Attached files
file | filename |
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EX-31.1 - Xtreme Link, Inc. | v210727_ex31-1.htm |
EX-32.2 - Xtreme Link, Inc. | v210727_ex32-2.htm |
EX-31.2 - Xtreme Link, Inc. | v210727_ex31-2.htm |
EX-32.1 - Xtreme Link, Inc. | v210727_ex32-1.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C.
20549
Form
10-Q
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For
the Quarterly Period Ended December 31,
2010
|
OR
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For
the transition period from ______________ to
______________
|
ORIENT
PETROLEUM AND ENERGY, INC.
(Exact
name of small business issuer as specified in its charter)
Nevada
(State
or other jurisdiction of
incorporation
or organization)
|
333-148098
(Commission
file number)
|
20-5240593
(I.R.S.
Employer
Identification
No.)
|
1
Xingqing Road, Cuiting Plaza, Suite 2201
Xi’an,
Shaanxi Province
People’s Republic of China
710032
(Address
of principal executive offices)
(86)
29-83213199
(Issuer
Telephone number)
(Former name, former
address and former fiscal year, if changed since last report)
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 whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
(Check one):
Large
accelerated filer o
|
Accelerated
filer o
|
Non-accelerated
filer o
|
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
number of shares of Common Stock, $0.001 par value, of the registrant
outstanding at February 14, 2011 was 30,000,000.
TABLE
OF CONTENTS
PART
I: FINANCIAL INFORMATION
|
3
|
Item
1. Financial Statements
|
3
|
CONDENSED
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2010 AND MARCH 31, 2010
(UNAUDITED)
|
3
|
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME FOR
THE THREE MONTHS AND NINE MONTHS ENDED DECEMBER 31, 2010 AND 2009
(UNAUDITED)
|
4
|
CONDENSED
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY AT MARCH 31, 2010 AND AT
DECEMBER 31, 2010 (UNAUDITED)
|
5
|
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED DECEMBER
31, 2010 AND 2009 (UNAUDITED)
|
6
|
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
7
|
Item
2. Management’s Discussion and Analysis of Financial Condition
and Results of Operations
|
18
|
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
|
23
|
Item
4. Controls and Procedures
|
23
|
PART
II: OTHER INFORMATION
|
24
|
Item
1. Legal Proceedings
|
24
|
Item
1A. Risk Factors
|
24
|
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
|
39
|
Item
3. Defaults Upon Senior Securities
|
39
|
Item
4. Reserved
|
39
|
Item
5. Other Information
|
39
|
Item
6. Exhibits
|
40
|
SIGNATURES
|
41
|
PART I.
CONDENSED
CONSOLIDATED BALANCE SHEETS
|
||||||||
As
of December 31, 2010 and March 31, 2010 (unaudited)
|
||||||||
(Amounts
expressed in thousands)
|
As
at December 31,
|
As at March 31, | |||||||
2010
|
2010
|
|||||||
|
||||||||
ASSETS |
|
|||||||
CURRENT
ASSETS:
|
|
|
||||||
Cash
and cash equivalents
|
$ | 2,791 | $ | 1,733 | ||||
Restricted
cash
|
4,745 | 6,812 | ||||||
Accounts
receivable, net
|
145 | 576 | ||||||
Advance
to suppliers
|
45,931 | 23,468 | ||||||
Inventories
|
5,995 | 3,447 | ||||||
Prepaid
expenses and other receivables
|
962 | 1,034 | ||||||
Total
current assets
|
$ | 60,569 | $ | 37,070 | ||||
Property,
plant and equipment, net
|
$ | 3,033 | $ | 2,874 | ||||
Long-term
lease payment
|
9,727 | 10,084 | ||||||
TOTAL
ASSETS
|
$ | 73,329 | $ | 50,028 | ||||
LIABILITIES
|
|
|
||||||
CURRENT
LIABILITIES:
|
|
|
||||||
Notes
payables
|
$ | 13,804 | $ | 12,452 | ||||
Advance
from customers
|
117 | 27 | ||||||
Income
tax payable
|
3,116 | 2,390 | ||||||
Other
payables
|
1,018 | 1,015 | ||||||
Short-term
loan
|
4,530 | 3,516 | ||||||
Total
current liabilities
|
$ | 22,585 | $ | 19,400 | ||||
Commitments
and contingencies
|
|
|
||||||
STOCKHOLDERS'
EQUITY
|
|
|
||||||
Common
stock - 75,000,000 shares authorized, par value $0.001,
30,000,000
and 7,900,000 shares issued and outstanding at
December
31, 2010 and March 31, 2010, respectively
|
$ | 30 | $ | 27 | ||||
Additional
paid-in capital
|
|
|
13,940 | 13,943 | ||||
Reserve
|
4,361 | 4,361 | ||||||
Retained
earnings
|
27,877 | 9,043 | ||||||
Accumulated
other comprehensive income
|
4,536 | 3,254 | ||||||
Total
equity
|
50,744 | 30,628 | ||||||
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
$ | 73,329 | $ | 50,028 |
The
accompanying notes are an integral part of these consolidated financial
statements.
3
ORIENT
PETROLEUM AND ENERGY, INC
|
|||||||||||||||
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE
INCOME
|
|||||||||||||||
For
the three and nine months ended December 31, 2010 and 2009
(unaudited)
|
|||||||||||||||
(Amounts
expressed in thousands)
|
Three
months ended December 31,
|
Nine
months ended December 31,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Sales
|
$ | 64,585 | $ | 44,358 | $ | 176,066 | $ | 128,229 | ||||||||
Less:
sales tax and surcharges
|
(158 | ) | (122 | ) | (449 | ) | (324 | ) | ||||||||
Net
sales
|
$ | 64,427 | $ | 44,236 | $ | 175,617 | $ | 127,905 | ||||||||
Cost
of sales
|
(53,939 | ) | (37,130 | ) | (147,258 | ) | (108,441 | ) | ||||||||
Gross
profit
|
$ | 10,488 | $ | 7,106 | $ | 28,359 | $ | 19,464 | ||||||||
|
|
|
|
|
||||||||||||
Operating
expenses:
|
|
|
|
|
||||||||||||
Selling
expenses
|
$ | (777 | ) | $ | (762 | ) | $ | (2,230 | ) | $ | (2,031 | ) | ||||
General
and administrative expenses
|
(207 | ) | (125 | ) | (525 | ) | (413 | ) | ||||||||
Total
operating expenses
|
$ | (984 | ) | $ | (887 | ) | $ | (2,755 | ) | $ | (2,444 | ) | ||||
Income
from operations
|
$ | 9,504 | $ | 6,219 | $ | 25,604 | $ | 17,020 | ||||||||
Other
income (expense):
|
|
|
|
|
||||||||||||
Interest
income
|
$ | 31 | $ | 9 | $ | 106 | $ | 46 | ||||||||
Interest
expense
|
(338 | ) | (125 | ) | (588 | ) | (368 | ) | ||||||||
Bank
charges
|
(7 | ) | (4 | ) | (17 | ) | (56 | ) | ||||||||
Other
|
- | (3 | ) | (1 | ) | 80 | ||||||||||
Total
other income (expense)
|
$ | (314 | ) | $ | (123 | ) | $ | (500 | ) | $ | (298 | ) | ||||
Income
before income tax
|
9,190 | 6,096 | 25,104 | 16,722 | ||||||||||||
Income
tax
|
(2,297 | ) | (1,525 | ) | (6,270 | ) | (4,181 | ) | ||||||||
Net
income
|
$ | 6,893 | $ | 4,571 | $ | 18,834 | $ | 12,541 | ||||||||
Other
comprehensive income
|
||||||||||||||||
Foreign
currency translation gain
|
544 | 1 | 1,282 | 27 | ||||||||||||
Comprehensive
income
|
$ | 7,437 | $ | 4,572 | $ | 20,116 | $ | 12,568 | ||||||||
Weighted
average shares outstanding:
|
||||||||||||||||
Basic
and diluted
|
30,000,000 | 27,100,000 | 28,312,727 | 27,100,000 | ||||||||||||
Earnings
per share:
|
||||||||||||||||
Basic
and diluted
|
$ | 0.25 | $ | 0.17 | $ | 0.71 | $ | 0.46 |
The
accompanying notes are an integral part of these consolidated financial
statements.
4
ORIENT
PETROLEUM AND ENERGY, INC
|
||||||||||
CONDENSED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(unaudited)
|
||||||||||
(Amounts
expressed in thousands)
|
|
Common
Stock
|
|
|
Accumulated
other
|
Capital
&
|
|
||||||||||||||||||||||
|
|
Par
value
|
Additional
|
Retained
|
Comprehensive
|
Statutory
|
|
|||||||||||||||||||||
|
Shares
|
$0.001
|
Paid-in
Capital
|
Earnings
|
Income
|
Reserve
|
Total
|
|||||||||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||||||||||
Balance-
March 31, 2010
|
27,100 | 27 | 13,943 | 9,043 | 3,254 | 4,361 | 30,628 | |||||||||||||||||||||
Issuance
of share capital
|
2,900 | 3 | (3 | ) |
|
|
|
- | ||||||||||||||||||||
Comprehensive
income:
|
|
|
|
|
|
|
|
|||||||||||||||||||||
Net
income
|
|
|
|
18,834 |
|
|
18,834 | |||||||||||||||||||||
Foreign
currency translation adjustment, net of taxes of $0
|
|
|
|
|
1,282 |
|
1,282 | |||||||||||||||||||||
Balance-
December 31, 2010
|
30,000 | 30 | 13,940 | 27,877 | 4,536 | 4,361 | 50,744 |
The
accompanying notes are an integral part of these consolidated financial
statements.
5
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|||||||||
For
the nine months ended December 31, 2010 and 2009
(unaudited)
|
|||||||||
(Amounts
expressed in thousands)
|
|
Nine
months ended December 31,
|
|||||||
|
2010
|
2009
|
||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
||||||
Net
income
|
$ | 18,834 | $ | 12,541 | ||||
Adjustments:
|
|
|
||||||
Depreciation
and amortization
|
197 | 184 | ||||||
Amortization
of long-term lease payment
|
655 | 442 | ||||||
Changes
in operating assets and liabilities:
|
|
|
||||||
(Increase)
decrease in assets
|
|
|
||||||
Accounts
receivable
|
441 | (511 | ) | |||||
Advance
to suppliers
|
(21,331 | ) | (5,533 | ) | ||||
Inventories
|
(2,404 | ) | (773 | ) | ||||
Prepaid
expenses and other receivables
|
102 | (134 | ) | |||||
Increase
(decrease) in liabilities
|
|
|
||||||
Note
payables
|
900 | 10,247 | ||||||
Other
payables
|
(29 | ) | 24 | |||||
Advance
from customers
|
89 | (495 | ) | |||||
Tax
payables (recoverables)
|
644 | 1,298 | ||||||
Net
cash (used in) provided by operating activities
|
(1,902 | ) | 17,290 | |||||
CASH
FLOWS FROM INVESTING ACTIVITIES
|
||||||||
Purchase
of property, plant and equipment
|
(262 | ) | (41 | ) | ||||
Payment
of long-term lease payment
|
-
|
(5,126 | ) | |||||
Net
cash used in investing activities
|
(262 | ) | (5,167 | ) | ||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
||||||
Capital
injection
|
-
|
10,257 | ||||||
Net
proceeds from short term loan
|
879 | 1,757 | ||||||
Dividend
distribution
|
- | (17,575 | ) | |||||
Restricted
cash
|
2,242 | (6,368 | ) | |||||
Net
cash provided by (used in) financing activities
|
3,121 | (11,929 | ) | |||||
Effect
of exchange rate changes on cash and cash equivalents
|
101 | 4 | ||||||
NET
INCREASE IN CASH & CASH EQUIVALENTS
|
1,058 | 198 | ||||||
CASH
& CASH EQUIVALENTS, BEGINNING BALANCE
|
1,733 | 993 | ||||||
CASH
& CASH EQUIVALENTS, ENDING BALANCE
|
$ | 2,791 | $ | 1,191 | ||||
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
||||||
Interest
paid
|
$ | 574 | $ | 332 | ||||
Income
taxes paid
|
$ | 5,677 | $ | 3,109 |
The
accompanying notes are an integral part of these consolidated financial
statements.
