UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 2006
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from ____________ to __________
000-31539
(Commission file number)
CHINA NATURAL GAS, INC.
(Exact name of small business issuer as specified in its charter)
Delaware 98-0231607
(State or other jurisdiction of (IRS Employer of
incorporation or organization) Identification No.)
Tang Xing Shu Ma Building, Suite 418
Tang Xing Road
Xian High Tech Area
Xian, Shaanxi Province, China
(Address of principal executive offices)
86-29-88323325
(Issuer's telephone number)
N/A
(Former name, former address and former fiscal year, if changed since last
report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes |X| No |_|
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
As of November 13, 2006 - 24,210,183 shares of common stock
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes |_| No |X|
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
CHINA NATURAL GAS, INC.
Index
Page
Number
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet as of September 30, 2006 (unaudited) 2
Consolidated Statements of Income and Other Comprehensive
Income for the three and nine month periods ended September
30, 2006 and 2005 (unaudited) 3
Consolidated Statements of Cash Flows for the nine month
periods ended September 30, 2006 and 2005 (unaudited) 4
Notes to Consolidated Financial Statements (unaudited) 5
Item 2. Management's Discussion and Analysis or Plan of Operations
Item 3. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CHINA NATURAL GAS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
AS OF SEPTEMBER 30, 2006
(Unaudited)
ASSETS
------
CURRENT ASSETS:
Cash & cash equivalents $ 5,031,991
Accounts receivable, net of allowance for
doubtful accounts of $0 316,829
Other receivable 1,831,998
Inventory 298,135
Advances to suppliers 3,121,797
Prepaid expense 165,628
-----------
Total current assets 10,766,378
PROPERTY AND EQUIPMENT, net 12,162,205
CONTRACTS IN PROGRESS 418,530
CONSTRUCTION IN PROGRESS 2,267,926
-----------
TOTAL ASSETS $25,615,039
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable & accrued expense $ 383,617
Other payables 1,310,839
Unearned revenue 518,687
-----------
Total current liabilities 2,213,143
STOCKHOLDERS' EQUITY:
Preferred stock, $0.0001 per share; authorized
5,000,000 shares; none issued
Common stock, $0.0001 per share; authorized
30,000,000 shares; issued and
outstanding 24,210,183 2,421
Additional paid-in capital 18,223,911
Cumulative translation adjustment 520,604
Statutory reserve 707,776
Retained earnings 3,947,184
-----------
Total stockholders' equity 23,401,896
-----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $25,615,039
===========
The accompanying notes are an integral part of these
consolidated financial statements.
2
CHINA NATURAL GAS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2006 AND 2005
(Unaudited)
For the Three Month Period Ended For the Nine Month Period Ended
September 30, September 30,
2006 2005 2006 2005
----------- ----------- ----------- -----------
Revenue
Natural gas revenue $ 5,210,834 $ 406,365 $ 8,580,236 $ 1,065,017
Construction / installation revenue 1,303,457 986,243 3,445,452 1,649,025
----------- ----------- ----------- -----------
Total revenue 6,514,291 1,392,608 12,025,688 2,714,042
Cost of revenue
Natural gas cost 2,752,594 315,116 4,862,202 830,527
Construction / installation cost 526,292 345,382 1,368,825 584,772
----------- ----------- ----------- -----------
3,278,886 660,498 6,231,027 1,415,299
Gross profit 3,235,405 732,110 5,794,661 1,298,743
Operating expenses
Selling expenses 366,616 129,353 923,960 299,352
General and administrative expenses 270,031 77,097 693,141 132,991
----------- ----------- ----------- -----------
Total operating expenses 636,647 206,450 1,617,101 432,343
----------- ----------- ----------- -----------
Income from operations 2,598,758 525,660 4,177,560 866,400
Non-operating income (expense):
Interest income 2,485 307 7,262 894
Other income (expense) (4,231) 700 (10,182) (468)
----------- ----------- ----------- -----------
Total non-operating income (expense) (1,746) 1,007 (2,920) 426
----------- ----------- ----------- -----------
Income before income tax 2,597,012 526,667 4,174,640 866,826
Income tax 393,226 130,024 633,005 130,024
----------- ----------- ----------- -----------
Net income $ 2,203,786 $ 396,643 $ 3,541,635 $ 736,802
Other comprehensive income
Foreign currency translation gain 258,640 -- 291,857 --
----------- ----------- ----------- -----------
Comprehensive Income $ 2,462,426 $ 396,643 $ 3,833,492 $ 736,802
=========== =========== =========== ===========
Weighted average shares outstanding
Basic 23,931,197 16,000,000 23,759,285 15,975,368
=========== =========== =========== ===========
Diluted 23,931,197 16,000,000 23,759,285 15,975,368
=========== =========== =========== ===========
Earnings per share
Basic $ 0.09 $ 0.02 $ 0.15 0.05
=========== =========== =========== ===========
Diluted $ 0.09 $ 0.02 $ 0.15 $ 0.05
=========== =========== =========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
3
CHINA NATURAL GAS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2006 AND 2005
(Unaudited)
Nine Months Ended September 30,
-------------------------
2006 2005
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,541,635 $ 736,802
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 497,072 204,426
Exchange gains (457,976) --
(Increase) / decrease in assets:
Accounts receivable (306,677) (297,892)
Other receivable (1,258,975) (33,390)
Inventory (248,642) 21,271
Receivable from related party -- (168,666)
Advances to suppliers (3,068,491) (291,955)
Prepaid expense (147,525) (16,474)
Contract in progress (413,237) 379,584
Increase / (decrease) in current liabilities:
Accounts payable 183,632 (1,128,496)
Other payables 549,701 1,388,554
Unearned revenue 206,537 (724,508)
----------- -----------
Net cash provided by (used in) operating activities (922,946) 69,256
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Payment on purchase of property and equipment (4,170,589) (2,671,533)
Additions to construction in progress (498,676) --
----------- -----------
Net cash used in investing activities (4,669,265) (2,671,533)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock 10,400,000 3,503,897
Proceeds from exercise of warrants 1,050,001 --
Payment of offering costs (1,557,147) --
----------- -----------
Net cash provided by in financing activities 9,892,854 3,503,897
----------- -----------
Effect of exchange rate changes on cash and cash equivalents 55,724 36,625
NET INCREASE IN CASH & CASH EQUIVALENTS 4,356,367 938,245
CASH & CASH EQUIVALENTS, BEGINNING BALANCE 675,624 62,998
----------- -----------
CASH & CASH EQUIVALENTS, ENDING BALANCE $ 5,031,991 $ 1,001,243
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ -- $ --
=========== ===========
Income taxes paid $ -- $ --
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
4
CHINA NATURAL GAS, INC. AND SUBSIDIARY
NOTES T0 CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1 - Organization and Basis of Presentation
The unaudited consolidated financial statements have been prepared by China
Natural Gas, Inc. (the "Company"), pursuant to the rules and regulations of the
Securities and Exchange Commission. The information furnished herein reflects
all adjustments (consisting of normal recurring accruals and adjustments) which
are, in the opinion of management, necessary to fairly present the operating
results for the respective periods. Certain information and footnote disclosures
normally present in annual consolidated financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have been omitted pursuant to such rules and regulations. These
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and footnotes for the year ended December 31,
2005 included in the Company's Annual Report on Form 10-KSB. The results of the
nine months ended September 30, 2006 are not necessarily indicative of the
results to be expected for the full year ending December 31, 2006.
