average basis. Cost of work in progress and finished goods comprises
direct material, direct labor, and an allocated portion of production
overheads.
Advances
from Customers
Advances
from customers consist of prepayments to the Company for products that have not
yet been shipped to the customers. Any amounts received prior to satisfying the
Company’s revenue recognition criteria are recorded as deferred revenue or
advances from customers. The Company will recognize the prepayments from the
customers as revenue at the time the delivery of goods is made. Advances from
customers as of December 31, 2009 and December 31, 2008 were $1,903,124 and
$4,580,462, respectively.
Property,
Plant, and Equipment
Plant,
property and equipment are stated at the actual cost on acquisition less
accumulated depreciation and amortization. Depreciation and amortization are
provided for in amounts sufficient to relate the cost of depreciation assets to
operations over their estimated service lives, principally on a straight-line
basis. Most property, plant and equipment have a residual value of 5% of actual
cost. The estimated lives used in determining depreciation are:
Years
|
|||
Building
|
20
|
||
Vehicle
|
5
|
||
Office
Equipment
|
5
|
||
Production
Equipment
|
10
|
In
accordance with accounting standards codification, “Accounting for the
Impairment or Disposal of Long-Lived Assets”, the Company examines the
possibility of decreases in the value of fixed assets when events or changes in
circumstances reflect the fact that their recorded value may not be recoverable.
There was no fixed asset impairment.
Impairment
of Long-Lived Assets
Long-lived
assets, which include property, plant and equipment and intangible assets, are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.
Recoverability
of long-lived assets to be held and used is measured by a comparison of the
carrying amount of an asset to the estimated undiscounted future cash flows
expected to be generated by the asset. If the carrying amount of an asset
exceeds its estimated undiscounted future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset exceeds the
fair value of the assets. Fair value is generally determined using the asset’s
expected future discounted cash flows or market value, if readily determinable.
Based on its review, the Company believes that, as of December 31, 2009 and
December 31, 2008, there were no impairments of its long-lived
assets.
Income
Taxes
The
Company utilizes the accounting standards codification, “Accounting for Income
Taxes”, which requires the recognition of deferred tax assets and liabilities
for the expected future tax consequences of events that have been included in
the financial statements or tax returns. Under this method, deferred income
taxes are recognized for the tax consequences in future years of differences
between the tax bases of assets and liabilities and their financial reporting
amounts at each period end based on enacted tax laws and statutory tax rates
applicable to the periods in which the differences are expected to affect
taxable income. Valuation allowances are established, when necessary, to reduce
deferred tax assets to the amount expected to be realized.
F-10
The
Company adopted the provisions of accounting standards codification, ”Accounting
for Uncertainty in Income Taxes” on January 1, 2007. As a result of the
implementation of the accounting standards codification, the Company made a
comprehensive review of its portfolio of tax positions in accordance with
recognition standards established by the accounting standards codification. As a
result of the implementation of the accounting standards codification, the
Company recognized no material adjustments to liabilities or stockholders
equity. When tax returns are filed, it is highly certain that some positions
taken would be sustained upon examination by the taxing authorities, while
others are subject to uncertainty about the merits of the position taken or the
amount of the position that would be ultimately sustained. The benefit of a tax
position is recognized in the financial statements in the period during which,
based on all available evidence, management believes it is more likely than not
that the position will be sustained upon examination, including the resolution
of appeals or litigation processes, if any. Tax positions taken are not offset
or aggregated with other positions. Tax positions that meet the
more-likely-than-not recognition threshold are measured as the largest amount of
tax benefit that is more than 50 percent likely of being realized upon
settlement with the applicable taxing authority. The portion of the benefits
associated with tax positions taken that exceeds the amount measured as
described above is reflected as a liability for unrecognized tax benefits in the
accompanying balance sheets along with any associated interest and penalties
that would be payable to the taxing authorities upon examination. Interest
associated with unrecognized tax benefits are classified as interest expense and
penalties are classified in selling, general and administrative expenses in the
statements of income. The adoption of the accounting standards codification did
not have a material impact on the Company’s financial statements.
Revenue
Recognition
The
Company’s revenue recognition policies are in compliance with Securities and
Exchange Commission (SEC) Staff Accounting Bulletin. For distribution of
finished oil, heavy oil products, and bio-diesel, sales revenue is recognized at
the date of shipment to customers when a formal arrangement exists, the price is
fixed or determinable, the delivery is completed, no other significant
obligations of the Company exist and collectability is reasonably assured.
Payments received before all of the relevant criteria for revenue recognition
are recorded as unearned revenue. For gas station retail sales,
revenue is recognized and cash is collected upon completion of fuel sales to
customers,
Sales
revenue represents the invoiced value of goods sold, net of value-added tax
(“VAT”). All of the Company’s products that are sold in the PRC are subject to
Chinese value-added tax of 17% of the gross sales price. This VAT may be offset
by VAT paid by the Company on raw materials and other materials or services
included in the cost of producing their finished product. The Company recorded
VAT payable and VAT receivable net of payments in the financial statements. The
VAT tax return is filed offsetting the payables against the
receivables.
There
were no sales returns and allowances for 2009 and 2008. The Company does not
provide unconditional right of return, price protection or any other concessions
to its customers.
Cost
of Goods Sold
Cost of
goods sold consists primarily of material costs, direct labor, manufacturing
overhead and related expenses, which are directly attributable to the production
of products. Write-down of inventory to lower of cost or market is also recorded
in cost of goods sold.
Concentration
of Credit Risk
Financial
instruments that potentially subject the Company to credit risk consist
primarily of accounts receivable and other receivables. The Company does not
require collateral or other security to support these receivables. The Company
conducts periodic reviews of its customers’ financial conditions and customer
payment practices to minimize collection risk on accounts
receivable.
The
operations of the Company are located in the PRC. Accordingly, the Company’s
business, financial condition, and results of operations may be influenced by
the political, economic, and legal environments in the PRC, as well as by the
general state of the PRC economy.
Statement
of Cash Flows
In
accordance with the accounting standards codification “Statement of Cash Flows,”
cash flows from the Company’s operations is calculated based upon the local
currencies. As a result, amounts related to assets and liabilities reported on
the statement of cash flows may not necessarily agree with changes in the
corresponding balances on the balance sheet.
Foreign
Currency Translation and Comprehensive Income (Loss)
The
Company’s functional currency is the Renminbi (“RMB”). For financial reporting
purposes, RMB has been translated into United States dollars (“USD”) as the
reporting currency. Assets and liabilities are translated at the exchange rate
in effect at the balance sheet date. Revenues and expenses are translated at the
average rate of exchange prevailing during the reporting period. Translation
adjustments caused by different exchange rates from period to period are
included as a component of stockholders’ equity as “Accumulated other
comprehensive income”. Gains and losses resulting from foreign currency
transactions are included in income. There has been no significant fluctuation
in exchange rate for the conversion of RMB to USD after the balance sheet
date.
On July
21, 2005, the central government of China allowed the RMB to fluctuate, ending
its decade old valuation peg to the U.S. dollar. Historically, the Chinese
government has benchmarked the RMB exchange ratio against the U.S. dollar,
thereby mitigating the associated foreign currency exchange rate fluctuation
risk. The Company does not believe that its foreign currency exchange rate
fluctuation risk is significant, especially if the Chinese government continues
to benchmark the RMB against the U.S. dollar.
F-11
This
fluctuation of the exchange rates does not imply free convertibility of RMB to
other foreign currencies. All foreign exchange transactions continue to take
place either through the People’s Bank of China or other banks authorized to buy
and sell foreign currencies at the exchange rate quoted by the People’s Bank of
China.