6
ORIENT
PETROLEUM AND ENERGY, INC.
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(unaudited)
Note
1 - Organization and basis of presentation
Orient
Petroleum and Energy, Inc. (the “Company” or “Orient”), formerly known as Xtreme
Link, Inc., was organized as a Nevada corporation on June 22,
2006. On October14, 2010, the Company changed its name to “Orient
Petroleum and Energy, Inc.” in connection with the share exchange transaction as
described below.
On
September 27, 2010, the Company completed a share exchange transaction with
Orient New Energy Investments Limited (“Orient BVI”), and Orient BVI became a
wholly-owned subsidiary of the Company. On the closing date of the share
exchange transaction, the Company issued 27,100,000 shares of its common stock
to Orient BVI’s stockholders in exchange for 100% of the capital stock of Orient
BVI, and Hong Gao (“Ms. Gao”), a shareholder of the Company, cancelled
13,250,000 shares of common stock held by her concurrently. Prior to the share
exchange transaction, the Company had 16,150,000 shares of common stock issued
and outstanding. After the share exchange transaction, the Company had
30,000,000 shares of common stock outstanding and Orient BVI’s stockholders
owned 90.33% of the issued and outstanding shares. The share exchange
transaction was accounted for as a reverse acquisition and recapitalization and,
as a result, the consolidated financial statements of the Company (the legal
acquirer) is, in substance, those of Orient BVI (the accounting acquirer), with
the assets and liabilities, and revenues and expenses, of the Company being
included effective from the date of the share exchange transaction. As the share
exchange transaction was accounted for as a reverse acquisition and
recapitalization, there was no gain or loss recognized on the transaction. The
historical financial statements for periods prior to March 31, 2010 are those of
Orient BVI except that the equity section and earnings per share have been
retroactively restated to reflect the recapitalization.
Since the
date of the share exchange transaction, the Company has had no separate
operations of its own. Instead, all of the Company’s business operations are
conducted by Xi’an Orient Petroleum Group Co., Ltd. (“Orient Petroleum”) in the
People’s Republic of China (“PRC” or “China”), which the Company controls
through contractual arrangements that Orient New Energy Xi’an Limited (“Orient
Xi’an”), entered into with Orient Petroleum and its owners. Orient Xi’an is
wholly-owned by Orient New Energy Holdings Limited (“Orient Hong Kong”), which
in turn is wholly-owned by Orient BVI.
Orient
BVI is an investment holding company established in British Virgin Islands
(“BVI”) on November 28, 2008. Other than holding 100% of the
outstanding equity interests of Orient Hong Kong, Orient has no separate
operations of its own.
Orient
Hong Kong is an investment holding company established in Hong Kong Special
Administrative Region on March 12, 2009. Other than holding 100% of
the outstanding equity interests of Orient Xi’an, Orient Hong Kong has no
separate operations of its own.
Orient
Xi’an is a limited liability company established in the PRC on July 30, 2010,
with registered capital of $16 million, 15% of which is due within 90 days from
the date of its organization and the balance within two years from its business
license issuance date. On
October 26, 2010, Orient Xi’an was granted a one-year extension to pay the 15%
of its registered capital by the local government. Because it is
wholly-owned by Orient Hong Kong, a non-PRC company, Orient Xi’an is deemed a
wholly foreign owned enterprise, or WFOE, under applicable PRC
law. The principal purpose of Orient Xi’an is to manage, hold and own
rights in and to the businesses, operations and net income of Orient Petroleum,
which it does through a series of contractual arrangements.
Orient
Petroleum is a limited liability company established in the PRC on December 4,
1996, with registered capital of 100 million Renminbi (“RMB”), all of which has
been fully paid by its three owners (the
“Owners”).
Because
PRC law currently has restrictions on foreign ownership of companies in the oil
distribution industry, Orient Xi’an entered into a series of contractual
arrangements with Orient Petroleum and the Owners. These agreements, entered
into on August 12, 2010, are as follows:
(1)
|
Under
the Consulting Services Agreement, Orient Petroleum appoints Orient Xi’an
as its exclusive services provider with consulting and other relevant
services in connection with the business. Orient Petroleum agrees to
accept all the consultations and services provided by Orient Xi’an, and
without Orient Xi’an’s consent shall not accept any consultations and/or
services provided by any third party or cooperate with any third party
regarding the matters contemplated by the Consulting Services Agreement.
The
Consulting Services Agreement shall remain in effect for the maximum
period of time permitted by law, unless sooner terminated by either Orient
Petroleum or Orient Xi’an, or if either party becomes bankrupt or
insolvent, or otherwise dissolves or cease business
operations.
|
7
(2)
|
Under
the Operating Agreement, Orient Xi’an agrees, at its discretion, to be
Orient Petroleum’s guarantor in connection with contracts, agreements and
transactions executed by Orient Petroleum and any third party, provided
that Orient Petroleum shall pledge all its relevant assets to Orient Xi’an
as counter-guarantee, and provided further that without the prior written
consent of Orient Xi’an, Orient Petroleum shall not conduct any
transactions, which may materially affect the assets, obligations, rights
or operations of Orient Petroleum. The
Operating Agreement shall remain in effect for 20 years unless terminated
by Orient Xi’an.
|
(3)
|
Under
the Voting Rights Proxy Agreement, the Owners agree to irrevocably grant
and entrust Orient Xi’an, for the maximum period of time permitted by law,
with all the rights as shareholder of Orient Petroleum. The
Voting Rights Proxy Agreement shall remain in effect for the maximum
period of time permitted by law unless terminated by Orient
Xi’an.
|
(4)
|
Under
the Equity Pledge Agreement, the Owners agree to pledge all the equity
interest in Orient Petroleum to Orient Xi’an for the performance of
obligation under the Consulting Service
Agreement.
|
(5)
|
Under
the Option Agreements, the Owners irrevocably grants Orient Xi’an an
exclusive right to purchase, or designate one or more persons to purchase
the equity interests in Orient Petroleum held by the Owners. Except for
Orient Xi’an and the designee, no other person shall be entitled to the
equity interest purchase option. The
Option Agreement shall remain in effect for 10
years.
|
As a
result of the foregoing contractual arrangements, which obligates Orient Xi’an
to absorb all of the risk of loss from Orient Petroleum’s activities and enables
the Orient Xi’an to receive all of Orient Petroleum’s expected residual returns,
the Company accounts for Orient Petroleum as a variable interest entity, or VIE,
under Financial Accounting Standards Board (“FASB”) Interpretation No. 46R (“FIN
46R”), “Consolidation of Variable Interest Entities, an Interpretation of ARB
No. 51”. Accordingly, this transaction has been accounted for on a basis similar to reorganization between entities under common control, and the financial statements of Orient Petroleum are
consolidated into the financial statements of the Company.
The
interim condensed consolidated financial statements included herein, presented
in accordance with United States generally accepted accounting principles and
stated in US dollars, have been prepared by the Company, without audit, pursuant
to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures are adequate to
make the information presented not misleading. These statements reflect all
adjustments, consisting of normal recurring adjustments, which, in the opinion
of management, are necessary for fair presentation of the information contained
therein. The results of operations for the three and nine months
ended December 31, 2010 are not necessarily indicative of the results that may
be expected for the entire year ending March 31, 2011.
Note
2 - Summary of significant accounting policies
The
Company’s consolidated financial statements reflect the activities of the
Company and the following subsidiaries and VIE:
Subsidiaries
|
Incorporated in
|
Percentage of
Ownership
|
|||
Orient
BVI
|
British
Virgin Islands
|
100.00
|
%
|
||
Orient
HK
|
Hong
Kong
|
100.00
|
%
|
||
Orient
Xi’an
|
PRCPRC
|
100.00
|
%
|
||
Orient
Petroleum
|
PRCPRC
|
VIE by Contractual Arrangements
|
Change in Fiscal
Year
Prior to
the share exchange as described in Note 1, the Company had a fiscal year end
date of May 31st. Upon consummation of the share exchange, the
Company changed its fiscal year end from May 31st to March 31st, to conform to
the year end date of Orient BVI.
Basis of
consolidation
The
condensed consolidated financial statements were prepared in conformity with
accounting principles generally accepted in the United States of America (“US
GAAP”). The condensed consolidated financial statements include the
accounts of the Company, its subsidiaries and its VIE for which the Company is
the primary beneficiary. All significant intercompany accounts and
transactions have been eliminated in consolidation.
8
Use of
estimates
The
preparation of condensed consolidated financial statements in conformity with US
GAAP 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 consolidated financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those
estimates. Areas that require estimates and assumptions include
valuation of accounts receivable and determination of useful lives of property,
plant and equipment.
Cash and cash
equivalents
Cash and
cash equivalents include all highly liquid debt instruments with original
maturities of three months or less.
Restricted
cash
Restricted
cash represents the Company's bank deposits pledged for bills payable and bears
fixed interest rates.
Allowance of doubtful
accounts
The
allowance for doubtful accounts is the Company's best estimate of the amount of
probable credit losses in the Company's existing 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. As of December 31, 2010 and
as of March 31, 2010, management determined no allowance for uncollectible
amounts was required.
Inventories
Inventories
are stated at the lower of cost, as determined on weighted average basis, or
market. Management compares the cost of inventories with the market value, and
an allowance is made for writing down the inventories to their market value, if
lower. Inventories also consist of petroleum and diesel.
Property, plant and
equipment
Property,
plant and equipment are stated at cost and net of accumulated
depreciation. Expenditures for maintenance and repairs are charged to
earnings as incurred, and additions, renewals and betterments are capitalized.