Organization and Line of Business
Xi'an Xilan Natural Gas Co, Ltd. ("XXNGC") was incorporated on January 8, 2000
in Xi'an city in the Shaanxi province, China. The core business of XXNGC is
distribution of natural gas to commercial, industrial and residential customers,
construction of pipeline networks, and installation of natural gas fittings and
parts for end-users and operation of retail filling stations for the
distribution of compressed natural gas as a vehicular fuel to retail end users.
XXNGC has an exclusive permit to provide gas utility service in Lantian County,
Lintong and Baqiao District of Xi'an city, China.
On December 6, 2005, XXNGC entered into and closed a share purchase agreement
with Coventure International, Inc. ("Coventure"), a public shell in the United
States of America incorporated in the state of Delaware. Pursuant to the
purchase agreement, Coventure acquired all of the issued and outstanding capital
stock of XXNGC in exchange for 16,000,000 (post-split) shares of Coventure's
common stock.
Concurrently with the closing of the purchase agreement and as a condition
thereof, Coventure entered into an agreement with John Hromyk, its President and
Chief Financial Officer, pursuant to which Mr. Hromyk returned 23,884,712
(post-split) shares of Coventure's common stock for cancellation. Upon
completion of the foregoing transactions, Coventure had an aggregate of
20,204,088 (post-split) shares of common stock issued and outstanding.
As a result of the merger, XXNGC's stockholders own approximately 80% of the
combined company and the directors and executive officers of XXNGC became the
directors and executive officers of Coventure. Accordingly, the transaction has
been accounted for as a reverse acquisition of Coventure by XXNGC resulting in a
recapitalization of XXNGC rather than as a business combination. XXNGC is deemed
to be the purchaser and surviving company for accounting purposes. Accordingly,
its assets and liabilities are included in the balance sheet at their historical
book values and the results of operations of XXNGC have been presented for the
comparative prior period. The historical cost of the net liabilities of
Coventure that were acquired was $3,378. Pro forma information is not presented
as the financial statements of Coventure are insignificant. In addition,
Coventure changed it name to China Natural Gas, Inc. (hereafter referred to as
the "Company") and the stockholders approved a stock dividend of three shares
for each share held, which has been accounted for as a four to one forward stock
split. All shares and per share data have been restated retrospectively.
5
The Company incorporated a new subsidiary, Shaanxi Natural Gas Equipment Co.,
Ltd. in February 2006. Shaanxi Natural Gas Equipment Co., Ltd. did not have any
operations during the period ended September 30, 2006.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of China
Natural Gas, Inc. and its wholly owned subsidiaries, XXNGC and Shaanxi Natural
Gas Equipment Co., Ltd. All inter-company accounts and transactions have been
eliminated in consolidation.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America. The Company's functional currency is the Chinese Renminbi; however the
accompanying consolidated financial statements have been translated and
presented in United States Dollars (USD).
Foreign Currency Translation
As of September 30, 2006 and 2005, the accounts of the Company were maintained,
and their consolidated financial statements were expressed in the Chinese Yuan
Renminbi (RMB). Such consolidated financial statements were translated into
United States Dollars (USD) in accordance with Statement of Financial Accounts
Standards ("SFAS") No. 52, "Foreign Currency Translation," with the RMB as the
functional currency. According to the Statement, all assets and liabilities were
translated at the exchange rate on the balance sheet date, stockholder's equity
are translated at the historical rates and statement of operations items are
translated at the weighted average exchange rate for the year. The resulting
translation adjustments are reported under other comprehensive income in
accordance with SFAS No. 130, "Reporting Comprehensive Income."
Note 2 - Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and cash in time deposits,
certificates of deposit and all highly liquid debt instruments with original
maturities of three months or less.
Accounts and Other Receivable
Accounts and other receivable are recorded at net realizable value consisting of
the carrying amount less an allowance for uncollectible accounts, as needed. The
Company allowance for uncollectible accounts is not significant.
6
The Company maintains 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. Reserves are recorded primarily on a
specific identification basis. The Company's management determined that all
receivables are good and there is no need of reserve for bad debts as on
September 30, 2006.
Other receivable includes a loan of $1,043,625 made to a third party in
September 2006, for a two month period. The loan is unsecured and carry an
interest rate of 4.5% per month. However, if the loan is not repaid in the
stipulated time frame, the interest rate increases to 20% per month.
Advances
The Company advances to certain vendors (for purchase of its material and
equipment) and a consultant . The advances are interest free and unsecured.
Inventory
Inventory is stated at the lower of cost, as determined on a first-in, first-out
basis, or market. Management compares the cost of inventories with the market
value, and allowance is made for writing down the inventories to their market
value, if lower. Inventory consists of material used in the construction of
pipelines.
Property and Equipment
Property and equipment are stated at cost. Expenditures for maintenance and
repairs are charged to earnings as incurred; additions, renewals and betterments
are capitalized. When property and equipment are retired or otherwise disposed
of, the related cost and accumulated depreciation are removed from the
respective accounts, and any gain or loss is included in operations.
Depreciation of property and equipment is provided using the straight-line
method for substantially all assets with estimated lives as follows:
Office equipment 5 years
Operating equipment 5-20 years
Vehicles 5 years
Buildings 30 years
At September 30, 2006, the following are the details of the property and
equipment:
Office equipment $ 51,875
Operating equipment 10,896,496
Vehicles 443,280
Buildings 2,380,653
-------------------------
13,772,305
Less accumulated depreciation (1,610,100)
-------------------------
$ 12,162,205
=========================
Depreciation expense for the nine months ended September 30, 2006 and 2005 was
$495,967 and $204,426, respectively.
7
Long-Lived Assets
Effective January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS 144"), which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets and supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," and the accounting and reporting provisions of APB Opinion No.
30, "Reporting the Results of Operations for a Disposal of a Segment of a
Business." The Company periodically evaluates the carrying value of long-lived
assets to be held and used in accordance with SFAS 144. SFAS 144 requires
impairment losses to be recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying amounts. In
that event, a loss is recognized based on the amount by which the carrying
amount exceeds the fair market value of the long-lived assets. Loss on
long-lived assets to be disposed of is determined in a similar manner, except
that fair market values are reduced for the cost of disposal.
Construction In Progress
Construction in progress consist of the cost of constructing fixed assets for
the Company's use. The major cost of construction in progress relates to
material, labor and overhead.