The
Company uses Statement of accounting standards codification “Reporting
Comprehensive Income”. Comprehensive income is comprised of net income and all
changes to the statements of stockholders’ equity, except those due to
investments by stockholders, changes in paid-in capital and distributions to
stockholders. Comprehensive income for 2009 and 2008 were included net income
and foreign currency translation adjustments.
Fair
value of financial instruments
The
accounting standards codification, “Disclosures about Fair Value of Financial
Instruments,” requires that the Company disclose estimated fair values of
financial instruments. The carrying amounts reported in the statements of
financial position for current assets and current liabilities qualifying as
financial instruments are a reasonable estimate of fair value
On
January 1, 2008, the Company adopted the accounting standards codification “Fair
Value Measurements.” The accounting standards codification defines fair value,
establishes a three-level valuation hierarchy for disclosures of fair value
measurement and enhances disclosures requirements for fair value measures. The
carrying amounts reported in the balance sheets for receivables and current
liabilities each qualify as financial instruments and are a reasonable estimate
of fair value because of the short period of time
between the origination of such instruments and their expected realization and
their current market rate of interest. The three levels are defined as
follow:
|
·
|
Level
1 inputs to the valuation methodology are quoted prices (unadjusted) for
identical assets or liabilities in active
markets.
|
|
·
|
Level
2 inputs to the valuation methodology include quoted prices for similar
assets and liabilities in active markets, and inputs that are observable
for the asset or liability, either directly or indirectly, for
substantially the full term of the financial
instrument.
|
|
·
|
Level
3 inputs to the valuation methodology are unobservable and significant to
the fair value measurement.
|
As of
December 31, 2009, the Company did not identify any assets and liabilities that
are required to be presented on the balance sheet at fair value.
Stock-Based
Compensation
The
Company accounts for its stock-based compensation in accordance with the
accounting standards codification, “Share-Based Payment. The Company recognizes
in the statement of operations the grant-date fair value of stock options and
other equity-based compensation issued to employees and
non-employees.
Consolidation
of Variable Interest Entities
VIE’s are
entities that lack one or more voting interest entity characteristics. The
Company consolidates VIEs in which it is the primary beneficiary of its economic
gains or losses. The FASB has issued the accounting standards codification
(Revised December 2004), “Consolidation of Variable Interest Entities”. The
accounting standards codification clarifies the application of Consolidated
Financial Statements, to certain entities in which equity investors do not have
the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. It separates
entities into two groups: (1) those for which voting interests are used to
determine consolidation and (2) those for which variable interests are used to
determine consolidation. The accounting standards codification clarifies how to
identify a variable interest entity and how to determine when a business
enterprise should include the assets, liabilities, non-controlling interests and
results of activities of a variable interest entity in its consolidated
financial statements.
Reclassification
Certain
reclassifications have been made to the prior years’ financial statements to
conform to the current year presentation. These reclassifications had no effect
on previously reported results or retained earnings.
F-12
New
Accounting Pronouncements
Non-controlling Interests in
Consolidated Financial Statements
In
December 2007, the FASB issued “Non-controlling Interests in Consolidated
Financial Statements - An Amendment of the accounting standards codification.
The amended accounting standards codification establishes new accounting and
reporting standards for the non-controlling interest in a subsidiary and for the
deconsolidation of a subsidiary. Specifically, this statement requires the
recognition of a non-controlling interest (minority interest) as equity in the
consolidated financial statements and separate from the parent’s equity. The
amount of net income attributable to the non-controlling interest will be
included in consolidated net income on the face of the income
statement. The non-controlling Interests in Consolidated Financial
Statements clarifies that changes in a parent’s ownership interest in a
subsidiary that do not result in deconsolidation are equity transactions if the
parent retains its controlling financial interest. In addition, this statement
requires that a parent recognize a gain or loss in net income when a subsidiary
is deconsolidated. Such gain or loss will be measured using the fair value of
the non-controlling equity investment on the deconsolidation date. The
non-controlling Interests in Consolidated Financial Statements also includes
expanded disclosure requirements regarding the interests of the parent and its
non-controlling interest. The non-controlling Interests in Consolidated
Financial Statements is effective for fiscal years, and interim periods within
those fiscal years, beginning on or after December 15, 2008. The Company expects
the non-controlling Interests in Consolidated Financial Statements will have an
impact on accounting for business combinations once adopted but the effect is
dependent upon acquisitions at that time.
Business
Combinations
In
December 2007, the FASB issued accounting standards codification (Revised 2007),
“Business Combinations”. The revised financial accounting standard of “Business
Combinations” will significantly change the accounting for business
combinations. Under the revised accounting standards codification of “Business
Combinations”, an acquiring entity will be required to recognize all the assets
acquired and liabilities assumed in a transaction at the acquisition-date fair
value with limited exceptions. The revised accounting standards codification of
“Business Combinations will change the accounting treatment for certain specific
items, including:
·
|
Acquisition costs will be
generally expensed as
incurred;
|
·
|
Non-controlling
interests (formerly known as “minority interests”) will be valued at fair
value at the acquisition
date;
|
·
|
Acquired contingent liabilities
will be recorded at fair value at the acquisition date and subsequently
measured at either the higher of such amount or the amount determined
under existing guidance for non-acquired
contingencies;
|
·
|
In-process research and
development will be recorded at fair value as an indefinite-lived
intangible asset at the acquisition
date;
|
·
|
Restructuring costs associated
with a business combination will be generally expensed subsequent to the
acquisition date; and
|
·
|
Changes in deferred tax asset
valuation allowances and income tax uncertainties after the acquisition
date generally will affect income tax
expense.
|
The
revised accounting standards codification of “Business Combinations also
includes a substantial number of new disclosure requirements. The revised
accounting standards codification of “Business Combinations applies
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. Earlier adoption is prohibited. Accordingly, since we are a
calendar year-end company, we will continue to record and disclose business
combinations following existing GAAP until January 1, 2009. The Company expects
the revised accounting standards codification of “Business Combinations will
have an impact on accounting for business combinations once adopted but the
effect is dependent upon acquisitions at that time.
Defining Warrant Indexed To
A Company’s Own Stock
In June
2008, the FASB ratified Emerging Issues Task Force (“EITF”) issue, “Determining
Whether an instrument (of Embedded Feature) is indexed to an Entity’s Own
Stock”. The accounting standards codification mandates a two-step process for
evaluating whether an equity-linked financial instrument or embedded feature is
indexed to the entity’s own stock. Warrants that a company issues
that contain a strike price adjustment feature, upon the adoption of the
accounting standards codification results in the instruments no longer being
considered indexed to the company’s own stock. Accordingly, adoption of the
accounting standards codification will change the current classification (from
equity to liability) and the related accounting for such warrants outstanding at
the date. The accounting standards codification, “Determining Whether an
instrument (of Embedded Feature) is indexed to an Entity’s Own Stock” is
effective for fiscal years beginning after December 15, 2008, and interim
periods within those fiscal years.
F-13
The full
ratchet period of the Company’s warrant A-1 and warrant A-2 series expired on
October 22, 2008 one year following the original issue date of October 23, 2007.
Adoption of the accounting standards codification does not effect on the
Company’s financial statements and disclosures.
Subsequent
Events
In May
2009, the FASB issued guidance regarding “Subsequent Events”. This guidance
establishes general standards of accounting for and disclosure of events that
occur after the balance sheet date but before the financial statements are
issued or are available to be issued. It requires the disclosure of the date
through which an entity has evaluated subsequent events and the basis for that
date. This guidance is effective for interim and annual reporting periods ending
after June 15, 2009, and shall be applied prospectively.