When property, plant 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 in the year of
disposal. Depreciation of property, plant and equipment is provided
using the straight-line method for substantially all assets with estimated lives
of:
Oil
storage tank
|
20
years
|
Gas
stations
|
10
- 30 years
|
Production
machinery
|
5
years
|
Office
equipment
|
5
years
|
Motor
vehicles
|
5
years
|
Valuation of long-lived
assets
The
Company applies FASB ASC 360-10, “Property, Plant, and Equipment”, which
established a “primary asset” approach to determine the cash flow estimation
period for a group of assets and liabilities that represents the unit of
accounting for a long-lived asset to be held and used. Long-lived
assets to be held and used are reviewed for impairment whenever events or
changes in circumstances indicate the carrying amount of an asset may not be
recoverable. The carrying amount of a long-lived asset is not
recoverable if it exceeds the sum of the undiscounted cash flows expected to
result from the use and eventual disposition of the asset. Long-lived
assets to be disposed of are reported at the lower of carrying amount or fair
value less cost to sell. There was no impairment of long-lived assets
for the periods ended December 31, 2010 and 2009.
Leases
9
Leases of
property, plant and equipment where the Company assumes substantially all the
benefits and risks of ownership are classified as finance leases. The Company
has no significant finance leases.
Leases of
assets under which a significant portion of the risks and benefits of ownership
are effectively retained by the lessors are classified as operating
leases. Payments made under operating leases (net of any incentives
received from the lessors) are expensed on a straight-line basis over the lease
terms.
Revenue
recognition
The
Company’s revenue recognition policies are in compliance with SEC Staff
Accounting Bulletin (“SAB”) 104. Revenue from the sales of goods is
recognized on the transfer of significant risks and rewards of ownership, which
generally coincides with the time when the goods are delivered and the title has
passed to the customers. For wholesale distribution of finished oil
where the selling price is set forth in a sales contract, sales revenue is
recognized at the date of shipment. No other significant obligations of the
Company exist and collectability is reasonably assured. For gas station
retail sales, revenue is recognized and cash is collected upon completion of
sales. Revenue excludes value-added tax and is arrived at after deduction
of trade discounts and allowances.
Interest
income is recognized on a time proportion basis, taking into account the
principal amounts outstanding and the applicable interest rates.
Comprehensive
Income
The
Company has adopted ASC Topic 220 “Comprehensive Income” (Formerly, SFAS No.
130, “Reporting Comprehensive Income”). ASC 220 establishes standards
for reporting and presentation of comprehensive income and its components in a
full set of general-purpose financial statements. The Company
has chosen to report comprehensive income in the statements of changes in
stockholders’ equity. Comprehensive income comprised net income and
all changes to stockholders’ equity except those due to investments by
owners and distributions to owners.
Income
taxes
The
Company accounts for income taxes in accordance with FASB ASC 740, “Income
Taxes” (“ASC 740”). ASC 740 requires a company use the asset and
liability method of accounting for income taxes, whereby deferred tax assets are
recognized for deductible temporary differences, and deferred tax liabilities
are recognized for taxable temporary differences. Temporary
differences are the differences between the reported amounts of assets and
liabilities and their tax bases. Deferred tax assets are reduced by a
valuation allowance when, in the opinion of management, it is more likely than
not that some portion, or all of, the deferred tax assets will not be
realized. Deferred tax assets and liabilities are adjusted for the
effects of changes in tax laws and rates on the date of enactment.
The
Company adopted the provisions of ASC 740 which clarifies the accounting for
uncertainty in income taxes recognized by prescribing a recognition threshold
and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return. ASC 740 also provides accounting guidance on de-recognition,
classification, interest and penalties, disclosure and transition.
Nature of
operations
Substantially
all of the Company’s operations are conducted in the PRC and are subject to
various political, economic, and other risks and uncertainties inherent in this
country. Among other risks, the Company’s operations are subject to
the risks of restrictions on transfer of funds; export duties, quotas and
embargoes; domestic and international customs and tariffs; changing taxation
policies; foreign exchange restrictions; and political conditions and
governmental regulations.
Concentration of credit
risk
Financial
instruments that potentially subject the Company to concentrations of credit
risk consist principally of cash, accounts receivable and advances to
suppliers.
As of
December 31, 2010, and as of March 31, 2010, the Company had cash deposits of
$7.5 million and $8.5 million, respectively, placed with several banks in the
PRC, where there is currently no rules or regulations in place for obligatory
insurance of bank accounts.
10
For the
three and nine months ended December 31, 2010 and 2009, all of the Company’s
sales and all accounts receivable arose in the PRC.
Concentration of
customers
For the
three months ended December 31, 2010, there was one customer that accounted for
12.0% of the Company’s total sales. For the nine months ended
December 31, 2010, there was one customer that accounted for 12.3% of the
Company’s total sales. For both the three and nine months ended
December 31, 2009, no single customer accounted for 10% of the Company’s total
sales.
Foreign currency
transactions and comprehensive income
The
functional currency of the Company’s wholly-owned PRC subsidiary and its VIE is
the Chinese Renminbi Yuan, (“RMB”). RMB is not freely convertible
into foreign currencies. The financial statements of the Company’s
PRC subsidiary and its VIE are maintained in the functional
currency. Monetary assets and liabilities denominated in currencies
other than the functional currency are translated into the functional currency
at rates of exchange prevailing at the balance sheet
date. Transactions denominated in currencies other than the
functional currency are translated into the functional currency at the exchange
rates prevailing at the dates of the transactions. Exchange gains or
losses arising from foreign currency transactions are included in the
determination of net income for the respective periods.
For
financial reporting purposes, the financial statements of the Company have been
translated into United States dollars. Assets and liabilities are translated at
exchange rates at the balance sheet dates and revenue and expenses are
translated at average exchange rates, and equity is translated at historical
exchange rates. Any resulting translation adjustments are not
included in determining net income but are included in foreign exchange
adjustment to other comprehensive income, a component of equity.
Segment
reporting
FASB ASC
280, “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. The Company determined it has two operating segments, (1) the
wholesale distribution of finished oil products and (2) the operation of retail
gas stations.
Variable Interest
Entities
FASB
issued ASC 810-10-05-8, "Consolidation of VIEs”, which states that in general, a
VIE is a corporation, partnership, limited liability corporation, trust or any
other legal structure used to conduct activities or hold assets that either (1)
has an insufficient amount of equity to carry out its principal activities
without additional subordinated financial support, (2) has a group of equity
owners that are unable to make significant decisions about its activities, or
(3) has a group of equity owners that do not have the obligation to absorb
losses or the right to receive returns generated by its operations.
Research and development
cost
The
Company accounts for its research and development cost in accordance with FASB
ASC 730 “Research and Development”. Since the future economic
benefits are uncertain, research and development cost is charged to expense when
incurred. For the three months ended December 31, 2010 and 2009, $2,706 and
$4,394 are charged to general and administrative expenses respectively. For the
nine months ended December 31, 2010 and 2009, $9,706 and $13,394 are charged to
general and administrative expenses respectively.
Retirement
cost
Retirement
costs are charged to expense at a certain percentage of the payroll costs as
required under the PRC regulations.
11
Note
3 – Earnings per share
Basic
earnings per share is computed in accordance with ASC 260, “Earnings Per Share,”
by dividing the net income by the weighted average number of outstanding common
stock during the period. The diluted earnings per share calculation
includes the impact of dilutive convertible securities, if
applicable. The weighted average number of outstanding common stock
is determined by relating the portion of time within a reporting period that a
particular number of common stock has been outstanding to the total time in that
period.
The
weighted average number of outstanding shares of common stock as shown in the
financial statements presented herewith was computed based on the number of
shares of common stock outstanding, and took into account the reverse
acquisition transaction as described in Note 9 accompanying these financial
statements. Detailed computations are set out as follows:
Date of issue
or
|
Number
of
the
Company's
|
Number
of days
outstanding
three
months ended
December
31
|
Weighted
average
number
of
outstanding
common
stock
three
months ended
December
31
|
||||||||||||||||||
cancellation
|
common
stock
|
2010
|
2009
|
2010
|
2009
|
||||||||||||||||
Number
of days in reporting period
|
92 | 92 | |||||||||||||||||||
Existing
shares as of March 31, 2010
|
Pre
3/31/2010
|
7,900,000 | 92 | 7,900,000 | |||||||||||||||||
Issued
new shares
|
9/1/2010
|
8,250,000 | 92 | 8,250,000 | |||||||||||||||||
The
Company's stock at time of reverse acquisition
|
16,150,000 | ||||||||||||||||||||
Issue
stock in exchange for 10,000 shares of Orient BVI stock (100% equity in
Orient BVI)
|
9/7/2010
|
27,100,000 | 92 | 92 | 27,100,000 | 27,100,000 | |||||||||||||||
Cancel of stock | 9/7/2010 | (8,250,000 | ) | 92 | (8,250,000 | ) | |||||||||||||||
Cancel
of stock in conjunction with reverse acquisition
|
9/7/2010
|
(5,000,000 | ) | 92 | (5,000,000 | ) | |||||||||||||||
30,000,000 | 30,000,000 | 27,100,000 |
Date of
issue
|
Number
of
the
Company's
|
Number
of days
outstanding
nine
months ended
December
31
|
Weighted
average
number
of
outstanding
common
stock
nine
months ended
December
31
|
||||||||||||||||||
or
cancellation
|
common
stock
|
2010
|
2009
|
2010
|
2009
|
||||||||||||||||
Number
of days in reporting period
|
275 | 275 | |||||||||||||||||||
Existing
shares as of March 31, 2010
|
Pre
3/31/2010
|
7,900,000 | 115 | 3,303,636 | |||||||||||||||||
Issued
new shares
|
9/1/2010
|
8,250,000 | 115 | 3,450,000 | |||||||||||||||||
The
Company's stock at time of reverse acquisition
|
16,150,000 | ||||||||||||||||||||
Issue
stock in exchange for 10,000 shares of Orient BVI stock (100% equity in
Orient BVI)
|
9/7/2010
|
27,100,000 | 275 | 275 | 27,100,000 | 27,100,000 | |||||||||||||||
Cancel of stock | 9/7/2010 | (8,250,000 | ) | 115 | (3,450,000 | ) | |||||||||||||||
Cancel
of stock in conjunction with reverse acquisition
|
9/7/2010
|
(5,000,000 | ) | 115 | (2,090,909 | ) | |||||||||||||||
30,000,000 | 28,312,727 | 27,100,000 |
12
Three
months ended
December
31,
|
Nine
months ended
December
31,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
(Amount
expressed in thousands)
|
||||||||||||||||
Earnings
per share – Basic and diluted
|
||||||||||||||||
Income
for the period
|
$
|
7,437
|
$
|
4,572
|
$
|
20,116
|
$
|
12,568
|
||||||||
Basic
average common stock outstanding
|
30,000
|
27,100
|
28,313
|
27,100
|
||||||||||||
Earnings
per share
|
$
|
0.25
|
$
|
0.17
|
$
|
0.71
|
$
|
0.46
|
Note
4 – Inventories
Inventories
consist of the following at the dates indicated (amounts in
thousands):
December
31,
|
March
31,
|
|||||||
2010
|
2010
|
|||||||
Merchandised
goods:
|
||||||||
Petroleum
|
$ | 3,400 | $ | 1,870 | ||||
Diesel
|
2,561 | 1,559 | ||||||
Oil
additives
|
34 | 18 | ||||||
$ | 5,995 | $ | 3,447 |
Note
5 – Property, plant and equipment
Property,
plant and equipment consist of the following at the dates indicated (amounts in
thousands):
December
31,
|
March
31,
|
|||||||
2010
|
2010
|
|||||||
Oil
storage tank
|
$
|
3,113
|
$
|
3,021
|
||||
Gas
stations
|
658
|
638
|
||||||
Production
machinery
|
59
|
53
|
||||||
Office
equipment
|
59
|
53
|
||||||
Motor
vehicles
|
739
|
462
|
||||||
$
|
4,628
|
$
|
4,227
|
|||||
Less: Accumulated
depreciation
|
(1,595
|
)
|
(1,353
|
)
|
||||
$
|
3,033
|
$
|
2,874
|
Depreciation
expenses for the three months ended December 31, 2010 and 2009 were $69,000 and
$61,000, respectively. Depreciation expenses for the nine months ended December
31, 2010 and 2009 were $197,000 and $184,000, respectively.