Contracts in progress consist of the cost of constructing pipelines for
customers. The major cost of construction relates to material, labor and
overhead. Revenue from construction and installation of pipelines is recorded
when the contract is completed and accepted by the customers. The construction
contracts are usually completed within one to two months time. As of September
30, 2006, the Company had $418,530 of contracts in progress.
Fair Value of Financial Instruments
Statement of financial accounting standard No. 107, 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.
Revenue Recognition
The Company's revenue recognition policies are in compliance with Staff
accounting bulletin (SAB) 104. Revenue is recognized when services are rendered
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 collectibility is reasonably assured. Payments received before
all of the relevant criteria for revenue recognition are satisfied are recorded
as unearned revenue. Revenue from gas sales is recognized when gas is pumped
through pipelines to the end users. Revenue from construction and installation
of pipelines is recorded when the contract is completed and accepted by the
customers. The construction contracts are usually completed within one to three
months time.
Unearned Revenue
Unearned revenue represents prepayments by customers for gas purchases and
advance payments on construction and installation of pipeline contracts. The
Company records such prepayment as unearned revenue when the payments are
received.
8
Advertising Costs
The Company expenses the cost of advertising as incurred or, as appropriate, the
first time the advertising takes place. Advertising costs for the nine months
ended September 30, 2006 and 2005 were insignificant.
Stock-Based Compensation
The Company accounts for its stock-based compensation in accordance with SFAS
No. 123R, "Share-Based Payment, an Amendment of FASB Statement No. 123." 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.
Income Taxes
The Company utilizes SFAS No. 109, "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. At September 30, 2006, there was no significant book to
tax differences. There is no difference between book depreciation and tax
depreciation as the Company uses the same method for both book and tax.
Local PRC Income Tax
Pursuant to the tax laws of China, general enterprises are subject to income tax
at an effective rate of 33%. The Company is in the natural gas industry whose
development is encouraged by the government. According to the income tax
regulation, any company engaged in the natural gas industry enjoys a favorable
tax rate. Accordingly, the Company's income is subject to a reduced tax rate of
15%.
Basic and Diluted Earning Per Share
Earning per share is calculated in accordance with the Statement of Financial
Accounting Standards No. 128 ("SFAS No. 128"), "Earnings per share". SFAS No.
128 superseded Accounting Principles Board Opinion No.15 (APB 15). Net earning
per share for all periods presented has been restated to reflect the adoption of
SFAS No. 128. Basic net earning per share is based upon the weighted average
number of common shares outstanding. Diluted net earning per share is based on
the assumption that all dilutive convertible shares and stock options were
converted or exercised. At September 30, 2006, the Company had outstanding
1,140,286 warrants. The average stock price for the three and nine months ended
September 30, 2006 was less than the exercise price of the warrants; therefore,
the warrants are not factored into the diluted earning per share calculation as
they are anti-dilutive.
9
Statement of Cash Flows
In accordance with Statement of Financial Accounting Standards No. 95,
"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 will not
necessarily agree with changes in the corresponding balances on the balance
sheet.
Segment Reporting
Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosure
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 and services, geography, legal structure, management
structure, or any other manner in which management disaggregates a company. SFAS
131 has no effect on the Company's consolidated financial statements as the
Company consists of one reportable business segment. All revenue is from
customers in the People's Republic of China. All of the Company's assets are
located in the People's Republic of China.
Recent Pronouncements
In December 2004, the FASB issued FASB Statement No. 123R, "Share-Based Payment,
an Amendment of FASB Statement No. 123" ("FAS No. 123R"). FAS No. 123R requires
companies to recognize in the statement of operations the grant- date fair value
of stock options and other equity-based compensation issued to employees. FAS
No. 123R is effective beginning in the Company's second quarter of fiscal 2006.
The Company adopted FAS No. 123R on January 1, 2006 and the adoption of this
statement did not have a material impact on its financial position, results of
operations or cash flows.
In May 2005, the FASB issued FASB Statement No. 154, "Accounting Changes and
Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No.
3". This statement replaces APB Opinion No. 20, "Accounting Changes", and FASB
Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements",
and changes the requirements for the accounting for and reporting of a change in
accounting principle. This statement applies to all voluntary changes in
accounting principle. It also applies to changes required by an accounting
pronouncement in the unusual instance that the pronouncement does not include
specific transition provisions. This statement is effective for accounting
changes and correction of errors made in fiscal years beginning after December
15, 2005. Management believes the adoption of this pronouncement will not have a
material effect on our financial statements.
In June 2005, the FASB ratified the EITF consensus to amend EITF No. 96-16,
"Investor's Accounting for an Investee When the Investor Has a Majority of the
Voting Interest but the Minority Shareholders Have Certain Approval or Veto
Rights". The EITF agreed to amend the Protective Rights section of this
consensus, as well as Example of Exhibit 96-16A, to be consistent with the
consensus reached in Issue No. 04-5, "Determining Whether a General Partner, or
the General Partners as a Group, Controls a Limited Partnership or Similarly
Entity When the Limited Partners Have Certain Rights." The provisions of this
amendment should be applied prospectively to new investments and to investment
agreements that are modified after June 29, 2005. Management believes the
adoption of this pronouncement will not have a material effect on our financial
statements.
10
In June 2005, the EITF reached consensus on Issue No. 05-6, determining the
Amortization Period for Leasehold Improvements ("EITF 05-6.") EITF 05-6 provides
guidance on determining the amortization period for leasehold improvements
acquired in a business combination or acquired subsequent to lease inception.
The guidance in EITF 05-6 will be applied prospectively and is effective for
periods beginning after June 29, 2005. EITF 05-6 is not expected to have a
material effect on its financial position or results of operations.
In February 2006, FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments". SFAS No. 155 amends SFAS No 133, "Accounting for
Derivative Instruments and Hedging Activities", and SFAF No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities". SFAS No. 155, permits fair value remeasurement for any hybrid
financial instrument that contains an embedded derivative that otherwise would
require bifurcation, clarifies which interest-only strips and principal-only
strips are not subject to the requirements of SFAS No. 133, establishes a
requirement to evaluate interest in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation, clarifies
that concentrations of credit risk in the form of subordination are not embedded
derivatives, and amends SFAS No. 140 to eliminate the prohibition on the
qualifying special-purpose entity from holding a derivative financial instrument
that pertains to a beneficial interest other than another derivative financial
instrument. This statement is effective for all financial instruments acquired
or issued after the beginning of the Company's first fiscal year that begins
after September 15, 2006. The Company has not evaluated the impact of this
pronouncement its financial statements.
In March 2006 FASB issued SFAS 156 'Accounting for Servicing of Financial
Assets' this Statement amends FASB Statement No. 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities, with
respect to the accounting for separately recognized servicing assets and
servicing liabilities. This Statement:
1. Requires an entity to recognize a servicing asset or servicing liability each
time it undertakes an obligation to service a financial asset by entering into a
servicing contract.