Accounting Standards
Codification and the Hierarchy
In June
2009, the financial accounting standards Board (“FASB”) issued FASB Statement,
“The FASB Accounting Standards Codification (“ASC”) and the Hierarchy of
Generally Accepted Accounting Principles,” which is a significant restructuring
of accounting and reporting standards designed to simplify user access to all
authoritative U.S. generally accepted accounting principles by providing the
authoritative literature in a topically organized structure. The
Company has adopted the ASC, which became effective for interim and annual
periods ending after September 15, 2009.
Consolidations –
Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities
In
December 2009, the FASB issued guidance for Consolidations – Improvements to
Financial Reporting by Enterprises Involved with Variable Interest Entities (
Topic 810 ). The amendments in this update are a result of
incorporating the provisions of accounting standards codification,
“Consolidation of Variable Interest Entities”, Amendments to accounting
standards codification, “, and accounting standards codification,
“Interpretation of Consolidation of Variable Interest Entities, revised December
2004”. The provisions of such Statement are effective for fiscal years, and
interim periods within those fiscal years, beginning on or after November 15,
2009. Earlier adoption is not permitted. The presentation and disclosure
requirements shall be applied prospectively for all periods after the effective
date. Management believes this Statement will have immaterial impact on the
financial statements of the Company once adopted.
3. CASH
IN BANK ACCOUNTS
Cash
includes cash on hand and demand deposits in accounts maintained with
state-owned banks within the PRC. Total cash in state-owned banks at December
31, 2009 and 2008 amounted to $41,905,658 and $21,901,405, respectively, of
which no deposits are covered by insurance. The Company has not experienced any
losses in such accounts and believes it is not exposed to any risks on its cash
in bank accounts.
4. PREPAID
RENT
Prepaid
expenses mainly consisted of prepaid rents for the gas stations (see Note 13 -
Commitments) and other expenses. At December 31, 2009 and 2008, the current
portion of prepaid rental expenses of gas stations was $2,732,546 and
$1,884,102, respectively. At December 31, 2009 and 2008, the noncurrent portion
of prepaid expenses amounted $24,620,685 and $6,408,568, respectively, which
represents the prepaid rents that will be expensed after one year.
5. INVENTORIES
Inventories
consisted of the following:
December
31,
2009
|
December
31,
2008
|
|||||||
Petroleum
|
$ | 10,449,525 | $ | 5,676,454 | ||||
Diesel
|
5,601,725 | 8,727,090 | ||||||
Raw
material for manufacturing bio-diesel oil
|
4,903,601 | 8,018,594 | ||||||
Subtotal
|
20,954,851 | 22,422,138 | ||||||
Less:
Inventory pricing reserve
|
- | (153,235 | ) | |||||
Total
|
$ | 20,954,851 | $ | 22,268,903 |
F-14
6. OTHER
RECEIVABLES AND DEPOSITS
At
December 31, 2009, other receivables represented deposits made for purchase of
equipments and short term cash advances to third parties in the amount of
$7,231,586, of which $6,973,439 was a deposit for the purchase of Jinzhen gas
station . At December 31, 2008, other receivables represented an advance to
Ningxia Yuanshun Petrochemical Co. in the amount of $3,047,242 (see Note 11 -
Other Payables), and deposits made for purchase of equipments and short term
cash advances to third parties in the amount of $939,742.
7. PROPERTY,
PLANT, AND EQUIPMENT
Plant,
property, and equipment are summarized as follows:
December
31,
2009
|
December
31,
2008
|
|||||||
Building
|
$ | 336,051 | $ | 335,624 | ||||
Diesel
Processing Equipment
|
8,360,404 | 10,325,005 | ||||||
Office
Equipment
|
145,456 | 120,588 | ||||||
Other
Equipment
|
34,047 | 31,888 | ||||||
Motor
Vehicles
|
1,142,029 | 797,020 | ||||||
10,017,987 | 11,610,125 | |||||||
Less:
Accumulated Depreciation
|
(2,456,080 | ) | (1,612,451 | ) | ||||
Total
|
$ | 7,561,907 | $ | 9,997,674 |
Depreciation
expense for the periods ended December 31, 2009 and 2008 were $1,145,538 and
$1,040,924, respectively.
8. MAJOR
CUSTOMERS AND VENDORS
For the
year ended December 31, 2009, one major customer accounted for approximately
26.2% of the Company’s total sales, and this customer had no accounts receivable
balance at December 31, 2009. No other major customers accounted for over 10% of
the Company’s total sales.
For the
year ended December 31, 2009, ten vendors accounted for approximately 79.3% of
the Company’s total purchase; within them one vendor provided approximately
30.8% of the Company’s total purchases. There were no accounts payables due to
these vendors at December 31, 2009 and 2008.
9. TAX
PAYABLE
Tax
payable consisted of the following at December 31, 2009 and 2008:
December,
31
2009
|
December
31,
2008
|
|||||||
Value
added tax payable
|
$ | 1,150,725 | $ | 683,842 | ||||
Urban
maintenance and construction tax payable
|
80,551 | 48,879 | ||||||
Other
tax payable
|
11,655 | 2,740 | ||||||
$ | 1,242,931 | $ | 735,461 |
10. INCOME
TAXES
Xi’an
Baorun Industrial Development Co., Ltd. (Baorun Industrial ) obtained approval
from the PRC tax authority for the exemption of income taxes from 2004 to the
end of 2010 as the incentive from the Government for bio energy
products.
Effective
January 1, 2008, the PRC government implemented a new corporate income tax law
with a new maximum corporate income tax rate of 25%. Despite the income tax
exemption of Baorun Industrial, the Company is governed by the Income Tax Law of
the PRC concerning privately-run enterprises, which are generally subject to tax
at a statutory rate of 25% (33% prior to 2008) on income reported in the
statutory financial statements after appropriate tax adjustments. Redsky had a
net operating loss of approximately $15,800 and $31,000 for the years ended
December 31, 2009 and 2008, respectively. A 100% valuation allowance has been
established due to the uncertainty of its realization.
F-15
Baorun
China Group Limited is subject to Hong Kong profits tax rate of 16.5%, and has
insignificant net operating losses for years ended December 31, 2009 and 2008,
and has loss carryover of approximately $178,600 at December 31,
2009. The net
operating loss carries forward infinitely for the Hong Kong profits tax,
and may be available to reduce future years’ taxable income. Management
believes that the realization of the benefits from these losses appears not more
than likely due to the Company’s limited operating history and continuing losses
for the Hong Kong profits tax purpose. Accordingly, the Company has provided a
100% valuation allowance on the deferred tax asset benefit to reduce the asset
to zero. Management will review this valuation allowance periodically and
make adjustments as needed.
The
parent company, China Integrated Energy, Inc. is incorporated in the United
States and has
incurred an aggregate net operating loss of $200,000 for income tax purposes
through December 31, 2009, subject to the Internal Revenue Code Section 382,
which places a limitation on the amount of taxable income that can be offset by
net operating losses after a change in ownership. The net operating loss carries
forward for the United States income taxes, and may be available to reduce
future years’ taxable income. These carryforwards will expire, if not utilized,
through 2029. Management believes that the realization of the benefits from
these losses appears not more that likely due to the Company’s limited operating
history and continuing losses for the United States income tax purposes.
Accordingly, the Company has provided a 100% valuation allowance on the deferred
tax asset benefit to reduce the asset to zero. Management will review this
valuation allowance periodically and make adjustment as
warranted.