Note
6 – Short term loans
The
carrying amounts of the Company’s borrowings at the dates indicated are as
follows (amounts in thousands):
13
December
31,
|
March
31,
|
|||||||||||||||
2010
|
2010
|
|||||||||||||||
Amounts
|
Interest
rate
|
Amounts
|
Interest
rate
|
|||||||||||||
Bank
loans
|
||||||||||||||||
Everbright
Bank
|
$
|
-
|
$
|
586
|
6.37
|
%
|
||||||||||
Construction
Bank of China
|
4,530
|
7.67%
-8.44
|
%
|
2,930
|
7.67%
-8.44
|
%
|
||||||||||
Total
|
$
|
4,530
|
$
|
3,516
|
As of
December 31, 2010 and March 31, 2010, short-term loans were guaranteed by
Huangling Qinlong Ltd., an unrelated third party, and two of the Owners, Xi’an
Ocean Petro-chemical Construction Co. and Anping Yao, who is also the Company’s
Chief Executive Officer.
Note
7 - Notes payable
Notes
payable are lines of credit extended by the banks. When purchasing raw
materials, the Company often issues a short term note payable to the vendor
funded with draws on the Company’s lines of credit. Such note is
guaranteed by the bank from which line of credit it is drawn upon for its
complete face value and usually matures within nine months to one year of its
issuance date. The banks do not charge interest but require the Company to
deposit a certain amount of cash with them as a guarantee deposit, which is
classified on the balance sheet as restricted cash. In addition, the
banks charge processing fees based on the face value of the note.
As of
December 31, 2010, $4,745,000 of restricted cash was deposited as collateral for
$13,804,000 of notes, which was approximately 34% of the notes issued by the
Company. As of March 31, 2010, $6,812,000 of restricted cash was
deposited as collateral for $12,452,000 of notes, which was approximately 55% of
the notes issued by the Company.
Note
8 – Income taxes
Effective
on January 1, 2008, the PRC Enterprise Income Tax Law and its Implementing Rules
imposed a unified enterprise income tax rate of 25% on all domestic-invested
enterprises and foreign-invested enterprises in the PRC, from 33% prior to
January 1, 2008, unless they qualify under certain limited
exceptions.
The
Company adopted the provisions of FASB ASC 740 “Income Taxes.” ASC 740
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. FASB ASC 740 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and the transition. The Company’s adoption of
FASB ASC 740 had no impact on the Company beginning retained earnings, balance
sheets, or statements of operations.
United
States
The
Company is incorporated in Nevada and is subject to the tax law of the
United States of America (the “U.S.”). It is management's intention to
reinvest all the income attributable to the Company earned by its operations
outside the U.S. Accordingly, no U.S. corporate income taxes are provided in
these condensed consolidated financial statements.
BVI
Under the
current laws of the BVI, dividends and capital gains arising from the Company's
investments in the BVI are not subject to income taxes.
PRC
Income
taxes consist of the following at the dates indicated (amount in
thousands):
14
Three
months ended
December
31,
|
Nine
months ended
December
31,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Income
tax expenses:
|
||||||||||||||||
Current
|
$
|
2,297
|
$
|
1,525
|
$
|
6,270
|
$
|
4,181
|
||||||||
Deferred
|
-
|
-
|
-
|
-
|
||||||||||||
Total
|
$
|
2,297
|
$
|
1,525
|
$
|
6,270
|
$
|
4,181
|
The
Company’s effective income tax rate differed from the PRC statutory income tax
rate of 25% for the periods indicated as follows:
Three
months ended
December
31,
|
Nine
months ended
December
31,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Statutory
income tax rate
|
25
|
%
|
25
|
%
|
25
|
%
|
25
|
%
|
||||||||
Change
in income tax rate
|
-
|
-
|
-
|
-
|
||||||||||||
Valuation
allowance
|
-
|
-
|
-
|
-
|
||||||||||||
Effective
income tax rate
|
25
|
%
|
25
|
%
|
25
|
%
|
25
|
%
|
The
Company has not provided deferred taxes on undistributed earnings attributable
to its subsidiaries as they are to be permanently reinvested. On
February 22, 2008, the PRC’s Ministry of Finance (“MOF”) and the State
Administration of Taxation (“SAT”) jointly issued Cai Shui [2008] Circular 1
(“Circular 1”). According to Article 4 of Circular 1, distributions
of accumulated profits earned by wholly foreign owned enterprises (“WFOE”) prior
to January 1, 2008 to foreign investors will be exempt from withholding tax
(“WHT”) while distributions after January 1, 2008 to foreign investors shall be
subject to WHT.
Since the
Company intends to reinvest its earnings to further expand its businesses in the
PRC, its WFOE does not intend to declare dividends to its
immediate parent company in the foreseeable
future. Accordingly, the Company has not recorded any WHT on the
cumulative amount of distributed and undistributed retained
earnings.
Should
the Company’s WFOE distributes all of its profits generated after
December 31, 2007, the aggregate withholding tax amount would have been
approximately $4,366,000 and $2,483,000 as of December 31, 2010 and March 31,
2010, respectively.
Note
9 – Stockholders equity
On
September 1, 2010, the Company entered into a Securities Purchase
Agreement with Ms. Gao, pursuant to which the Company agreed to issue and
sell 8,250,000 shares of its common stock, par value $0.001 per share, to Ms.
Gao for $0.003 per share.
On
September 7, 2010, the Company executed a share exchange agreement (the
“Exchange Agreement”) by and between Orient BVI and the holders of 100% of
Orient BVI’s issued and outstanding capital stock, on the one hand, and the
Company and Ms. Gao on the other hand. The Company issued 27,100,000
shares of its common stock to the Orient BVI’s Stockholders in exchange for 100%
of the issued and outstanding capital stock of Orient
BVI. Concurrently, Ms. Gao cancelled 13,250,000 shares of the
Company’s common stock held by her, which constituted 82.04% of the Company’s
issued and outstanding common stock immediately prior to the closing of the
Exchange Agreement.
Note
10 – Reserves
Under PRC
regulations, Orient Petroleum is permitted to pay dividends only out of its
accumulated profits, if any, as determined in accordance with PRC
GAAP. In addition, Orient Petroleum sets aside 10% of its after-tax
net profits each year, as required by PRC regulation, to fund its statutory
reserves until the balance of the reserves reaches 50% of its registered
capital. The statutory reserves are not distributable in the form of
cash dividends to the Company but can be used to make up prior year cumulative
losses and to increase its registered capital.
Note
11 – Commitments and contingencies
Prepaid
lease
15
On
January 1, 2006, the Company entered into a 10-year non-cancelable and renewable
operating lease agreement with Minxiao Zhao from January 1, 2006 to
December 31, 2015 for the purpose of retail gas station
operation. The annual lease payment is $90,000 (RMB 600,000). The
Company has paid approximately $895,000 (RMB 6,000,000) in advance as prepaid
lease payments over the next ten years, which will be amortized
accordingly.
On
October 1, 2006, the Company entered into a 15-year non-cancelable and
renewable operating lease agreement with Shann’xi Shengda Oil&Gas Co., Ltd.
from October 1, 2006 to September 30, 2021 for the purpose of retail gas
station operation. The annual lease payment is $89,000 (RMB 593,000).
The Company has paid approximately $1,328,000 (RMB 8,900,000) in advance as
prepaid lease payments over the next fifteen years, which will be amortized
accordingly.
On
November 1, 2006, the Company entered into a 15-year non-cancelable and
renewable operating lease agreement with Shann’xi Huawei Trading Ltd. from
November 1, 2006 to October 31, 2021 for the purpose of retail gas station
operation. The annual lease payment is $80,000 (RMB 533,000). The
Company has paid approximately $1,194,000 (RMB 8,000,000) in advance as prepaid
lease payments over the next fifteen years, which will be amortized
accordingly.
On
October 1, 2008, the Company entered into a 15-year non-cancelable and
renewable operating lease agreement with Shann’xi Huawei Trading Ltd. from
October 1, 2008 to September 30, 2023 for the purpose of retail gas station
operation. The annual lease payment is $80,000 (RMB 533,000). The
Company has paid approximately $1,194,000 (RMB 8,000,000) in advance as prepaid
lease payments over the next fifteen years, which will be amortized
accordingly.
On
October 1, 2008, the Company entered into a 15-year non-cancelable and
renewable operating lease agreement with Yu Hengming from October 1, 2008 to
September 30, 2023 for the purpose of retail gas station
operation. The annual lease payment is $75,000 (RMB 500,000). The
Company has paid approximately $1,119,000 (RMB 7,500,000) in advance as prepaid
lease payments over the next fifteen years, which will be amortized
accordingly.
On
November 1, 2008, the Company entered into a 15-year non-cancelable and
renewable operating lease agreement with Shann’xi Yanxing Petro-chemical Trading
Co., Ltd. from November 1, 2008 to October 31, 2023 for the purpose of retail
gas station operation. The annual lease payment is $119,000 (RMB
800,000). The Company has paid approximately $1,791,000 (RMB 12,000,000) in
advance as prepaid lease payments over the next fifteen years, which will be
amortized accordingly.
On
October 1, 2009, the Company entered into a 15-year non-cancelable and
renewable operating lease agreement with Weng Wang’an from October 1, 2009 to
September 30, 2024 for the purpose of retail gas station
operation. The annual lease payment is $80,000 (RMB 533,000). The
Company has paid approximately $1,194,000 (RMB 8,000,000) in advance as prepaid
lease payments over the next fifteen years, which will be amortized
accordingly.
On
November 1, 2009, the Company entered into a 15-year non-cancelable and
renewable operating lease agreement with Liu Jimin from November 1, 2009 to
October 31, 2024 for the purpose of retail gas station operation. The
annual lease payment is $119,000 (RMB 800,000). The Company has paid
approximately $1,791,000 (RMB 12,000,000) in advance as prepaid lease payments
over the next fifteen years, which will be amortized accordingly.