2. Requires all separately recognized servicing assets and servicing liabilities
to be initially measured at fair value, if practicable.
3. Permits an entity to choose 'Amortization method' or Fair value measurement
method' for each class of separately recognized servicing assets and servicing
liabilities.
4. At its initial adoption, permits a one-time reclassification of
available-for-sale securities to trading securities by entities with recognized
servicing rights, without calling into question the treatment of other
available-for-sale securities under Statement 115, provided that the
available-for-sale securities are identified in some manner as offsetting the
entity's exposure to changes in fair value of servicing assets or servicing
liabilities that a servicer elects to subsequently measure at fair value.
5. Requires separate presentation of servicing assets and servicing liabilities
subsequently measured at fair value in the statement of financial position and
additional disclosures for all separately recognized servicing assets and
servicing liabilities. An entity should adopt this Statement as of the beginning
of its first fiscal year that begins after September 15, 2006. Management
believes that this statement will not have a significant impact on the financial
statement.
11
In September 2006, FASB issued SFAS 157 `Fair Value Measurements'. This
Statement defines fair value, establishes a framework for measuring fair value
in generally accepted accounting principles (GAAP), and expands disclosures
about fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the Board having
previously concluded in those accounting pronouncements that fair value is the
relevant measurement attribute. Accordingly, this Statement does not require any
new fair value measurements. However, for some entities, the application of this
Statement will change current practice. This Statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. The management is currently
evaluating the effect of this pronouncement on financial statements.
In September 2006, FASB issued SFAS 158 `Employers' Accounting for Defined
Benefit Pension and Other Postretirement Plans--an amendment of FASB Statements
No. 87, 88, 106, and 132(R)' This Statement improves financial reporting by
requiring an employer to recognize the overfunded or underfunded status of a
defined benefit postretirement plan (other than a multiemployer plan) as an
asset or liability in its statement of financial position and to recognize
changes in that funded status in the year in which the changes occur through
comprehensive income of a business entity or changes in unrestricted net assets
of a not-for-profit organization. This Statement also improves financial
reporting by requiring an employer to measure the funded status of a plan as of
the date of its year-end statement of financial position, with limited
exceptions. An employer with publicly traded equity securities is required to
initially recognize the funded status of a defined benefit postretirement plan
and to provide the required disclosures as of the end of the fiscal year ending
after December 15, 2006. An employer without publicly traded equity securities
is required to recognize the funded status of a defined benefit postretirement
plan and to provide the required disclosures as of the end of the fiscal year
ending after June 15, 2007. However, an employer without publicly traded equity
securities is required to disclose the following information in the notes to
financial statements for a fiscal year ending after December 15, 2006, but
before June 16, 2007, unless it has applied the recognition provisions of this
Statement in preparing those financial statements. The requirement to measure
plan assets and benefit obligations as of the date of the employer's fiscal
year-end statement of financial position is effective for fiscal years ending
after December 15, 2008. The management is currently evaluating the effect of
this pronouncement on financial statements.
Note 3 - Other Payables
Other payable consists of the following as of September 30, 2006:
Other accounts payable $ 99,784
Welfare payable 12,075
Tax payable 1,178,388
Other 20,592
-------------------------
$ 1,310,839
=========================
12
Note 4 - Stockholders' Equity
Common stock
On January 6, 2006 and January 9, 2006, the Company entered into securities
purchase agreements with four accredited investors and completed the sale of
$5,380,000 of units. The units contained an aggregate of 1,921,572 shares of
common stock and 523,055 common stock purchase warrants. Each common stock
purchase warrant is exercisable for a period of three years at an exercise price
of $3.60 per share. Pursuant to the terms of the warrant, each investor has
contractually agreed to restrict its ability to exercise the warrants to an
amount which would not exceed the difference between the number of shares of
common stock beneficially owned by the holder or issuable upon exercise of the
warrant held by such holder and 9.9% of the outstanding shares of common stock
of the Company.
In connection with the offering, the Company paid a placement fee of 10% of the
proceeds in cash, together with non-accountable expenses in the amount of 3% of
the proceeds, in cash. In addition, the placement agent was issued warrants to
purchase 298,888 shares of common stock on the same terms and conditions as the
investors. The warrants issued to the placement agent are being treated as a
cost of raising capital. The warrants were valued using the Black Scholes
pricing model; however, recording the value of the warrants in the financial
statements has no impact as the value of the warrants is both debited and
credited to additional paid in capital.
On January 10, 2006 through January 13, 2006, the Company entered into
securities purchase agreements with four accredited investors and completed the
sale of $2,195,198 of units. The units contained an aggregate of 783,999 shares
of common stock and 213,422 common stock purchase warrants. Each common stock
purchase warrant is exercisable for a period of three years at an exercise price
of $3.60 per share. Pursuant to the terms of the warrant, each investor has
contractually agreed to restrict its ability to exercise the warrants to an
amount which would not exceed the difference between the number of shares of
common stock beneficially owned by the holder or issuable upon exercise of the
warrant held by such holder and 9.9% of the outstanding shares of common stock
of the Company.
In connection with the offering, the Company paid a placement fee of 10% of the
proceeds in cash, together with non-accountable expenses in the amount of 3% of
the proceeds, in cash. In addition, the placement agent was issued warrants to
purchase 121,955 shares of common stock on the same terms and conditions as the
investors. The warrants issued to the placement agent are being treated as a
cost of raising capital. The warrants were valued using the Black Scholes
pricing model; however, recording the value of the warrants in the financial
statements has no impact as the value of the warrants is both debited and
credited to additional paid in capital.
On January 17, 2006, the Company entered into securities purchase agreements
with an accredited investor and completed the sale of $2,824,802 of units. The
units contained an aggregate of 1,008,857 shares of common stock and 274,633
common stock purchase warrants. Each common stock purchase warrant is
exercisable for a period of three years at an exercise price of $3.60 per share.
Pursuant to the terms of the warrant, each investor has contractually agreed to
restrict its ability to exercise the warrants to an amount which would not
exceed the difference between the number of shares of common stock beneficially
owned by the holder or issuable upon exercise of the warrant held by such holder
and 9.9% of the outstanding shares of common stock of the Company.
13
In September 2006, the Company received $1,050,001 from the exercise of 291,667
warrants.
Warrants
Following is a summary of the warrant activity:
Weighted
Average Aggregate
Warrants Exercise Intrinsic
outstanding Price Value
Outstanding, December 31, 2005 - - -
Granted 1,431,953 $3.60
Forfeited - -
Exercised (291,667) $3.60
---------------
Outstanding, September 30, 2006 1,140,286 $3.60 $ 0
===============
Following is a summary of the status of warrants outstanding at September 30,
2006:
Outstanding Warrants Exercisable Warrants
Average
Remaining Average
Exercise Contractual Exercise
Price Number Life Price Number
$3.60 1,140,286 2.28 $3.60 1,140,286
Note 5 - Employee Welfare Plan
The Company has established its own employee welfare plan in accordance with
Chinese law and regulations. The Company makes annual contributions of 14% of
all employees' salaries to employee welfare plan. The total expense for the
above plan was $34,919 and $8,360 for the nine months ended September 30, 2006
and 2005, respectively.