The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the years ended December 31,
2009
|
2008
|
|||||||
US
statutory rates
|
34%
|
34%
|
||||||
Tax
rate difference
|
(9)%
|
(9)%
|
||||||
Effect
of tax holiday
|
(25)%
|
(25)%
|
||||||
Valuation
allowance
|
-0-%
|
-0-%
|
||||||
Tax
per financial statements
|
- | - |
The
following table gives the unaudited pro forma financial impact had the PRC taxes
not been abated.
For
the Years Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
(pro
forma)
|
(pro
forma)
|
|||||||
Net
income before income taxes
|
$ | 37,870,963 | $ | 18,724,367 | ||||
Tax
provision
|
(9,696,897 | ) | (7,208,710 | ) | ||||
Net
income
|
$ | 28,174,066 | $ | 11,515,657 | ||||
Earnings
per share (diluted)
|
$ | 0.78 | $ | 0.35 |
11.
OTHER PAYABLES
Other
payable mainly consisted of payables for the unpaid balances of the leased gas
stations. Other payables balances at December 31, 2009 and 2008 were $2,700,988
and $3,232,088, respectively. At December 31, 2008, there was an advance of
$3,047,242 from Ningxia Yuanshun Petrochemical Co. to Baorun Industrial;
concurrently, Ningxia Yuanshun received $3,047,242 prepayment from Redsky
Industrial.
12. LOANS
PAYABLE
The
Company was obligated under one short term loan from a commercial banks in the
PRC. The loan was entered into on October 26, 2009 with maturity to October 25,
2010. The principal will be repaid at maturity and the interest is payable per
quarter, currently the Company’s rate is at 5.841% per annum. This loan is
guaranteed by Xi’an City Economic & Technology Investment Guarantee Co., Ltd
and Shaanxi Security & Trust Guarantee Co. Xi’an City Economic &
Technology Investment Guarantee Co insured $2,930,017 (RMB 20,000,000). Shaanxi
Security & Trust Guarantee Co. insured $1,465,008 (RMB 10,000,000). The
guarantee fee was 2.375% of total loan amount or $110,478 (RMB 754,110). Mr. Gao
Xincheng, Chairman and CEO, provided counter guarantee to the guarantee
companies to secure the loan. The Company collateralized its diesel processing
equipments and inventory in the value of approximately $3,516,000 (RMB
24,000,000) for the guarantee. At December 31, 2009, the loan carried a balance
of $4,395,025 (RMB 30,000,000).
F-16
13. COMMITMENTS
Lease
Agreements
The
Company leased one oil storage facility with Northwest Naihuo Material Factory
under a long term, non-cancelable, and renewable operating lease agreement since
2006 with expiration date on June 30, 2008. This lease has been renewed for
additional six years with annual lease payment of $102,000 (RMB
700,000).
The
Company leases another two oil storage facilities under one year,
non-cancelable, and renewable operating lease agreements expiring on December
31, 2007. One lease agreement with Shanxi Continental Petroleum Co. Ltd. has
been renewed for one year with expiration date on December 31, 2008, and renewed
again at the end of 2008 for another one year lease with annual lease payment of
$57,000 (RMB 400,000). The other lease agreement has been terminated as lease
term expired. The Company then entered into a new one year, non-cancelable and
renewable lease agreement with 456 Oil Storage Warehouse for a new oil storage
facility with expiration date on December 31, 2008, which was renewed again at
the end of 2008 for another one year lease with lease payment charged at RMB 30
per ton for the first month of leasing, and RMB 7 per ton for the months
thereafter. Due to upkeep of the storage tank, occupancy of the 456 Oil Storage
Warehouse actually took place in June 2009. The lease term has subsequently been
extended to December 30, 2010.
In August
of 2008, the Company entered into another non-cancelable and renewable operating
lease agreement with 68103 Troops for five years oil storage from November 16,
2008 to November 16, 2013 with lease payment charged at RMB 30 per ton for the
first month of leasing, and RMB 10 per ton for the months thereafter. The
Company has paid approximately $507,000 (RMB 3,500,000) in advance to help the
lessee to rebuild and improve the oil storage warehouse with the commitment from
the lessee that such rebuild will be completed within 70 days. The prepaid lease
payment will be used to against future lease payment at RMB 700,000 per annum
for five years.
On February
1, 2007, the Company leased one gas station for operation under a long term,
non-cancelable operating lease agreement with expiration date on December 31,
2027. The annual lease payment is approximately $17,500 (RMB 125,000) with a 5%
increase every five year. The Company is required to pay in advance 50% of the
sum of the first three year lease payments $53,000 (RMB 375,000) upon receiving
the operating permits and related documents from the lessor, and pay the
remaining 50% at the time of officially taking over the operation. The Company
will pay the 4th year
lease payment at the end of the second year of leasing, and pay the rents
annually thereafter. This lease is classified as operating lease.
On May
20, 2008, the Company leased additional four gas stations for operation under a
long term operating lease agreement with an initial term expiring on May 31,
2023. The annual lease payment for each gas station is approximately $437,000
(RMB 3,000,000). The Company is required to make the lease payments for all four
gas stations in the amount of $8,747,631 (RMB 60,000,000) in advance in
five-year increments. The Company has paid $8,747,631 (RMB 60,000,000) for the
lease payments during year 2008. This lease is classified as operating
lease.
On May
28, 2009, the Company leased a gas station for operation under a thirty-year
operating lease with expiration date on May 31, 2039. The annual lease payment
is approximately $88,000 (RMB 600,000). The Company is required to pay in
advance of the thirty year lease payments approximately $2,635,000 (RMB
18,000,000).
On July
27, 2009, the Company leased a gas station for operation under a twenty-nine
year operating lease with expiration date on July 31, 2038. The annual lease
payment is approximately $293,000 (RMB 2,000,000).
On
December 14, 2009, the Company leased a gas station for operation under a
ten-year operating lease with expiration date on December 14, 2019. The annual
lease payment is approximately $264,000 (RMB 1,800,000). The Company is required
to pay in advance of 80% of the sum of the ten year lease payments approximately
$2,110,000 (RMB 14,400,000) upon executing the lease agreement, and pay the
remaining 20% of the sum of the ten year lease payments approximately $527,000
(RMB 3.600,000) upon delivery of operating permits and related documents from
the lessor.
On
December 17, 2009, the Company leased a gas station for operation under a
twenty-year operating lease with expiration date on December 16, 2029. The
annual lease payment is approximately $322,000 (RMB 2,200,000). The Company is
required to pay in advance of 80% of the sum of the twenty year
lease payments approximately $5,157,000 (RMB 35,200,000) upon executing the
lease agreement, and pay the remaining 20% of the sum of the twenty-year lease
payments approximately $1,289,000 (RMB 8,800,000) upon delivery of operating
permits and related documents from the lessor.
F-17
These
operating lease agreements require that the Company pays certain operating
expenses applicable for the leased premises. According to the lease agreements,
the Company has prepaid lease payments for some or all of the
lease terms, and recorded prepaid lease payments as prepaid
rent that will be amortized over the terms of the
lease agreements. Future minimum rental expense recognitions and
obligations required under these operating leases are as
follows:
Years
Ending December 31,
|
Amount
|
|||
2010
|
$
|
3,054,000
|
||
2011
|
2,937,000
|
|||
2012
|
2,938,000
|
|||
2013
|
2,924,000
|
|||
2014
|
2,784,000
|
|||
Years
thereafter
|
30,126,000
|
|||
Total
|
$
|
44,763,000
|
Total
rental expense for the years ended December 31, 2009 and 2008 amounted to
approximately $1,736,000 and $1,301,000, respectively.