On
December 1, 2009, the Company entered into a 15-year non-cancelable and
renewable operating lease agreement with Weinan Jinzheng Petro-chemical Co.,
Ltd. from December 1, 2009 to November 30, 2024 for the purpose of retail gas
station operation. The annual lease payment is $149,000 (RMB
1,000,000). The Company has paid approximately $2,238,000 (RMB 15,000,000) in
advance as prepaid lease payments over the next fifteen years, which will be
amortized accordingly.
Lease
commitments
At
December 31, 2010, the total future minimum lease payments under operating
leases were as follows (amounts in thousands):
Amount
|
||||
12
months ending December 31, 2011
|
$
|
90
|
||
12
months ending December 31, 2012
|
60
|
|||
12
months ending December 31, 2013
|
60
|
|||
12
months ending December 31, 2014
|
60
|
|||
12
months ending December 31, 2015
|
60
|
|||
Thereafter
|
559
|
|||
Total
|
$
|
889
|
16
For the
three months ended December 31, 2010 and 2009, the Company had lease expenses of
$299,000 and $312,000, respectively. For the nine months ended
December 31, 2010 and 2009, the Company had lease expenses of $881,000 and
$707,000, respectively.
Note
12 – Business and credit concentrations
The
Company operates in the wholesale and retail oil distribution industries and
generates all of its sales in the PRC. The PRC wholesale and retail
oil distribution industries are impacted by the general
economy. Changes in the marketplace would significantly affect
management’s estimates and the Company’s performance.
The
Company had the following concentrations of business with each customer
constituting 10% or more of the Company’s sales for the periods
indicated:
Three
months ended
December
31,
|
Nine
months ended
December
31,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Customer
|
||||||||||||||||
A
|
12 | % | * | 12 | % | * |
*indicates
concentrations of business with the customer constituting less than 10% of the
Company’s sales for the period.
The
Company had the following concentrations of business with each vendor
constituting 10% or more of the Company’s purchases for the periods
indicated:
Three
months ended
December
31,
|
Nine
months ended
December
31,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Vendors
|
||||||||||||||||
A
|
52 | % | 54 | % | 53 | % | 57 | % | ||||||||
B
|
31 | % | 37 | % | 30 | % | 34 | % |
Note
13 – Benefit plan
Pursuant
to relevant PRC regulations, Orient Petroleum participates in a local municipal
government retirement benefits scheme (the “Scheme”), whereby Orient Petroleum
is required to contribute a certain percentage of the basic salaries of its
employees to the Scheme to fund their retirement
benefits. Contributions under the Scheme charged to income statement
for the three months ended December 31, 2010 and 2009 were $6,000 and $10,000,
respectively. Contributions under the Scheme charged to income
statement for nine months ended December 31, 2010 and 2009 were $30,000 and
$21,000, respectively.
Note
14 – Segment information
Based on
FASB ASC 280 “Segment Reporting,” the Company identified two operating segments,
wholesale distribution of finished oil and retail gas stations. The
Company evaluates segment performance based on gross profit. The following table
summarizes the Company's revenue and cost of sales in each segment for the
periods indicated (amounts in thousands):
Three
months ended
December
31,
|
Nine
months ended
December
31,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Revenue
|
||||||||||||||||
Wholesale
distribution
|
$
|
47,102
|
$
|
31,533
|
$
|
127,129
|
$
|
94,933
|
||||||||
Retail
gas stations
|
17,483
|
12,825
|
48,937
|
33,296
|
||||||||||||
Sales
tax and surcharges
|
(158
|
)
|
(122
|
)
|
(449
|
)
|
(324
|
)
|
||||||||
Wholesale
distribution
|
46,987
|
31,446
|
126,805
|
94,693
|
||||||||||||
Retail
gas stations
|
17,440
|
12,790
|
48,812
|
33,212
|
||||||||||||
Cost
of sales
|
||||||||||||||||
Wholesale
distribution
|
39,471
|
27,456
|
106,861
|
83,390
|
||||||||||||
Retail
gas stations
|
14,468
|
9,674
|
40,397
|
25,051
|
||||||||||||
Gross
profit
|
||||||||||||||||
Wholesale
distribution
|
7,516
|
3,990
|
19,944
|
11,303
|
||||||||||||
Retail
gas stations
|
2,972
|
3,116
|
8,415
|
8,161
|
||||||||||||
Total
Gross profit
|
10,488
|
7,106
|
28,359
|
19,464
|
Substantially
all of the Company's assets are located in the PRC. Management has
determined that most of the Company’s assets are shared by the two segments, and
cannot be allocated by segment on a reasonable basis and in a cost-effective
manner. Accordingly, no analysis of the carrying amount of segment assets is
presented.
17
Item2. Management’s Discussion and Analysis
of Results of Operations and Financial Conditions
This
Quarterly Report on Form 10-Q (“Form 10-Q”) and the documents we
incorporate by reference herein include forward-looking statements. All
statements other than statements of historical facts contained in this Form 10-Q
and the documents we incorporate by reference, including statements regarding
our future financial position, business strategy and plans and objectives of
management for future operations, are forward-looking statements. The
words “believe,” “may,” “estimate,” “continue,” “anticipate,” “intend,”
“should,” “plan,” “could,” “target,” “potential,” “is likely,” “will,” “expect”
and similar expressions, as they relate to us, are intended to identify
forward-looking statements within the meaning of the “safe harbor” provisions of
Section 27A of the Securities Act of 1933, as amended, and Section 21E
of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). We have
based these forward-looking statements largely on our current expectations and
projections about future events and financial trends that we believe may affect
our financial condition, results of operations, business strategy and financial
needs.
These
forward-looking statements are subject to a number of risks, uncertainties and
assumptions described set forth under the Risk Factors and elsewhere in
this Form 10-Q. In addition, our past results of operations do not
necessarily indicate our future results. New risk factors emerge from
time to time and it is not possible for us to predict all such risk factors, nor
can we assess the impact of all such risk factors on our business or the extent
to which any risk factor, or combination of risk factors, may cause actual
results to differ materially from those contained in any forward-looking
statements.
Except
as otherwise required by applicable laws, we undertake no obligation to publicly
update or revise any forward-looking statements or the risk factors described in
this Form 10-Q or in the documents we incorporate by reference, whether as
a result of new information, future events, changed circumstances or any other
reason after the date of this Form 10-Q. You should not rely upon
forward-looking statements as predictions of future events or performance. We
cannot assure you that the events and circumstances reflected in the
forward-looking statements will be achieved or occur. Although we believe that
the expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements.
Overview
Orient
Petroleum and Energy, Inc. (“Orient” or the “Company”), formally known as Xtreme
Link, Inc, is in the business of wholesale distribution of finished oil products
(such as gasoline, diesel and methanol gasoline) and operation of retail gas
stations as a result of the share exchange transaction described
below.
On
September 7, 2010, the Company executed a share exchange agreement (the
“Exchange Agreement”) by and between Orient New Energy Investments Limited, a
British Virgin Islands company (“Orient BVI”), and the holders of 100% of Orient
BVI’s issued and outstanding capital stock (the “Orient BVI Stockholders”), on
the one hand, and the Company and Hong Gao (“Ms. Gao”) on the other hand. At the
closing of the Exchange Agreement (the “Closing”), the Company issued 27,100,000
shares of its common stock to the Orient BVI Stockholders in exchange for 100%
of the capital stock of Orient BVI. Concurrently, Ms. Gao cancelled 13,250,000
shares of the Company’s common stock held by her, which constituted 82.04% of
the Company’s issued and outstanding common stock immediately prior to the
Closing. Immediately after the Closing, the Company had a total of 30,000,000
shares of common stock issued and outstanding, with the Orient BVI Stockholders
owning approximately 90.33% in the aggregate, and the balance held by those who
held the Company’s common stock prior to the Closing. As a result of the share
exchange transaction, the Orient BVI Stockholders became the Company’s
controlling shareholders and Orient BVI became the Company’s wholly-owned
subsidiary, and the Company acceded to the businesses and operations of Orient
BVI.
All of
the Company’s business operations are currently conducted in the People’s
Republic of China (“PRC” or “China”) by Xi’an Orient Petroleum Group Co., Ltd.
(“Orient Petroleum”), a PRC limited liability company. Orient
controls Orient Petroleum through a series of contractual arrangements entered
into with Orient Petroleum and its owners by Orient New Energy Xi’an Ltd.
(“Orient Xi’an”), a PRC company. Orient Xi’an is wholly-owned by
Orient New Energy Holdings Limited (“Orient Hong Kong”), a Hong Kong company
wholly owned by Orient BVI.
Critical
Accounting Policies and Estimates
Certain
of the Company’s accounting policies are important to the portrayal of the
Company’s financial condition, since they require management to make difficult,
complex or subjective judgments, some of which may relate to matters that are
inherently uncertain. Estimates associated with these policies are
susceptible to material changes as a result of changes in facts and
circumstances.
18
While our
significant accounting policies are more fully described in Note 2 to
our consolidated financial statements, we believe that the following
accounting policies are the most critical to aid you in fully understanding and
evaluating this management discussion and analysis:
Revenue
recognition
The
Company’s revenue recognition policies are in compliance with SEC Staff
Accounting Bulletin (“SAB”) 104. Revenue from the sales of goods is
recognized on the transfer of significant risks and rewards of ownership, which
generally coincides with the time when the goods are delivered and the title has
passed to the customers. For wholesale distribution of finished oil
where the selling price is set forth in a sales contract, sales revenue is
recognized at the date of shipment. No other significant obligations of the
Company exist and collectability is reasonably assured. For gas station
retail sales, revenue is recognized and cash is collected upon completion of
sales to customers. Revenue excludes value-added tax and is arrived at
after deduction of trade discounts and allowances.
Interest
income is recognized on a time proportion basis, taking into account the
principal amounts outstanding and the applicable interest rates.
Allowance for doubtful
accounts
The
allowance for doubtful accounts is the Company's best estimate of the amount of
probable credit losses in the Company's existing 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. As of December 31, 2010, and
March 31, 2010, the management determined no allowance for uncollectible amounts
was required.
Use of
Estimates
The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates. Areas that require estimates and
assumptions include valuation of accounts receivable and determination of useful
lives of property, plant and equipment.