Note 6 - Statutory Common Welfare Fund
As stipulated by the Company Law of the People's Republic of China (PRC) as
applicable to Chinese companies with foreign ownership, net income after
taxation can only be distributed as dividends after appropriation has been made
for the following:
14
i. Making up cumulative prior years' losses, if any;
ii. Allocations to the "Statutory surplus reserve" of at least 10% of income
after tax, as determined under PRC accounting rules and regulations, until
the fund amounts to 50% of the Company's registered capital;
iii. Allocations of 5-10% of income after tax, as determined under PRC
accounting rules and regulations, to the Company's "Statutory common
welfare fund", which is established for the purpose of providing employee
facilities and other collective benefits to the Company's employees; and
iv. Allocations to the discretionary surplus reserve, if approved in the
shareholders' general meeting.
The Company has appropriated $538,054 and $110,520 as reserve for the statutory
surplus reserve and welfare fund for the nine months ended September 30, 2006
and 2005, respectively.
Note 7 - Earnings Per Share
Earnings per share for nine months September 30, 2006 and 2005 were determined
by dividing net income for the periods by the weighted average number of both
basic and diluted shares of common stock and common stock equivalents
outstanding. There were no common stock equivalents that were dilutive during
the three and nine months ended September 30, 2006 and 2005; accordingly, basic
and diluted earning per share were the same for all periods presented.
Note 8 - Current Vulnerability Due to Certain Concentrations
For the nine months ended September 30, 2006 and 2005, the Company purchased all
of the natural gas for resale from one vendor, Shaanxi Natural Gas Co., Ltd., a
government owned enterprise and two other wholesale vendors. $0. was owing to
one of the wholesale vendors at September 30, 2006. The Company has had annual
agreements with Shaanxi Natural Gas that requires the Company to purchase a
minimum amount of natural gas. For the years ended December 31, 2005, the
minimum purchases was 2.36 million cubic meters. In the past, contracts were
renewed on an annual basis. However, as the volume of usage has increased,
Shaanxi Natural Gas has revised their policies, and contract terms are now six
months and subject to review prior to renewal. The Company's management reports
that it does not expect any issues or difficulty in continuing to renew the
supply contracts going forward. Price points for natural gas are strictly
controlled by the government and have remained stable over the past 3 years.
For the nine months ended September 30, 2006, two supplier accounts for 42.2%
and 17.0% of the total equipment purchased by the Company.
One customer accounted for 36.1% and 87.0% of the Company's revenue for the nine
months ended September 30, 2006 and 2005, respectively.
The Company's operations are carried out in the People's Republic of China.
Accordingly, the Company's business, financial condition and results of
operations may be influenced by the political, economic and legal environments
in the People's Republic of China, by the general state of the People's Republic
of China`s economy. The Company's business may be influenced by changes in
governmental policies with respect to laws and regulations, anti-inflationary
measures, currency conversion and remittance abroad, and rates and methods of
taxation, among other things.
15
Note 9 - Related Party Transactions
Included in other payables in the accompanying balance sheet at September 30,
2006 is $0 due to stockholder of the Company.
Item 2. Management's Discussion and Analysis or Plan of Operations
Forward-Looking Statements
The information in this report contains forward-looking statements. All
statements other than statements of historical fact made in this report are
forward looking. In particular, the statements herein regarding industry
prospects and future results of operations or financial position are
forward-looking statements. These forward-looking statements can be identified
by the use of words such as "believes," "estimates," "could," "possibly,"
"probably," anticipates," "projects," "expects," "may," "will," or "should" or
other variations or similar words. No assurances can be given that the future
results anticipated by the forward-looking statements will be achieved.
Forward-looking statements reflect management's current expectations and are
inherently uncertain. Our actual results may differ significantly from
management's expectations.
The following discussion and analysis should be read in conjunction with our
audited financial statements included in our Annual Report on Form 10KSB for the
year ended December 31, 2005. This discussion should not be construed to imply
that the results discussed herein will necessarily continue into the future, or
that any conclusion reached herein will necessarily be indicative of actual
operating results in the future. Such discussion represents only the best
present assessment of our management.
Corporate History
We were incorporated in the state of Delaware on March 31, 1999, as Bullet
Environmental Systems, Inc. and on May 25, 2000 we changed our name to
Liquidpure Corp. and on February 14, 2002 we changed our name to Coventure
International Inc. On December 6, 2005, we closed a Share Purchase Agreement
with Xian Xilan Natural Gas Co., Ltd., a corporation formed under the laws of
the People's Republic of China on January 8, 2000, and the shareholders of Xian
Xilan Natural Gas Co., Ltd. Pursuant to the Agreement, we acquired all of the
issued and outstanding capital stock of Xian Xilan Natural Gas Co., Ltd. from
the shareholders of Xian Xilan Natural Gas Co., Ltd. In exchange the
shareholders of Xian Xilan Natural Gas Co., Ltd. received 16,000,000 (post
split) shares of common stock of Coventure International Inc. On December 19,
2005 we changed our name to China Natural Gas, Inc.
Significant Accounting Policies
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
16
Accounts receivable
Accounts and other receivable are recorded at net realizable value consisting of
the carrying amount less an allowance for uncollectible accounts, as needed. Our
allowance for uncollectible accounts is not significant.
We 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. Reserves are recorded primarily on a specific
identification basis.
Advances to Suppliers
We advance to certain vendors for purchase of our material. The advances to
suppliers are interest free and unsecured.
Inventory
Inventory is stated at the lower of cost, as determined on a first-in, first-out
basis, or market. Management compares the cost of inventories with the market
value, and allowance is made for writing down the inventories to their market
value, if lower. Inventory consists of material used in the construction of
pipelines.
Property and equipment
Property and equipment are stated at cost. Expenditures for maintenance and
repairs are charged to earnings as incurred; additions, renewals and betterments
are capitalized. When property and equipment are retired or otherwise disposed
of, the related cost and accumulated depreciation are removed from the
respective accounts, and any gain or loss is included in operations.
Depreciation of property and equipment is provided using the straight-line
method for substantially all assets with estimated lives.
Construction In Progress
Construction in progress consist of the cost of constructing fixed assets for
our use. The major cost of construction in progress relates to material, labor
and overhead. As of September 30, 2006 the Company has $2,267,926 Construction
in progress.
Contracts In Progress
Contracts in progress consist of the cost of constructing pipelines for
customers. The major cost of construction relates to material, labor and
overhead. Revenue from construction and installation of pipelines is recorded
when the contract is completed and accepted by the customers. The construction
contracts are usually completed within one to two months time. As of September
30, 2006, the Company has $418,530 contracts in progress.