Shipping Agreement
During
2008, the Company entered a shipping agreement with a transportation company for
transporting the raw materials for manufacturing the bio-diesel product for a
period of July 1, 2008 through August 31, 2009. The contact was renewed for
another year. The Company pays RMB 60 per ton for transporting the raw material
from the suppliers to its various oil extract plants, and pays a range of RMB 30
/ ton – RMB 100 / ton for transporting the raw oil from its various oil extract
plants to its bio-diesel production facility. For the years ended December 31,
2009 and 2008, the shipping cost paid to this transportation company was
approximately $660,000 and $627,000, respectively.
14.
BASIC AND DILUTED EARNING PER SHARES (EPS)
Basic EPS
is computed by dividing income available to common shareholders by the weighted
average number of common shares outstanding for the period. Diluted EPS is
computed similar to basic net income per share except that the denominator is
increased to include the number of additional common shares that would have been
outstanding if the potential common shares had been issued and if the additional
common shares were dilutive. Diluted net earning per share is based on the
assumption that all dilutive convertible shares and stock options were converted
or exercised. Dilution is computed by applying the treasury stock method. Under
this method, options and warrants are assumed to be exercised at the beginning
of the period (or at the time of issuance, if later), and as if funds obtained
thereby were used to purchase common stock at the average market price during
the period. The following table presents a reconciliation of basic and diluted
earnings per share:
For
the Year Ended
|
||||||||
2009
|
2008
|
|||||||
Net
income
|
$ | 37,870,963 | $ | 18,724,367 | ||||
Deemed
dividend to preferred stockholders
|
- | 863,014 | ||||||
Net
income available to common stockholders
|
37,870,963 | 17,861,353 | ||||||
Weighted
average shares outstanding - basic
|
28,230,461 | 25,889,748 | ||||||
Effect
of dilutive securities:
|
||||||||
Convertible
preferred stock
|
6,836,687 | 5,072,383 | ||||||
Unexercised
warrants and stock option
|
1,187,827 | 1,915,439 | ||||||
Weighted
average shares outstanding - diluted
|
36,254,975 | 32,877,570 | ||||||
Earnings
per share - basic
|
$ | 1.34 | $ | 0.69 | ||||
Earnings
per share - diluted
|
$ | 1.04 | $ | 0.54 |
F-18
15. STATUTORY
RESRVES
Pursuant
to the new corporate law of the PRC effective January 1, 2006, the Company is
required to maintain one statutory reserve by appropriating from its after-tax
profit before declaration or payment of dividends. The statutory reserve
represents restricted retained earnings.
Surplus reserve
fund
The
Company is required to transfer 10% of its net income, as determined under PRC
accounting rules and regulations, to a statutory surplus reserve fund until such
reserve balance reaches 50% of the Company’s registered capital.
The
surplus reserve fund is non-distributable, other than during liquidation, and
can be used to fund previous years’ losses, if any, and may be utilized for
business expansion or converted into share capital by issuing new shares to
existing shareholders in proportion to their shareholding or by increasing the
par value of the shares currently held by them, provided that the remaining
reserve balance after such issue is not less than 25% of the registered
capital.
16. STOCKHOLDERS’
EQUITY
Concurrently
with the share exchange, the Company entered into a Series A Convertible
Preferred Stock purchase agreement (the “Purchase Agreement”) with one
accredited investor for the sale of securities consisting of (i) 1,000,000
shares of the Company’s Series A convertible preferred stock, (ii) a series A-1
warrant to purchase 3,409,091 shares of the Company’s common stock at an
exercise price of US$3.00 per share, and (iii) a Series A-2 warrant to purchase
2,272,728 shares of the Company’s common at an exercise price of US$4.40 per
share (the Series A-1 and Series A-2 warrants, collectively the “Warrants”), for
aggregate gross proceeds equal to $10,000,000. Net proceeds of $9,774,993 have
been received by the Company.
Each
share of preferred stock is convertible into a number of fully paid and
non-assessable shares of common stock equal to the quotient of the liquidation
preference amount per share of preferred stock, or $10.00, divided by the
conversion price, which initially is $2.20 per share, subject to certain
adjustments, or approximately 4,545,455 shares of common stock if all 1,000,000
shares of preferred stock converted. No dividend is declared during the
year.
Deemed
dividend allocated to warrants is $1,585,631. The value of warrants mentioned
was determined by allocation of principal using the Black-Scholes pricing model
with the following assumptions: discount rate – 1.37%; dividend yield
– 0%; expected volatility – 30% and term of 5 years. Additionally,
the Company recorded $1,812,903 as dividend from a beneficial conversion
feature, which reflects the difference between the fair market price and
effective conversion rate. Pursuant to the accounting standards codification,
"Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios" and the accounting standards
codification, “Application of Issue in Certain Convertible Instruments,” the
total value of $3,398,534 was recorded as a deemed dividend in
2007.
The full
ratchet period of the Company’s warrant A-1 and warrant A-2 series expired on
October 22, 2008 one year following the original issue date of October 23, 2007.
Effective January 1, 2009, the Company entered verbal agreements with the
investor to terminate the warrant anti-dilution protection provision for both
warrant A-1 and warrant A-2. These verbal agreements were followed up by written
agreements that were executed January 22, 2010.
On
October 14, 2008, the Company entered into a Convertible
Debenture purchase agreement (“Debenture Purchase Agreement”) with an
institutional investor for the issuance and sale of a non-interest bearing
convertible debenture in an aggregate amount of $9,000,000, which will
automatically convert into 2,465,753 shares of Series B Convertible Preferred
Stock at $3.65 per share upon the date of the filing with the Secretary of the
State of Delaware of an amendment to the Company’s Certificate of Incorporation
to increase the authorized shares of preferred stock from 1,000,000 shares to
10,000,000 shares and the filing of a certificate of designation of the Series B
Preferred Stock. Because the Debenture Purchase Agreement lacked of the
characteristics of liability, such as no repayment term of the principal, no
stipulated interest rate, and no maturity date, as defined in the paragraph 36
of Financial Concepts Statement,, the Company recorded $863,013 deemed dividend
for the beneficial conversion feature in connection with the issuance
of convertible debenture as it was the preferred stock in substance as per
the accounting standards codification.
The
Company also received an additional $5,113,635 from the exercise of
approximately1.7 million issued and outstanding warrants at a strike price of
$3.00.
On July
1, 2009, the investor converted 350,000 shares of Series B Convertible Preferred
stock to 350,000 shares of common stock.
F-19
Following
is a summary of warrant activity for the year ended December 31,
2009:
Number
of
Shares
|
Average
Exercise
Price
per Share
|
Weighed
Average
Remaining
Contractual
Term
in Years
|
||||||||||
Outstanding
at December 31, 2008
|
3,977,273 | $ | 3.80 | 3.81 | ||||||||
Exercisable
at December 31, 2008
|
3,977,273 | - | - | |||||||||
Granted
|
30,000 | 6.00 | 1.62 | |||||||||
Exercised
|
- | - | - | |||||||||
Forfeited
|
- | - | - | |||||||||
Outstanding
at December 31, 2009
|
4,007,273 | $ | 3.82 | 3.43 | ||||||||
Exercisable
at December 31, 2009
|
3,977,273 | - | - |
On
November 4, 2009, the Company completed a public equity offering issuing
5,000,000 shares of common stock at a public offering price of $5.75 per share.
On November 18, the Company issued additional 750,000 shares upon the exercise
of over-allotment option granted to the underwriters in the public offering.