Results
of Operations
Comparison
of results of operations for the three and nine months ended December 31, 2010
and 2009
Three
months ended December 31,
|
Nine
months ended December 31,
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||||||||||||||||||
Amount
|
%
of net sales
|
Amount
|
%
of net sales
|
Amount
|
%
of net sales
|
Amount
|
%
of net sales
|
|||||||||||||||||||||||||
Net
sales
|
$
|
64,427
|
100.00
|
%
|
$
|
44,236
|
100.00
|
%
|
$
|
175,617
|
100.00
|
%
|
$
|
127,905
|
100.00
|
%
|
||||||||||||||||
Gross
profit
|
10,488
|
16.28
|
%
|
7,106
|
16.06
|
%
|
28,359
|
16.15
|
%
|
19,464
|
15.22
|
%
|
||||||||||||||||||||
Operating
expenses
|
||||||||||||||||||||||||||||||||
Selling
expenses
|
(777
|
)
|
(1.21
|
)%
|
(762
|
)
|
(1.72
|
)%
|
(2,230
|
)
|
(1.27
|
)%
|
(2,031
|
)
|
(1.59
|
)%
|
||||||||||||||||
General
and administrative expenses
|
(207
|
)
|
(0.32
|
)%
|
(125
|
)
|
(0.28
|
)%
|
(525
|
)
|
(0.30
|
)%
|
(413
|
)
|
(0.32
|
)%
|
||||||||||||||||
Income
from operations
|
9,504
|
14.75
|
%
|
6,219
|
14.06
|
%
|
25,604
|
14.58
|
%
|
17,020
|
13.31
|
%
|
||||||||||||||||||||
Other
expense
|
(314
|
)
|
(0.49
|
)%
|
(123
|
)
|
(0.28
|
)%
|
(500
|
)
|
(0.28
|
)%
|
(298
|
)
|
(0.23
|
)%
|
||||||||||||||||
Income
tax expenses
|
(2,297
|
)
|
(3.57
|
)%
|
(1,525
|
)
|
(3.45
|
)%
|
(6,270
|
)
|
(3.57
|
)%
|
(4,181
|
)
|
(3.27
|
)%
|
||||||||||||||||
Net
income
|
$
|
6,893
|
10.70
|
%
|
$
|
4,571
|
10.34
|
%
|
$
|
18,834
|
10.72
|
%
|
$
|
12,541
|
9.80
|
%
|
19
Net
Sales
We
operate two business segments: wholesale distribution of finished oil products
and operation of retail gas stations. Net sales from our two business segments
for the three months ended December 31, 2010 increased by $20 million or 46%
from the same period in 2009. Net sales for the nine months ended
December 31, 2010 increase by $48 million or 37% from the same period in
2009. The increases were mainly due to sales growth generated by the
wholesale segment, as well as increases in our average wholesale and retail
selling prices.
The
following table is a breakdown of our net sales by business segments for
the periods indicated (amounts in thousands):
Three
months ended December 31,
|
Nine
months ended December 31,
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||||||||||||||||||
Amount
|
%
of net sales
|
Amount
|
%
of net sales
|
Amount
|
%
of net sales
|
Amount
|
%
of net sales
|
|||||||||||||||||||||||||
Wholesale
distribution of finished oil
|
$
|
47,102
|
73.11
|
%
|
$
|
31,533
|
71.29
|
%
|
$
|
127,129
|
72.39
|
%
|
$
|
94,933
|
74.22
|
%
|
||||||||||||||||
Gas
stations
|
17,483
|
27.14
|
%
|
12,825
|
28.99
|
%
|
48,937
|
27.87
|
%
|
33,296
|
26.03
|
%
|
||||||||||||||||||||
Sales
tax and surcharges
|
(158
|
)
|
(0.25
|
)%
|
(122
|
)
|
(0.28
|
)%
|
(449
|
)
|
(0.26
|
)%
|
(324
|
)
|
(0.25
|
)%
|
||||||||||||||||
Total
net sales
|
$
|
64,427
|
100.00
|
%
|
$
|
44,236
|
100.00
|
%
|
$
|
175,617
|
100.00
|
%
|
$
|
127,905
|
100.00
|
%
|
Sales
from wholesale distribution for the three months ended December 31, 2010
increased by $15.6 million, or 49%, from the same period in 2009 due
to increases in sales volume and price. Sales volume increased
from 38,323 metric tons for the three months ended December 31, 2009 to 46,941
metric tons for the same period in 2010, an increase of 8,618 metric tons or
22%. In addition, average selling price increased by 22%
period-over-period. Sales from wholesale distribution for the nine
months ended December 31, 2010 increased by $32 million, or 34%, as compared to
the same period in 2009, also due to increases in sales volume and
price. Sales volume increased by 9,774 metric tons or 8%, from
122,130 metric tons for the nine months ended December 31, 2009 to 131,904
metric tons for the same period in 2010. In addition, average selling
price increased by 24% over the same nine month periods. The increased sales
volume is attributable to increased vehicle ownerships over the periods reported
and our enhanced sales efforts. The increased price is the result of three price
hikes effected by the PRC National Development and Reform Commission (“NDRC”)
during 2010 in response to rising international crude oil price. The latest price adjustment by
NDRC was on December 22, 2010, which raised wholesale guidance price of finished
oil by approximately $45 per metric ton.
Sales
from retail gas stations for the three months ended December 31, 2010 increased
by $4.7 million or 36%, from the same period in 2009, mainly due to increases in
sales volume and price. Sales volume for the three months ended
December 31, 2010 increased by 3,309 metric tons, or 25%, to 16,715 metric tons
from 13,406 metric tons for the same period in 2009. In addition,
average selling price increased by 9% period-over-period. Sales from
retail gas stations for the nine months ended December 31, 2010 increased by $16
million or 47%, as compared to the same period in 2009, also due to increases in
sales volume and price. Sales volume for the nine months ended
December 31, 2010 increased by 11,896 metric tons, or 33%, to 48,357 metric tons
from 36,461 metric tons for the same period in 2009. In addition,
average selling price increased by 11% over the same nine month periods. The
increased sales volume is attributable to the three new gas stations that we
opened during the last three months of 2009. We also had to raise our retail
price in response to the NDRC’s price adjustments. The latest price adjustment
by NDRC on December 22, 2010 also raised retail price cap of finished oil by
approximately $45 per metric ton.
The
following table sets forth our average per metric ton selling prices by business
segments for the periods indicated:
Three
months ended
December
31,
|
Nine
months ended
December
31,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Wholesale
distribution of finished oil
|
$
|
1,003
|
$
|
823
|
$
|
963
|
$
|
777
|
||||||||
Retail
gas stations
|
$
|
1,046
|
$
|
957
|
$
|
1,012
|
$
|
913
|
20
Based on
the historical trend of international crude oil price, we can expect our
wholesale and retail prices to continue to increase. We also anticipate the NDRC
to effectuate another price hike after the Chinese New Year. At the same time,
we believe that the NDRC should continue to adjust price gradually as it has
done in the past in order to ease consumer sensitivity. In addition, we believe
that the trend of rising vehicle ownerships should continue in China.
Accordingly, we are hopeful that anticipated price increases should not have any
materially adverse effect on our business operations and prospects in the near
term.
Cost
of Sales and Gross Profit Margin
Cost of
sales includes inventory cost of products sold. The following table
sets forth our cost of sales and gross profit both in absolute amounts and as a
percentage of net sales for the periods indicated (amounts in
thousands):
Three
months ended December 31,
|
Nine
months ended December 31,
|
|||||||||||||||||||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||||||||||||||||||
Amount
|
%
of net sales
|
Amount
|
%
of net sales
|
Amount
|
%
of net sales
|
Amount
|
%
of net sales
|
|||||||||||||||||||||||||
Net
sales
|
$
|
64,427
|
100.00
|
%
|
$
|
44,236
|
100.00
|
%
|
$
|
175,617
|
100.00
|
%
|
$
|
127,905
|
100.00
|
%
|
||||||||||||||||
Cost
of sales
|
(53,939
|
)
|
(83.72
|
)%
|
(37,130
|
)
|
(83.94
|
)%
|
(147,258
|
)
|
(83.85
|
)%
|
(108,441
|
)
|
(84.78
|
)%
|
||||||||||||||||
Gross
profit
|
$
|
10,488
|
16.28
|
%
|
$
|
7,106
|
16.06
|
%
|
$
|
28,359
|
16.15
|
%
|
$
|
19,464
|
15.22
|
%
|
Cost of
sales increased by $17 million for the three months ended December 31, 2009 as
compared to the three months ended December 31, 2010 due to increased sales
activities. At the same time, cost of sales as a percentage to net
sales decreased, from 83.9% to 83.7%, as the increase to our wholesale and
retail selling prices in response to the NDRC’s finished oil price
adjustments, exceeded the increase to our purchase price of
petroleum. Consequently, gross margin as a percentage of net sales
increased to 16.3% for the three months ended December 31, 2010 as compared to
16.1% for the same period in 2009.
Likewise,
cost of sales as a percentage of net sales decreased to 83.9% for the nine
months ended December 31, 2010, from 84.8% for the same nine-month period of
2009, despite an increase in cost of sales of $39 million from increased sales
period-over-period. As a result, gross margin as a percentage of net sales
increased to 16.2% for the nine months ended December 31, 2010 as compared to
15.2 % a year ago.
The
following table sets forth net sales, cost of sales, gross profit and gross
margin by business segments for the periods indicated (amounts in
thousands):
Three
months ended December 31,
|
||||||||||||||||||||||||||||||||
2010
|
2009
|
|||||||||||||||||||||||||||||||
Net
sales
|
Cost
of Sales
|
Gross
profit
|
Gross
margin
|
Net
sales
|
Cost
of sales
|
Gross
profit
|
Gross
margin
|
|||||||||||||||||||||||||
Wholesale
distribution of finished oil
|
$
|
46,987
|
$
|
(39,471
|
)
|
$
|
7,516
|
16.00
|
%
|
$
|
31,446
|
$
|
(27,456
|
)
|
$
|
3,990
|
12.69
|
%
|
||||||||||||||
Gas
stations
|
17,440
|
(14,468
|
)
|
2,972
|
17.04
|
%
|
12,790
|
(9,674
|
)
|
3,116
|
24.36
|
%
|
||||||||||||||||||||
Total
|
$
|
64,427
|
$
|
(53,939
|
)
|
$
|
10,488
|
16.28
|
%
|
$
|
44,236
|
$
|
(37,130
|
)
|
$
|
7,106
|
16.06
|
%
|
Nine
months ended December 31,
|
||||||||||||||||||||||||||||||||
2010
|
2009
|
|||||||||||||||||||||||||||||||
Net
sales
|
Cost
of Sales
|
Gross
profit
|
Gross
margin
|
Net
sales
|
Cost
of sales
|
Gross
profit
|
Gross
margin
|
|||||||||||||||||||||||||
Wholesale
distribution of finished oil
|
$
|
126,805
|
$
|
(106,861
|
)
|
$
|
19,944
|
15.73
|
%
|
$
|
94,693
|
$
|
(83,390
|
)
|
$
|
11,303
|
11.94
|
%
|
||||||||||||||
Gas
stations
|
48,812
|
(40,397
|
)
|
8,415
|
17.24
|
%
|
33,212
|
(25,051
|
)
|
8,161
|
24.55
|
%
|
||||||||||||||||||||
Total
|
$
|
175,617
|
$
|
(147,258
|
)
|
$
|
28,359
|
16.15
|
%
|
$
|
127,905
|
$
|
(108,441
|
)
|
$
|
19,464
|
15.22
|
%
|
Our cost
of sales is largely driven by the international crude oil price, which impacts
the pricing guidance set by the NDRC. As noted earlier, we anticipate the
increase in oil price to continue based on the historical trend of international
crude oil price. As such, we expect that our cost of sales should continue to
increase. To some extent, however, we can control our costs of sales by
adjusting our inventory of finished oil. In addition, since the NDRC currently
does not have pricing control on methanol gasoline, we can control its
associated cost of sales through sourcing and managing orders.