17
Revenue recognition
Our revenue recognition policies are in compliance with Staff accounting
bulletin (SAB) 104. Revenue is recognized when services are rendered to
customers when a formal arrangement exists, the price is fixed or determinable,
the delivery is completed, no other significant obligations exist and
collectibility is reasonably assured. Payments received before all of the
relevant criteria for revenue recognition are satisfied are recorded as unearned
revenue. Revenue from gas sales is recognized when gas is pumped through
pipelines to the end users. Revenue from construction and installation of
pipelines is recorded when the contract is completed and accepted by the
customers. The construction contracts are usually completed within one to three
months time.
Stock-based compensation
We account for our stock-based compensation in accordance with SFAS No. 123R,
"Share-Based Payment, an Amendment of FASB Statement No. 123." We recognize in
the statement of operations the grant- date fair value of stock options and
other equity-based compensation issued to employees and non-employees.
Income taxes
We utilize SFAS No. 109, "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.
Local PRC Income Tax
Pursuant to the tax laws of China, general enterprises are subject to income tax
at an effective rate of 33%. We are in the natural gas industry whose
development is encouraged by the government. According to the income tax
regulation, any company engaged in the natural gas industry enjoys a favorable
tax rate. Accordingly, our income is subject to a reduced tax rate of 15%.
Foreign currency transactions and comprehensive income (loss)
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Certain statements, however, require
entities to report specific changes in assets and liabilities, such as gain or
loss on foreign currency translation, as a separate component of the equity
section of the balance sheet. Such items, along with net income, are components
of comprehensive income. Transactions occur in Chinese Renminbi. The unit of
Renminbi is in Yuan.
Recent Accounting Pronouncements
In March 2006 FASB issued SFAS 156 `Accounting for Servicing of Financial
Assets' this Statement amends FASB Statement No. 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities, with
respect to the accounting for separately recognized servicing assets and
servicing liabilities. This Statement:
18
1. Requires an entity to recognize a servicing asset or servicing
liability each time it undertakes an obligation to service a
financial asset by entering into a servicing contract.
2. Requires all separately recognized servicing assets and servicing
liabilities to be initially measured at fair value, if practicable.
3. Permits an entity to choose `Amortization method' or Fair value
measurement method' for each class of separately recognized
servicing assets and servicing liabilities:
4. At its initial adoption, permits a one-time reclassification of
available-for-sale securities to trading securities by entities with
recognized servicing rights, without calling into question the
treatment of other available-for-sale securities under Statement
115, provided that the available-for-sale securities are identified
in some manner as offsetting the entity's exposure to changes in
fair value of servicing assets or servicing liabilities that a
servicer elects to subsequently measure at fair value.
5. Requires separate presentation of servicing assets and servicing
liabilities subsequently measured at fair value in the statement of
financial position and additional disclosures for all separately
recognized servicing assets and servicing liabilities.
This Statement is effective as of the beginning of the Company's first fiscal
year that begins after September 15, 2006. Management believes that this
statement will not have a significant impact on the consolidated financial
statements.
Results of Operations
Three Months Ended September 30, 2006 compared to Three Months Ended September
30, 2005
Revenue. We generated revenues of $6,514,291 for the three months ended
September 30, 2006, an increase of $5,121,683 or 367.8%, compared to $1,392,608
for the three months ended September 30, 2005. The increase in revenues was due
to an 1182% increase in our natural gas revenues, as we opened 4 new filling
stations during the three months ended September 30, 2006. In addition, we had
approximately a 32.2% increase in our construction/installation revenues during
this period, as we continue to increase the number of households we serve to
approximately 67,540.
Approximately 80% of our total revenues, for the three months ended September
30, 2006, are from the sale of natural gas, 92.9% of our revenues of natural gas
were sold in our natural gas filling stations. We sell the compressed natural
gas at the filling stations to CNG powered vehicles. Utility customers accounted
for 4.19% of our natural gas sales, and 2.88% of natural gas revenues was sold
wholesale to third party natural gas filling station operators.
The balance of our total revenues for the three month period ended September 30,
2006, 20%, was from construction/installation revenue. New households pay
approximately 60% of the construction costs of the pipeline that supplies their
homes with natural gas up front and the balance is paid as part of the monthly
natural gas bill. Three customers accounted for 47.9%, 33.9% and 14.9% of our
construction/installation revenue for the three months ended September 30, 2006
and one customer accounted for 81.35% of our revenue for the three months ended
September 30, 2005.
Gross profit. We have achieved a gross profit of $3,235,405 for the three months
ended September 30, 2006, an increase of $2,503,295 or 341.9%, compared to
$732,110 for the three months ended September 30, 2005. Gross profit for natural
gas sale for the three month period ended September 30, 2006 was $2,458,240 or
76% of the total gross profit, construction and installation accounted for
$777,165 or 24% of the period's gross profit.
19
Gross profit for the sale of natural gas was $2,458,240 for the three months
ended September 30, 2006, an increase of $2,366,991 or 2594%, compared to
$91,249 for the three months ended September 30, 2005. Gross profit on the
construction and installation activity increased to $777,165 for the three
months ended September 30, 2006, an increase of $136,304 or 21.3%, compared to
$640,861 for the three months ended September 30, 2005.
Gross margin, as a percentage of revenues, decreased to 49.7% for the three
months ended September 30, 2006, from 52.6% for the three months ended September
30, 2005. The decrease in gross profit margin is due to the large increase in
our filling station revenues and natural gas revenues overtaking
construction/installation revenues as the major contributor to our total
revenues. The gross profit margin on construction/installation is 59.6% for this
period while the sale of natural has a gross profit margin of 47.2%. We work
with gross margins on the construction and installation activity that are
approximately 60%, dependent on the scope of the job, mostly due to the low cost
of labor. This segment of our business, although not a monthly recurring
business is highly profitable.
We purchase all of our natural gas for resale from a government owned entity,
the Shaanxi Natural Gas Co. Inc. As all land in China is owned by the
government, the government controls and owns all the natural resources coming
from the ground, thus the government controls the price and flow of the natural
gas. As China shifts from a centrally planned economy to a market economy, we
believe that it is in the government's best interest to keep prices stable, as
they have been for the last 3 years, and maintain a stable flow of supply. The
government has undertaken programs to promote the growth of the region in which
we are located. The rate that we pay for natural gas is set by the central
government, and has been stable for the past 3 years. Therefore, we expect
supply and our cost price to continue to be stable in the future. There is one
price that we charge all of our household, retail/commercial and industrial
customers (utility customers) set by the local provincial government. There is
no fixed formula to derive the selling price, nor are the rates designed to
capture costs and expenses, or achieve a specified level of profit.