Aggregate gross proceeds were approximately $33,062,500 and the Company paid
$2,378,366 in underwriting commissions, legal fees, accounting fees, and others
offering expenses. The Company raised $30,684,134 in net proceeds. The net
proceeds will be used for acquisitions, leasing of gas stations, working
capital, and other general corporate purposes.
17. ESCROW
AGREEMENT
In
connection with the October 2008 financing, the Company also entered into a
Management Escrow Agreement with the Investor, pursuant to which $750,000 of the
Financing proceeds was delivered into an escrow account, which funds will be
released in installments of $250,000 upon the appointment of (i) a new Chief
Financial Officer, (ii) a Vice President of Investor Relations, and (iii) upon
the Company’s compliance with NASDAQ’s corporate governance requirements,
including but not limited to appointing three persons to serve as “independent”
directors (as such term is defined under the NASDAQ Stock Market rules) on our
Board of Directors, and form the Audit Committee and the Compensation Committee
of our Board of Directors.
As of
June 30, 2009, $750,000 was released from the escrow account to the Company as
the Company has successfully completed the appointments of a Vice President of
Investor Relations and three independent directors of the Company’s Board of
Directors, and Chief Financial Officer. As of September 30, 2009, the
Company had satisfied the requirements of the escrow agreement and annulled the
escrow account.
18. MAKE
GOOD ESCROW AGREEMENT
In
connection with the Financing, the Company entered into an escrow agreement with
the investor and the major stockholder of the Company, pursuant to which
2,465,753 shares of common stock owned by the major stockholder have been
deposited in escrow and held as security for the achievement by the Company of
(i) $28,000,000 Net Income (as defined below), and (ii) fully diluted earnings
per share of no less than $0.73 (the “Performance Thresholds”). If the Company
achieves the Performance Thresholds, the Escrow Shares will be released to such
stockholder. If the Company achieves no more than 50% of the Performance
Thresholds, the Escrow Shares will be disbursed to the investor. If the Company
achieves more than 50% and less than 100% of the Performance Thresholds, the
Escrow Agent will disburse to the investor that number of Escrow Shares equal to
two (2) times the percentage by which the lowest performance threshold was not
achieved.
Excluding
the make good provision of $9,838,354, the net income is $28,562,721 for 2008
with fully diluted earnings per share of $0.84 and thus the Company has achieved
the 2008 guaranteed performance threshold.
According
to SAB 107, following the achievement of the 2008 performance criteria, the
shares to be released back to major shareholder is treated as an expense.
According to accounting standards codification, “Accounting for Stock-Based
Compensation”, the amount of the expense is valued at market value of the shares
as of the date of the performance goals are met, i.e. December 31, 2008. The
total expense recognized for the fiscal year 2008 is $9,838,354, such expense is
treated as an unusual item since it is deemed to be unusual in nature but may
not be infrequent in occurrence.
F-20
19. SHARED-BASED PAYMENT ARRANGEMENTS
On
November 17, 2008, the Company issued non-transferable stock purchase options to
two newly appointed independent directors to purchase 20,000 shares of common
stock each. The exercise price is at $4.00 per share. These options were
accounted for using the fair value method. The option shall be terminated on the
earlier of (i) the tenth anniversary of the date of the agreement or (ii) the
date as of which the option has been fully exercised. The option is vested and
becomes exercisable after three months from the grant date. The option is vested
in a 25% increment every 3 months, in which each director provides directorship
service to the Company. The Company recognized approximately $155,000 of
compensation expense for these options for the year ended December 31,
2009.
In
February 2009, the Company retained an investor relations consulting firm for
the investor relations services. As a part of investor relations consulting fee,
the Company issued the investor relations consulting firm warrants to purchase
30,000 shares of the Company’s common stock with a strike price at $6.00 per
share. The warrants will be vested on the one year anniversary of the contract
signature date and exercisable only for cash; and will expire 18 months from the
date of vesting.
On
September 10, 2009, the Company issued stock purchase options to financial
advisory consultant to purchase 310,320 shares of common stock and to investor
relations consultant to purchase 206,880 shares of common stock. The exercise
prices of both stock purchase options are at $4.50 per share. The stock purchase
options are remunerations for the financial advisory and investor relations
consulting services provided. The options were accounted for using the fair
value method. The options expire in one year from and are immediately vested
upon the option issuance date. The Company recognized approximately $487,000 of
compensation expense for these options for the year ended December 31,
2009.
On
December 16, 2009, the Company issued stock purchase options to financial
advisory consultant to purchase 20,000 shares of common stock. The exercise
prices of the stock purchase option are at $7.09 per share. The stock purchase
option is a part of remunerations for the financial advisory consulting service
to be provided in the next 12 months. The option was accounted for using the
fair value method. The option expires in six year from the grant date and is
evenly vested each quarter. The Company recognized approximately $4,000 of
compensation expense for this option for the year ended December 31,
2009.
Following
is a summary of stock option activity for the year ended December 31,
2009:
Options
|
Weighted
Average
Exercise
Price
|
Weighed
Average
Remaining
Contractual
Term
in Years
|
Aggregate
Intrinsic Value
|
|||||||||||||
Outstanding
at December 31, 2008
|
40,000 | $ | 4.00 | 9.13 | - | |||||||||||
Issued
|
537,200 | 4.60 | 0.85 | |||||||||||||
Exercised
|
- | - | - | |||||||||||||
Cancelled
|
- | - | - | |||||||||||||
Outstanding
at December 31, 2009
|
577,200 | $ | 4.56 | 1.41 | $ | 1,546,728 | ||||||||||
Exercisable
at December 31, 2009
|
557,200 | 4.31 | 1.28 | $ | 1,514,328 |
Following
is a summary of non-vested options as of December 31, 2009 and changes during
the twelve months then ended:
Options
|
Weighted
Average
Fair
Value at Grant Date
|
||||||||
Non-vested options
as of December 31, 2008
|
40,000 | $ | 4.00 | ||||||
Issued
|
20,000 | 7.09 | |||||||
Exercised
|
- | - | |||||||
Cancelled
|
- | - | |||||||
Non-vested
options as of December 31, 2009
|
20,000 | $ | 7.09 |
20.
SEGMENT REPORTING
The
accounting standards codification “Disclosures about Segments of an Enterprise
and Related Information” requires use of the “management approach” model for
segment reporting. The management approach model is based on the way a company’s
management organizes segments within the company for making operating decisions
and assessing performance. Reportable segments are based on products, services,
and channels. The management has determined that the Company has
three operating segments as defined by the accounting standards codification:
wholesale distribution of finished oil and heavy oil products, production and
sale of biodiesel, and operation of retail gas stations.