21
Operating
Expenses
Selling
Expenses
Selling
expenses include rental expense for our gas stations, freight, payroll for both
our wholesale and retail operations, depreciations and taxes. Selling
expenses increased by $15,000 for the three months ended December 31, 2009 as
compared to the three months ended December 31, 2010. The increase was mainly
due to increased payroll, from $108,000 to $136,000.
Selling
expenses increased by $199,000 for the nine months ended December 31, 2009 as
compared to the nine months ended December 31, 2010. The increase was
mainly due to increased rental expense, which increased from $707,000 to
$881,000, offset by a decrease in freight from $635,000 to
$550,000. Increased sales activities and the resulting payroll
increase, from $335,000 to $416,000, also contributed to the
increase.
General
and Administrative Expenses
General
and administrative expenses include salaries for administrative and accounting
personnel, professional fees, travel expenses, research and development, and
local water conservancy fund.
General
and administrative expenses increased to $207,000 for the three months ended
December 31, 2010 from $125,000 for the same period in 2009, from increase in
salaries, professional fees, water conservancy fund payments and travel
expenses. Research and development, which mainly consists of payroll, decreased
from $4,394 to $2,706 period-over-period due to personnel
reduction.
General
and administrative expenses increased to $525,000 for the nine months ended
December 31, 2010 as compared to $413,000 for the same period in 2009, from
increase in local water conservancy fund payments, salaries and professional
fees. Research and development decreased from $13,394 to $9,706
period-over-period.
Interest
Expenses
Interest
expenses increased to $338,000 for the three months ended December 31, 2010 as
compared to $125,000 for the same period in 2009. Interest expenses
increased to $588,000 for the nine months ended December 31, 2010 as compared to
$368,000 for the same period in 2009. This increase was mainly due to
an increase of our short-term loan borrowings for the periods reported for
2010.
Income
Tax Expenses
Income
tax expenses for the three months ended December 31, 2010 increased by $772,000
as compared to the same period in 2009. Income tax expenses for the
nine months ended December 31, 2010 increased by $2,089,000 as compared to the
same period in 2009. The increased income tax expenses resulted from
higher taxable income generated for the periods reported for 2010.
Net
Income
Net
income from our two business segments for the three months ended December 31,
2010 increased by $2.3 million as compared to the three months ended December
31, 2009. Net income from our two business segments for the nine
months ended December 31, 2010 increased by $6.3 million as compared to our net
income for the nine months ended December 31, 2009. This increase was
mainly attributable to the increase in net sales offset by increases in cost of
sales and operating expenses.
Liquidity
and Capital Resources
In
summary, our cash flows are as follows for the periods indicated (amounts in
thousands):
Nine
months ended December 31,
|
||||||||
2010
|
2009
|
|||||||
Net
cash (used in) provided by operating activities
|
$
|
(1,902
|
)
|
$
|
17,290
|
|||
Net
cash used in investing activities
|
(262
|
)
|
(5,167
|
)
|
||||
Net
cash provided by (used in) financing activities
|
$
|
3,121
|
$
|
(11,929
|
)
|
22
We
presently finance our operations primarily from the cash flow from our
operations and short-term bank loans, and we anticipate that this will continue
to be our primary source of funds to finance our short-term cash
needs. If we require additional capital to expand or enhance our
existing facilities, we may consider debt or equity offerings or institutional
borrowing as potential means of financing.
As of
December 31, 2010, we had cash and cash equivalents of $2.8 million, other
current assets of $57.8 million and current liabilities of $22.6
million.
Net cash
used in operating activities for the nine months ended December 31, 2010 was
$1.9 million as compared with net cash provided by operating activities of
approximately $17.3 million for the same period in
2009. This decrease in net cash from operating
activities was mainly attributable to increased advance payments made to
our suppliers as required by our agreements with them.
Net cash
used in investing activities was $262,000 for the nine months ended December 31,
2010, as compared with $5,167,000 used in investing activities for the same
period in 2009. This decrease in net cash used in investing
activities was mainly due to decrease in prepayments of long-term leases for our
gas stations.
Net cash
provided by financing activities was $3.1 million for the nine months ended
December 31, 2010, as compared with $11.9 million net cash used in financing
activities for the same period in 2009. The decrease in net cash used in
financings activities was due to Orient Petroleum declaring and paying a $17.6
million dividend to its equity owners during the nine months ended December 31,
2009, offset by the capital injection of $10 million to Orient Petroleum made in
December 2009. No dividends were declared or paid by Orient Petroleum during the
same period in 2010.
Obligations
under Material Contracts
The
following table sets forth our material contractual obligations as of December
31, 2010 (amounts in thousands):
Payment
due by period
|
||||||||||||||||||||
Contractual
Obligations
|
Total
|
Less
than
1
year
|
1-3
years
|
3-5
years
|
More
than 5 years
|
|||||||||||||||
Operating
Lease Obligations
|
$
|
889
|
$
|
90
|
$
|
120
|
$
|
120
|
$
|
559
|
||||||||||
Total
|
$
|
889
|
$
|
90
|
$
|
120
|
$
|
120
|
$
|
559
|
Off-Balance
Sheet Arrangements
Item
3. Quantitative and Qualitative Disclosures About Market Risk
Foreign Exchange Rate
Risk
The
RMB is not a freely convertible currency. Limitation in foreign
exchange transactions imposed by the PRC government could cause future exchange
rates to vary significantly from current or historical exchange
rates.
Since our
business is conducted primarily in RMB, and we do not have any foreign currency
payments for imported equipments or materials, we do not have any foreign
exchange rate risk exposure.
Item
4. Controls and Procedures
Evaluation of Disclosure
Controls and Procedures
Our Chief
Executive Officer and Chief Financial Officer (collectively, the "Certifying
Officers") are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under
the Exchange Act) for us. Based on their evaluation of our disclosure
controls and procedures as of the end of the period covered by this quarterly
report on Form 10-Q, the Certifying Officers have concluded that (a) our
disclosure controls and procedures are effective for ensuring that information
required to be disclosed by us in the reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms; and (b) our disclosure controls
and procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by us under the Exchange Act is
accumulated and communicated to our management, including our principal
executive and principal financial officers, or persons performing similar
functions, as appropriate to allow timely decisions regarding required
disclosure.
23
Changes in Internal Control
over Financial Reporting
There
were no changes in our internal control over financial reporting that occurred
during the quarter ended December 31, 2010 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
PART
II: OTHER INFORMATION
Item
1.
|
Legal
Proceedings
|
None.
Item
1A.
|
Risk
Factors
|
You
should carefully consider the risks described below together with all of the
other information included in this Form10-Q before making an investment decision
with regard to our securities. The statements contained in or incorporated into
this Form 10-Q that are not historic facts are forward-looking statements that
are subject to risks and uncertainties that could cause actual results to differ
materially from those set forth in or implied by forward-looking statements. If
any of the following events described in these risk factors actually occurs, our
business, financial condition or results of operations could be harmed. In that
case, the trading price of our common stock could decline, and you may lose all
or part of your investment.
Risks
Related to Our Business and Industry
We
rely on a limited number of third-party suppliers for our supply of finished 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 products. Our five largest suppliers provided 99.41%, 96.55%, 96.79% and
87.78% of our finished oil requirements for nine-month ended December 31, 2010
and fiscal years ended March 31, 2010, 2009 and 2008, respectively, with our
largest supplier providing approximately 52.98%, 55.2%, 44.3% and 53.3%,
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 products
business in competition with us, we may be unable to procure sufficient amounts
of finished oil products to fulfill our demand. If we are unable to obtain
adequate quantities of finished 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. 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 products business segment, which accounted for
72,39%, 72.89%, 76.48% and 76.19% of our net sales in nine-month ended
December 31, 2010 and fiscal years ended March 31, 2010, 2009 and 2008,
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 diesel fuels, which are subject to government control in the PRC.
If petroleum and diesel 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 products, which are subject to state-imposed pricing control.
According to the Administrative Measures on Oil
Prices, Shaanxi Province Price Control Administration is responsible
for setting the retail price cap of gasoline and diesel oil products sold in
Shaanxi Province. We are allowed, subject to the retail price cap set by the
provincial government, to determine the retail price of our
products.
24
For the
nine months ended December 31, 2010, our average selling price for gasoline was
$1,048.49 per metric ton, and our average selling price for diesel was $928.24
per metric ton. For the years ended March 31, 2010, 2009 and 2008, our average
selling prices for gasoline were $846.73, $820.38 and $679.11 per metric ton,
respectively. Our average selling price for diesel were $802.07, $760.67 and
$671.94 per metric ton for the years ended March 31, 2010, 2009 and
2008.
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 finished oil products price. The PRC government can
also be expected to exercise price control over finished oil products once
international crude oil price experiences sustained growth or become
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 finished oil products as well as the discretionary
actions of the PRC government.
We
face substantial competition in our wholesale distribution of finished
oil.
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 both state-owned and non-state-owned companies based in Shaanxi
Province and elsewhere that engage in wholesale distribution of finished oil
products. In addition to state-owned petroleum enterprises such as SINOPEC and
PetroChina, there are currently 19 non-state-owned enterprises (including us) in
Shaanxi Province licensed to distribute finished oil products. Of the
non-state-owned enterprises, seven of them currently distribute finished oil
products similar to ours, including Shaanxi Dongda Petro-Chemical Co., Ltd.,
China Integrated Energy, Inc. and Shaanxi Zhonglian Petroleum Co., Ltd. Many of
our competitors 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.
An
increase in competition arising from an increase in the number or size of
competitors in the wholesale distribution of finished 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.
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 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.
Of
our two oil depots, only one currently has use of a dedicated railway
line connecting to the main railway in Shaanxi Province, which enables us to
distribute our products to customers within and outside Shaanxi Province. We
stopped using the railway line connecting the other depot because the loading
capacity of such depot does not meet the requirement of the Ministry of
Railways. We are now trying to get the governmental approval to use the railway
line, but we do not provide assurance that this approval will be
issued.
Our
gross margins in our wholesale distribution of finished 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 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.
25
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. Anping Yao, 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 management, 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
business will suffer if we cannot obtain, maintain or renew necessary permits or
licenses.
All PRC
enterprises engaging in the sale of finished oil products are required to obtain
from various PRC governmental authorities certain permits and licenses,
including, without limitation, the Certificate for Wholesale Distribution of
Finished Oil, the License for Retail Sale of Finished Oil and the Dangerous
Chemical Distribution License. We have obtained permits and licenses required
for the distribution of finished oil. 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.
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.
Our
legal right to lease certain properties 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 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
rely on leases with third parties who either own the properties or lease the
properties from the ultimate property owner. There may be challenges to the
title of the properties which, if successful, could impair the development or
operations of our oil storage depots 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.