For the three months ended September 30, 2006, three suppliers accounted for
37.22%, 14.31% and 9.08% of the total equipment we purchased for construction
activities. We believe that as a result of our relationships within the
construction industry and the construction equipment vendor community, and the
availability of other vendors to supply the construction equipment and
materials, the loss of any one of the three vendors would not have a material
adverse effect on our operations.
Operating expenses. We incurred operating expenses of $636,647 for the three
months ended September 30, 2006, an increase of $430,197 or 208.4%, compared to
$206,450 for the three months ended September 30, 2005. These operating expenses
are related to increased sales and marketing costs to sign new residential and
commercial customers (utility customers) as well as marketing for the four new
filling stations we began to operate during the period. The four new filling
stations also added additional staff to our operations. We currently have in
place a marketing strategy targeting professional drivers to increase their
awareness of our filling stations and educating them about the differences
between our filling stations and our competitors run by inefficient government
entities or other privately owned operators that lack sufficient supply. We
continue to identify possible locations for new filling stations, and are
applying to the proper governmental agencies for all necessary approvals and
licenses to construct the new filling stations. We are also in discussions to
acquire existing filling stations from our competitors.
20
Net Income. Net income was $2,203,786 for the three months ended September 30,
2006, an increase of $1,807,143 or 455.6% from $396,643 for the three months
ended September 30, 2005. The increase is attributed to the growth of all
segments of our business, from construction and installation to the sale of
natural gas to our three classes of customers (utility, our own filling stations
and wholesale to third party filling stations). The greatest impact has been
from the addition of four new natural gas filling stations during the three
months ended September 30, 2006.
Nine Months Ended September 30, 2006 compared to Nine Months Ended September 30,
2005
Revenue. We generated revenues of $12,025,688 for the nine months ended
September 30, 2006, an increase of $9,311,646 or 343.1%, compared to $2,714,042
for the nine months ended September 30, 2005. The increase in revenues was due
to an approximately 705.6% increase in the sale of natural gas, from $1,065,017
in the nine months ended September 30, 2005 to $8,580,236 during the nine months
ended September 30, 2006. The major factor in this increase was the opening of
eleven natural gas filling stations during this period. We also increased
construction and installation revenue by approximately 108.9% from $1,649,025 in
the nine months ended September 30, 2005 to $3,445,452 during the nine months
ended September 30, 2006. This increase is attributed to the approximately
18,000 new residential and commercial customers we signed during the nine months
ended September 30, 2006.
Approximately 71.3% of our total revenues, for the nine months ended September
30, 2006, are from the sale of natural gas, and 89.95% of our revenues of
natural gas were sold in our natural gas filling stations. We sell the
compressed natural gas at the filling stations to CNG powered vehicles. Utility
customers accounted for 5.05% of our natural gas sales, and 4.99% of natural gas
revenues was sold wholesale to third party natural gas filling station
operators.
The balance of our total revenues for the nine month period ended September 30,
2006, approximately 28.7%, was from construction/installation revenue. In the
nine months ended September 30, 2005 construction/installation revenue was
approximately 60.8% of all revenues during the period. Two customers accounted
for 36.08%, and 25.5% of our construction/installation revenue for the nine
months September 30, 2006 and one customer accounted for 87.2 of our revenue for
the nine months ended September 30, 2005.
Gross profit. We have achieved a gross profit of $5,794,661 for the nine months
ended September 30, 2006, an increase of $4,495,918 or 346.2%, compared to
$1,298,743 for the nine months ended September 30, 2005. Gross profit for
natural gas sale for the nine month period ended September 30, 2006 was
$3,718,034 or 64.2% of the total gross profit, construction and installation
accounted for $2,076,627 or 35.8% of the period's gross profit.
Gross profit for natural gas sale increased to $3,718,034 for the nine months
ended September 30, 2006, an increase of $3,483,544 or 1485.6%, compared to
$234,490 for the nine months ended September 30, 2005. Gross profit on the
construction and installation activity increased to $2,076,627 for the nine
months ended September 30, 2006, an increase of $1,012,374 or 95.1%, compared to
$1,064,253 for the nine months ended September 30, 2005.
21
Gross margin, as a percentage of revenues, increased to 48.2% for the nine
months ended September 30, 2006, from 47.9% for the nine months ended September
30, 2005. The increase in gross profit is due to the increased construction and
installation activity. The gross profit margin on construction/installation is
60.3% for this period. We work with gross margins on the construction and
installation activity that historically are approximately 60%, dependent on the
scope of the job, mostly due to the low cost of labor. This segment of our
business, although not a monthly recurring business is highly profitable. The
sale of natural has a gross profit margin of 43.3% during the nine months ended
September 30, 2006. In the same nine month period in 2005 the sale of natural
gas had a gross profit margin of approximately 22%, the majority these sales
were utility sales. In the nine month period ended September 30, 2006 the
majority of our natural gas is sold through our natural gas filling stations. In
the same period in 2005 we had no filling stations. At these stations we are
able to receive a higher price for each cubic meter of natural gas sold.
We purchase all of our natural gas for resale from a government owned entity,
the Shaanxi Natural Gas Co. Inc. As all land in China is owned by the
government, the government controls and owns all the natural resources coming
from the ground, thus the government controls the price and flow of the natural
gas. As China shifts from a centrally planned economy to a market economy, we
believe that it is in the government's best interest to keep prices stable, as
they have been for the last 3 years, and maintain a stable flow of supply. The
government has undertaken programs to promote the growth of the region in which
we are located. The rate that we pay for natural gas is set by the central
government, and has been stable for the past 3 years. Therefore, we expect
supply and our cost price to continue to be stable in the future. There is one
price that we charge all of our household, retail/commercial and industrial
customers set by the local provincial government. There is no fixed formula to
derive the selling price, nor are the rates designed to capture costs and
expenses, or achieve a specified level of profit.
For the nine months ended September 30, 2006, three suppliers accounted for
approximately 44.2%, 16.99% and 10.41% of the total equipment we purchased for
construction activities. We believe that as a result of our relationships within
the construction industry and the construction equipment vendor community, and
the availability of other vendors to supply the construction equipment and
materials, the loss of any one of the three vendors would not have a material
adverse effect on our operations.
Operating expenses. We incurred operating expenses of $1,617,101 for the nine
months ended September 30, 2006, an increase of $1,184,758 or 274%, compared to
$432,343 for the nine months ended September 30, 2005. These operating expenses
are related to increased sales and marketing costs to sign new residential and
commercial customers (utility customers) that were put on line during the
period, as well as marketing for the eleven new filling stations we began to
operate during the period. The eleven new filling stations also added additional
staff to our operations. We commenced a marketing strategy targeting
professional drivers to increase their awareness of our filling stations and
educating them about the differences between our filling stations and our
competitors run by inefficient government entities or other privately owned
operators that lack sufficient supply. We continue identifying possible
locations for new filling stations, and are applying to the proper governmental
agencies for all necessary approvals and licenses to construct the new filling
stations. We are in discussions to acquire existing filling stations from our
competitors.