F-21
For
the years ended December 31, 2009 and 2008
Wholesale Distribution
of
Finished
Oil and Heavy Oil
|
Production
and Sale of Biodiesel
|
Operation
of
Retail
Gas
Stations
|
Total
|
|||||||||||||
2009
|
||||||||||||||||
Sales
|
$ | 195,864,501 | $ | 55,794,525 | $ | 37,913,027 | $ | 289,572,053 | ||||||||
Cost
of goods sold
|
175,325,275 | 39,964,368 | 32,811,696 | 248,101,339 | ||||||||||||
Gross
profit
|
20,539,226 | 15,830,157 | 5,101,331 | 41,470,714 | ||||||||||||
Selling,
general and administrative expenses
|
3,820,173 | |||||||||||||||
Income
from operations
|
37,650,541 | |||||||||||||||
Non-operating
income (expenses)
|
220,422 | |||||||||||||||
Net
income
|
37,870,963 | |||||||||||||||
Segment
assets
|
111,795,742 | 16,407,301 | 35,370,619 | 163,573,661 | ||||||||||||
Capital
expenditures
|
370,564 | - | - | 370,564 | ||||||||||||
2008
(Unaudited)
|
||||||||||||||||
Sales
|
$ | 143,498,550 | $ | 50,052,524 | $ | 22,955,895 | $ | 216,506,969 | ||||||||
Cost
of goods sold
|
129,846,614 | 35,527,828 | 20,484,060 | 185,858,502 | ||||||||||||
Gross
profit
|
13,651,936 | 14,524,696 | 2,471,835 | 30,648,467 | ||||||||||||
Selling,
general and administrative expenses
|
1,997,818 | |||||||||||||||
Income
from operations
|
28,650,649 | |||||||||||||||
Non-operating
income (expenses)
|
(9,926,282 | ) | ||||||||||||||
Net
income
|
18,724,367 | |||||||||||||||
Segment
assets
|
55,998,069 | 29,075,363 | 9,620,985 | 94,694,417 | ||||||||||||
Capital
expenditures
|
155,769 | 1,095,462 | - | 1,251,231 |
21.
SUBSEQUENT EVENTS
On
January 1, 2010, the Company granted 2,752,000 shares of common stock to
employees in accordance with the 2003 Employee Stock Option Plan. The exercise
price is at $7.04 per share as at the closing price of grant date. The options
are vested evenly by quarter over 5 years, and exercisable in 6
years.
On
January 4, 2010, the Company renewed service contracts with the three
independent directors and issued non-transferable stock purchase options to two
independent directors to purchase 20,000 shares of common stock each. The
exercise price is at $7.30 per share. These options were accounted for using the
fair value method. The option shall be terminated on the earlier of (i) the
tenth anniversary of the date of the agreement or (ii) the date as of which the
option has been fully exercised. The option is vested and becomes exercisable
after three months from the grant date. The option is vested in a 25% increment
every 3 months, in which each director provides directorship service to the
Company.
On
January 5, 2010, the Company leased a gas station for operation under a ten-year
operating lease with expiration date on January 7, 2010. The annual lease
payment is approximately $381,000 (RMB 2,600,000). The Company is required to
pay in advance of 80% of the sum of the ten year lease payments approximately
$3,047,000 (RMB 20,800,000) upon executing the lease agreement, and pay the
remaining 20% of the sum of the ten-year lease payments approximately $762,000
(RMB 5,200,000) upon delivery of operating permits and related documents from
the lessor.
On
January 9, 2010, the Company leased a gas station for operation under a
fifteen-year operating lease with expiration date on January 9, 2025. The annual
lease payment is approximately $337,000 (RMB 2,300,000). The Company is required
to pay in advance of 80% of the sum of the fifteen-year lease payments
approximately $4,043,000 (RMB 27,600,000) upon executing the lease agreement,
and pay the remaining 20% of the sum of the fifteen-year lease payments
approximately $1,011,000 (RMB 6,900,000) upon delivery of operating permits and
related documents from the lessor.
On
January 22, 2010, the Company and the investor executed agreements to amend the
warrant anti-dilution protection provisions of the warrant agreements for series
warrant A-1 and series warrant A-2 in relation to the Series A Convertible
Preferred Stock Agreement, dated October 23, 2007. Certain expired terms were
deleted from the agreements. Certain terms were modified to reflect current
market conditions. The execution of the amendments solidified the prior verbal
agreements.
F-22
On
January 29, 2010, the Company filed a $125 million Universal Shelf Registration
statement with SEC. The registration statement has become effective as February
26, 2010,
22. OPERATING
RISK
(a) Country risk
Currently,
the Company’s revenues are mainly derived from sale of oil products and
bio-diesel in the PRC. The Company hopes to expand its operations in the PRC,
however, such expansion has not been commenced and there are no assurances that
the Company will be able to achieve such an expansion successfully. Therefore, a
downturn or stagnation in the economic environment of the PRC could have a
material adverse effect on the Company’s financial condition.
(b) Products risk
The
Company competes with larger companies, who have greater resources available for
expansion, marketing, research and development and the ability to attract more
qualified personnel. There can be no assurance that the Company will remain
competitive with larger competitors.
(c) Exchange risk
The
Company can not guarantee that the current exchange rate will remain steady,
therefore there is a possibility that the Company could post the same amount of
profit for two comparable periods and because of a fluctuating exchange rate
actually post higher or lower profit depending on exchange rate of Chinese
Renminbi (RMB) converted to U.S. dollars on that date. The exchange rate could
fluctuate depending on changes in the political and economic environments
without notice.
(d) Political risk
Currently,
the PRC is in a period of growth and is openly promoting business development in
order to bring more business into the PRC. Additionally, the PRC allows a
Chinese corporation to be owned by a United States corporation. If the laws or
regulations are changed by the PRC government, the Company’s ability to operate
in the PRC could be affected.
(e) Key personnel risk
The
Company’s future success depends on the continued services of executive
management in China. The loss of any of their services would be detrimental to
the Company and could have an adverse effect on business development. The
Company does not currently maintain key-man insurance on their lives. Future
success is also dependent on the ability to identify, hire, train and retain
other qualified managerial and other employees. Competition for these
individuals is intense and increasing.
F-23
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) 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.
China
Integrated Energy, Inc.
|
||
By:
|
/s/
Gao Xincheng
|
|
Name:
Gao Xincheng
|
||
Title: Chief
Executive Officer and President
|
||
March
31, 2010
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
Signature
|
Title
|
Date
|
||
/s/ Gao Xincheng
|
Chairman
of the Board, Chief Executive
|
March
31, 2010
|
||
Gao
Xincheng
|
Officer
and President (principal executive officer
|
|||
/s/ Albert C. Pu
|
Chief
Financial Officer (principal
|
March
31, 2010
|
||
Albert
C. Pu
|
financial
and accounting officer)
|
|||
/s/ Li Gaihong
|
Executive
Vice President, Financial Controller, Director
|
March
31, 2010
|
||
Li
Gaihong
|
||||
/s/ Larry Goldman
|
Director
|
March
31, 2010
|
||
Larry
Goldman
|
||||
/s/ Wenbing Christopher
Wang
|
Director
|
March
31, 2010
|
||
Wenbing
Christopher Wang
|
||||
/s/ Guo Junrong
|
Director
|
March
31, 2010
|
||
Guo
Junrong
|
Exhibit
Number
|
Description
|
|
2.1
|
Share
Exchange Agreement dated as of October 23, 2007. (1)
|
|
2.2
|
Agreement
and Plan of Merger, dated November 15, 2007. (2)
|
|
3.1
|
Certificate
of Correction filed on July 24, 2007. (3)
|
|
3.1
|
Certificate
of Amendment filed on June 11, 2007. (4)
|
|
3.1
|
Articles
of Incorporation. (5)
|
|
3.1
|
Certificate
of Amendment to Articles of Incorporation. (6)
|
|
3.1
|
Certificate
of Ownership and Merger, dated November 15, 2007. (2)
|
|
3.1
|
Certificate
of Incorporation of China Integrated Energy, Inc. (7)
|
|
3.2
|
By-laws.
(5)
|
|
4.1
|
Form
of Warrant. (1)
|
|
4.2
|
Amended
and Restated Certificate of Designation of the Relative Rights and
Preferences of the Series A Convertible Preferred Stock.