22
Net Income. Net income was $3,541,635 for the nine months ended September 30,
2006, an increase of $2,804,833 or 380.7% from $736,802 for the nine months
ended September 30, 2005. The increase is attributed to the growth of all
segments of our business, from construction and installation to the sale of
natural gas to our three classes of customers (utility, our own filling stations
and wholesale to third party filling stations). The greatest impact has been due
to the addition of eleven new natural gas filling stations during the nine
months ended September 30, 2006.
Liquidity and Capital Resources
As of September 30, 2006 we had $5,031,991 of cash and cash equivalents on hand
compared to $1,001,243 cash and cash equivalents as of September 30, 2005.
In January 2006, we entered into securities purchase agreements with several
accredited investors and completed the sale of $10.4 million of units. The
proceeds of the financing are intended for the investment necessary to construct
or acquire natural gas filling stations, purchase of raw materials and working
capital. During the quarter ended September 30, 2006, an investor elected to
exercise 291,667 warrants and we received $1,050,001.
As of November 10, 2006, we have a total of 17 natural gas filling stations. Our
plans for the remainder of 2006 are to construct or acquire from third parties
at least four natural gas filling stations. Each filling station costs
approximately $600,000 to construct. There is a premium for filling stations
that we acquire dependent on historical sales, location and the ability for us
to produce revenue from that filling station immediately upon completing the
acquisition. We believe that the proceeds of the financing along with operating
cash flow will cover all expenses associated with the build out or acquisition
of these filling stations.
During the quarter ended September 30, 2006 we started the planning process of
building a Liquefied Natural Gas (LNG) facility. We have met with several
builders of such facilities and are evaluating our options. We feel that as the
acceptance of natural gas as an alternative fuel grows we will need to be ready
with the infrastructure to meet the demand.
We had net cash flows used in operations of $922,946 for the nine months ended
September 30, 2006 as compared to net cash provided by operations of $69,256 for
the nine months ended September 30, 2005. The increase in net cash flows used in
operations for the nine months ended September 30, 2006 as compared to
corresponding period in 2005 was mainly due to the increase of other
receivables, $1,258,975, and the increase of advances to suppliers, $3,068,491.
23
Cash outflows used in investing activities increased to $4,669,265 for the nine
months ended September 30, 2006 as compared to $2,671,533 for the nine months
ended September 30, 2005 as a result of payments made for property and equipment
for investments necessary to construct and build the filling stations and for
construction materials used to build the pipelines to individual households.
Typically, this construction is completed within thirty to sixty days. Any
prepayments that we make to our construction equipment/material vendors are made
to ensure timely delivery and ensure preferred treatment of any last minute or
rush delivery of materials that we may need. Based on our relationships with our
vendors the prepayments are unsecured and interest free, however, since most
construction projects are completed in slightly more than 30 days this fact
becomes inconsequential as materials are delivered to the job site well in
advance of the completion of each project.
We had cash flows from financing activities of $9,892,854 for the nine months
ended September 30, 2006, as compared to $3,503,897 for the nine months ended
September 30, 2005. The increase is due to the sale of 3,714,428 shares of
common stock and 1,432,953 warrants to purchase common stock, for gross proceeds
of $10.4 million. We also received $1.05 million during the quarter ended
September 30, 2006, the result of an investor electing to exercise 291,667
warrants. Based on past performance and current expectations, we believe our
cash and cash equivalents, cash generated from operations, as well as future
possible cash investments, will satisfy our working capital needs, capital
expenditures and other liquidity requirements associated with our operations and
near term growth strategies.
The majority of our revenues and expenses were denominated primarily in Renminbi
("RMB"), the currency of the People's Republic of China.
There is no assurance that exchange rates between the RMB and the U.S. Dollar
will remain stable. We do not engage in currency hedging. Inflation has not had
a material impact on our business.
24
Item 3. Controls and Procedures
The Chief Executive Officer and Chief Financial Officer conducted an evaluation
of the effectiveness of the design and operation of the Company's disclosure
controls and procedures (as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period
covered by this report. Based on that evaluation, the Chief Executive Officer
and Chief Financial Officer concluded that the Company's disclosure controls and
procedures were effective as of the end of the period covered by this report.
There were no significant changes in internal control over financial reporting
(as defined in Rule 13a-15f under the Exchange Act) that occurred during the
fourth quarter of 2004 that have materially affected, or are reasonably likely
to materially affect, the Company's internal control over financial reporting.
25
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
26
Item 6. Exhibits
(a) Exhibits
Exhibit Number Description of Exhibit
-------------- ----------------------
3.1 Articles of Incorporation (incorporated by reference to same
exhibit filed with the Company's Form 10SB Registration
Statement filed September 15, 2000, SEC file no. 000-31539).
3.2 Certificate of Ownership of Coventure international Inc. and
China Natural Gas, Inc., dated December 12, 2005 (incorporated
by reference to same exhibit filed with the Company's Form
10KSB filed March 22, 2006)
3.3 Registrant's By-Laws (incorporated by reference to same exhibit
filed with the Company's Form 10SB Registration Statement filed
September 15, 2000, SEC file no. 000-31539).
10.1 Share Purchase Agreement made as of December 6, 2005 among
Coventure International Inc., Xian Xilan Natural Gas Co., Ltd.
and each of Xilan's shareholders. (incorporated by reference to
the exhibits to Registrants Form 8-K filed on December 9,
2005).
10.2 Return to Treasury Agreement between Coventure International
Inc. and John Hromyk, dated December 6, 2005. (incorporated by
reference to the exhibits to Registrants Form 8-K filed on
December 9, 2005).
10.3 Purchase Agreement made as of December 19, 2005 between China
Natural Gas, Inc. and John Hromyk (incorporated by reference to
the exhibits to Registrants Form 8-K filed on December 23,
2005).
10.4 Form of Securities Purchase Agreement (incorporated by
reference to the exhibits to Registrants Form 8-K filed on
January 12, 2006).
10.5 Form of Common Stock Purchase Agreement (incorporated by
reference to the exhibits to Registrants Form 8-K filed on
January 12, 2006).
10.6 Form of Registration Rights Agreement (incorporated by
reference to the exhibits to Registrants Form 8-K filed on
January 12, 2006).
31.1 Certification of Principal Executive Officer pursuant to Rule
13a-14 and Rule 15d-14(a), promulgated under the Securities and
Exchange Act of 1934, as amended
31.2 Certification of Principal Financial Officer pursuant to Rule
13a-14 and Rule 15d 14(a), promulgated under the Securities and
Exchange Act of 1934, as amended
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Chief Executive Officer)
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Chief Financial Officer)
27
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
China Natural Gas, Inc.
November 14, 2006 By:
-------------------------------
Qinan Ji
Chief Executive Officer (Principal
Executive Officer)
November 14, 2006 By:
-------------------------------
Xiaogang Zhu
Chief Financial Officer
(Principal Financial and Accounting
Officer)