(1)
|
|
4.3
|
Amended
and Restated Certificate of Designation of the Relative Rights and
Preferences of Series B Convertible Preferred Stock
(10)
|
|
4.4
|
Form
of Debenture (9)
|
|
4.5
|
Series
A-1 Warrant Amendment, dated January 22, 2010(15)
|
|
4.6
|
Series
A-2 Warrant Amendment, dated January 22, 2010 (15)
|
|
10.1
|
Exclusive Business Cooperation Agreement by and between Redsky
China and Baorun Industrial , dated as of October 19, 2007.
(7)
|
|
10.2
|
Exclusive
Option Agreement by and between Gao Xincheng and Baorun Industrial, dated
as of October 19, 2007. (7)
|
|
10.3
|
Exclusive
Option Agreement by and between Gao Huiling and Baorun Industrial, dated
as of October 19, 2007. (7)
|
|
10.4
|
Exclusive
Option Agreement by and between Liu Yunlong and Baorun Industrial, dated
as of October 19, 2007. (7)
|
|
10.5
|
Equity
Pledge Agreement by and among Redsky China, Baorun Industrial and Gao
Xincheng, dated as of October 19, 2007. (7)
|
|
10.6
|
Equity
Pledge Agreement by and among Redsky China, Baorun Industrial and Gao
Huiling, dated as of October 19, 2007. (7)
|
|
10.7
|
Equity
Pledge Agreement by and among Redsky China, Baorun Industrial and Liu
Yunlong, dated as of October 19, 2007. (7)
|
|
10.8
|
Power
of Attorney of Gao Xincheng. (8)
|
|
10.9
|
Power
of Attorney of Gao Huiling. (8)
|
|
10.10
|
Power
of Attorney of Liu Yunlong. (8)
|
|
10.11
|
Nominee
Letter between Redsky China and Gao Xincheng. (8)
|
|
10.12
|
Nominee
Letter between Redsky China and Gao Huiling. (8)
|
|
10.13
|
Nominee
Letter between Redsky China and Liu Yunlong. (8)
|
|
10.14*
|
Employment
Agreement between Baorun Industrial and Gao Xincheng, dated as of October
23, 2007. (8)
|
|
10.15*
|
Employment
Agreement between Baorun Industrial and Li Gaihong, dated as of October
23, 2007. (8)
|
|
10.16
|
Amendment
to Exclusive Business Cooperation Agreement, dated March 24, 2008.
(8)
|
|
10.17
|
Securities
Purchase Agreement, dated as of October 14, 2008. (9)
|
|
10.18
|
Registration
Rights Agreement, dated as of October 14, 2008. (9)
|
|
10.19
|
Share
Escrow Agreement, dated as of October 14, 2008. (9)
|
|
10.20
|
Management
Escrow Agreement, dated as of October 14, 2008. (9)
|
|
10.21
|
Form
of Warrant Exercise Agreement. (9)
|
|
10.22
|
Gas
Station Lease Agreement, dated as of May 20, 2008. (10)
|
|
10.23
|
Employment
Agreement with Albert C. Pu, dated as of January 22, 2009
(11)
|
|
10.24
|
Gas
Station Leasing Business Contract, dated as of May 28, 2009
(12)
|
|
10.25
|
Gas
Station Lease Agreement, dated as of February 1, 2007
(13)
|
|
10.26
|
Gas
Station Lease Agreement, dated as of July 27, 2009 (13)
|
|
10.27
|
Land
Lease Agreement, dated as of April 20, 2006 (13)
|
|
10.28
|
Oil
Storage Service Agreement, effective as of January 1, 2009
(13)
|
|
10.29
|
Oil
Storage Service Agreement, dated as of August 26, 2008
(13)
|
|
10.30
|
Finished
Oil Sales Contract by and between Yanchang Petroleum Oil (Group) Co., Ltd.
and Xi’an Baorun Industrial, effective as of December 23, 2008
(13)
|
|
10.31
|
Finished
Oil Sales Contract by and between China Petroleum & Chemical
Corporation Chuanyu Trading Co., Ltd. and Xi’an Baorun Industrial, dated
as of January 25, 2009 (13)
|
|
10.32
|
Registration
Rights Agreement, dated September 10, 2009, by and between the Company and
Longgen Zhang and Yuan Gong
(14)
|
10.33
|
Lease
Contract, dated April 30, 2008, amending the terms of the Land Lease
Agreement, dated April 20, 2006 (14)
|
|
10.34
|
2003
Equity Incentive Program (6)
|
|
10.35+ |
Finished
Oil Products Sales Contract by and between Yanchang Petroleum (Group)
Corp. Ltd. and Xi’an Baorun Industrial Development
Co.
|
|
10.36+ |
Finished
Oil Products Sales Contract by and between Yanchang Petroleum (Group)
Corp. Ltd. and Xi’an Baorun Industrial Development
Co.
|
|
10.37+ |
Gas
Station Lease Agreement with Andong Gas Station, dated December 17,
2009
|
|
10.38+ |
Gas
Station Lease Agreement with Xi’an Jindou Gas Station, dated December
15, 2009
|
|
10.39+ |
Finished
Oil Sales Contract by and between Chongqing Oil Subsidiary Company of
China Petroleum & Chemical Corporation, dated as of January 6,
2010
|
|
10.40+ | Equity Transfer Agreement for Hanyang Jinzheng Petroleum Sales Co., Ltd, dated December 13, 2009 | |
14
|
Code
of Business Conduct and Ethics. (8)
|
|
21
|
List
of Subsidiaries. (7)
|
|
23.1+
|
Consent
of Sherb & Co.
|
|
31.1+
|
Certification
of Chief Executive Officer pursuant to Rule 13A-14(A)/15D-14(A) of the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
31.2+
|
Certification
of the Principal Financial Officer pursuant to Rule 13A-14(A)/15D-14(A) of
the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
|
|
32+
|
Certification
of Chief Executive Officer and Chief Financial Officer Pursuant to 18
U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of
2002).
|
_________________
+ Filed
herewith.
*
Management Contract or Compensatory Arrangement
(1)
|
Incorporated
by reference to the Company’s Form 8-K filed on October 29,
2007.
|
(2)
|
Incorporated
by reference to the Company’s Form 8-K filed on November 23,
2007.
|
(3)
|
Incorporated
by reference to the Company’s Form 10-QSB filed on November 13,
2007.
|
(4)
|
Incorporated
by reference to the Company’s Form 10-QSB filed on August 3,
2007.
|
(5)
|
Incorporated
by reference to the Company’s Registration Statement on Form
10-SB.
|
(6)
|
Incorporated
by reference to the Company’s Definitive Information Statement filed on
September 19, 2003.
|
(7)
|
Incorporated
by reference to the Company’s Registration Statement on Form S-1 initially
filed on December 7, 2007.
|
(8)
|
Incorporated
by reference to the Company’s Form 10-K filed on March 31,
2008.
|
(9)
|
Incorporated
by reference to the Company’s Form 8-K filed on October 20,
2008.
|
(10)
|
Incorporated
by reference to the Company’s Form 10-K filed on March 25,
2009.
|
(11)
|
Incorporated
by reference to the Company’s Form 10-Q filed on May 13,
2009
|
(12)
|
Incorporated
by reference to the Company’s Form 10-Q filed on August 11,
2009
|
(13)
|
Incorporated
by reference to the Company’s Registration Statement on Form S-1 filed on
September 10, 2009
|
(14)
|
Incorporated
by reference to the Company’s Registration Statement on Form S-1/A filed
on October 5, 2009
|
(15)
|
Incorporated
by reference to the Company’s Form 8-K filed on January 28,
2010.
|