26
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.
The building ownership or leasehold in connection with our oil storage depots
and gas retail operations could be subject to similar challenges.
The
breach of leasing agreements by our lessors may materially affect our ability to
conduct retail gas business.
Of the 13
gas stations that we currently operate, 11 of them are through lease agreements,
according to which the lessors have the proprietary right to all the assets of
the gas stations while we have the full management and operational rights within
the valid term of the lease agreements.
Although
in the opinion of our PRC counsel, Allbright Law Offices, each of these
lease agreements is valid, binding and enforceable, and will not result in
any violation of PRC laws or regulations currently in effect, they may not be as
effective in providing us with control of the gas stations as direct ownership,
and expose us to the risk of potential breach of contract by the owners of these
gas stations.
The
owners of these gas stations may breach, or cause the gas stations to breach,
the contracts for a number of reasons. For example, the interests of these
owners and our interests may conflict and we may fail to resolve such conflicts;
the owners may believe that breaching the contracts will lead to greater
economic benefit for them; or the owners may otherwise act in bad faith. If any
of the foregoing were to happen, we may have to rely on legal or arbitral
proceedings to enforce our contractual rights, including specific performance or
injunctive relief, and claiming damages. Such arbitral and legal proceedings may
cost us substantial financial and other resources, and result in disruption of
our business, and we cannot assure you that the outcome will be in our
favor.
Accidents
or injuries in or around our oil storage depots 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 or retail gas stations. Death and accidents could prevent us from
renewing our licenses and permits. One or more accidents or injuries at any of
our oil storage depots 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. We do not have insurance policy covering accidents on our properties
or injuries of our employees. If accidents or injuries occur, we may be held
liable for costs related to the damages or injuries, which 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.
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.
27
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. 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.
Risks
Related to Our Corporate Structure
If
the PRC government determines that the variable interest entity, or VIE,
structure for operating our business does not comply with PRC government
restrictions on foreign investment in the finished oil products industry, we
could face severe penalties.
Various
regulations in China currently restrict or prevent foreign-invested entities
from engaging in the wholesale and retail distribution of the finished oil
products. Because of these restrictions, our business operations are conducted
through our VIE, Orient Petroleum, a PRC company that is owned by three
Chinese nationals. However, Orient Petroleum is effectively controlled by
our subsidiary, Orient Xi’an, through a series of contractual arrangements. For
details of these contractual arrangements, see “Our Corporate History and
Structure.”
In the
opinion of our PRC counsel, Allbright Law Offices, (i) the structure for
operating our business and the business and operation model of each of our
subsidiaries and Orient Petroleum are in compliance with all existing PRC laws
and regulations, and (ii) each contract that Orient Xi’an entered into with
Orient Petroleum and its owners is valid and binding, and will not result in any
violation of PRC laws or regulations currently in effect. However, there are
substantial uncertainties regarding the interpretation and application of PRC
laws and regulations. Accordingly, we cannot assure you that the PRC regulatory
authorities will ultimately take a view that is consistent with the opinion of
our PRC counsel.
In
addition, new PRC laws, rules and regulations may be introduced from time to
time to impose additional requirements that may be applicable to our contractual
arrangements. For example, pursuant to the PRC Property Rights Law that became
effective on October 1, 2007, the pledge of any equity interests of a PRC
private entity shall become effective once it is duly registered with the local
branches of the State Administration for Industry and Commerce
(“SAIC”). Following the promulgation of the Property Law, SAIC
further issued the Administrative Measures for
Registrations of Share Pledge on September 1, 2008, which provided
detailed procedural guidance for the local SAIC offices to handle the
registrations of share pledge. The Equity Pledge Agreements entered by Orient
Xi’an and the owners of Orient Petroleum as part of the contractual arrangements
have created a legally binding obligation on the parties upon the execution
date; however, the pledge established under these agreements does not become
effective until due registration with local SAIC office.
If we are
found to be in violation of any existing or future PRC laws or regulations, the
relevant regulatory authorities would have broad discretion in dealing with such
violation, including levying fines, confiscating our income, revoking Orient
Petroleum’s or Orient Xi’an’s business or operating licenses, requiring us
to restructure the relevant ownership structure or operations, and
requiring us to discontinue all or any portion of our operations. Any of these
actions could cause significant disruption to our business
operations.
Due
to the lack of certainty in the interpretation and implementation of PRC
regulations relating to the establishment of offshore special purpose companies
by PRC residents, we cannot give assurance that the PRC regulatory authorities
will not determine that we are not in compliance with such
regulations.
Under
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 (“Circular 75”) issued in October 2005 by the PRC State
Administration of Foreign Exchange (“SAFE”), PRC residents are required to
register with the competent local SAFE branch before establishing or acquiring
control over an offshore special purpose company, or SPV, for the purpose of
engaging in an equity financing outside of China on the strength of domestic PRC
assets originally held by those residents. Internal implementing guidelines
issued by SAFE, which became public in June 2007 (“Notice 106”), expanded the
reach of Circular 75 by (1) purporting to cover the establishment or acquisition
of control by PRC residents of offshore entities which merely acquire “control”
over domestic companies or assets, even in the absence of legal ownership; (2)
adding requirements relating to the source of the PRC resident’s funds used to
establish or acquire the offshore entity; covering the use of existing offshore
entities for offshore financings; (3) purporting to cover situations in which an
offshore SPV establishes a new subsidiary in China or acquires an unrelated
company or unrelated assets in China; and (4) making the domestic affiliate of
the SPV responsible for the accuracy of certain documents which must be filed in
connection with any such registration, notably, the business plan which
describes the overseas financing and the use of proceeds. Amendments to
registrations made under Circular 75 are required in connection with any
increase or decrease of capital, transfer of shares, mergers and acquisitions,
equity investment or creation of any security interest in any assets
located in China to guarantee offshore obligations, and Notice 106 makes the
offshore SPV jointly responsible for these filings. In the case of an SPV which
was established, and which acquired a related domestic company or assets, before
the implementation date of Circular 75, a retroactive SAFE registration was
required to have been completed before March 31, 2006; this date was
subsequently extended indefinitely by Notice 106, which also required that the
registrant establish that all foreign exchange transactions undertaken by the
SPV and its affiliates were in compliance with applicable laws and regulations.
Failure to comply with the requirements of Circular 75, as applied by SAFE in
accordance with Notice 106, may result in fines and other penalties under PRC
laws for evasion of applicable foreign exchange restrictions. Any such failure
could also result in the SPV’s affiliates being impeded or prevented from
distributing their profits and the proceeds from any reduction in capital, share
transfer or liquidation to the SPV, or from engaging in other transfers of funds
into or out of China.
28
The
owners of Orient Petroleum are PRC nationals. They did not, however, establish
Orient or Orient Hong Kong, and the equity interests of Ultimate Sino Holdings
Limited (“Ultimate”), our majority shareholder after the Exchange, will not
transfer to them until their option exercise under their option agreement with
the current shareholder of Ultimate, a Philippines passport holder. As such, we
have been advised by Allbright Law Offices, our PRC counsel, that SAFE
registration is presently not required. However, due to the continuing
uncertainty over how Circular 75 is interpreted and implemented, and how SAFE
will apply it to us, we cannot give assurance that the PRC regulatory
authorities will agree with our PRC counsel, or predict how it will affect our
business operations or future strategies.
Orient
Xi’an’s contractual arrangements with Orient Petroleum and its owners may not be
as effective in providing control over Orient Petroleum as direct ownership of
Orient Petroleum and the owners of Orient Petroleum may have potential conflicts
of interest with us.
We have
no ownership interest in Orient Petroleum and conduct substantially all of our
operations and generate substantially all our revenues through contractual
arrangements that our indirect subsidiary, Orient Xi’an, has entered into with
Orient Petroleum and its owners, and such contractual arrangements are designed
to provide us with effective control over Orient Petroleum. See “Our Corporate History and
Structure” for a description of these contractual arrangements. We depend
on Orient Petroleum to hold and maintain certain licenses necessary for its
wholesale and retail distribution of the finished oil products business. Orient
Petroleum also owns all of the necessary intellectual property, facilities and
other assets relating to our business operations, and employs personnel
necessary to operate our business.
Although
in the opinion of our PRC counsel, Allbright Law Offices, each of these
contractual arrangements is valid, binding and enforceable, and will not result
in any violation of PRC laws or regulations currently in effect, they may not be
as effective in providing us with control over Orient Petroleum as direct
ownership. If we had direct ownership of Orient Petroleum, we would be able to
exercise our rights as an owner to effect changes in the board of directors of
Orient Petroleum, which in turn could effect changes, subject to any applicable
fiduciary obligations, at the management level. Due to the VIE structure, we
have to rely on contractual rights to effect control and management of Orient
Petroleum, which exposes us to the risk of potential breach of contract by the
owners of Orient Petroleum. In addition, as Orient Petroleum is jointly owned by
its owners, it may be difficult for us to change Orient Petroleum’s corporate
structure if such owners refuse to cooperate with us.
The
owners, officers and/or directors of Orient Petroleum may breach, or cause
Orient Petroleum to breach, the contracts for a number of reasons. For example,
the interests of the owners of Orient Petroleum and our interests may conflict
and we may fail to resolve such conflicts; the owners may believe that breaching
the contracts will lead to greater economic benefit for them; or the owners may
otherwise act in bad faith. If any of the foregoing were to happen, we may have
to rely on legal or arbitral proceedings to enforce our contractual rights,
including specific performance or injunctive relief, and claiming damages. Such
arbitral and legal proceedings may cost us substantial financial and other
resources, and result in disruption of our business, and we cannot assure you
that the outcome will be in our favor.
In
addition, as all of these contractual arrangements are governed by PRC law and
provide for the resolution of disputes through either arbitration or litigation
in the PRC, they 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 other jurisdictions, such as
the United States. As a result, uncertainties in the PRC legal system could
further limit our ability to enforce these contractual arrangements.
Furthermore, these contracts may not be enforceable in China if PRC government
authorities or courts take a view that such contracts contravene PRC laws and
regulations or are otherwise not enforceable for public policy reasons. In the
event we are unable to enforce these contractual arrangements, we may not be
able to exert effective control over Orient Petroleum, and our ability to
conduct our business may be materially and adversely affected.
29
Orient
Xi’an and Orient Petroleum’s contractual arrangements may result in adverse PRC
tax consequences to us.
Under
the Tax Collection and
Management Law and its implementation rules issued in 2001, and
2002, respectively, arrangements and transactions among related parties may be
subject to audit or challenge by the PRC tax authorities. “Related parties” are
defined as organizations or entities that (1) have a director or indirect
control relationship in terms of capital, operation or sales/purchase; (2) are
directly or indirectly owned by a common third party; or (3) possess any other
connected relationship based on equity. In the Tax Management Procedures on the
Connected Transactions between Related Parties issued in 2004, it is
further stated that the management fee payable between the related parties shall
be determined on an arms-length basis. We could face material and adverse tax
consequences if the PRC tax authorities determine that the contractual
arrangements between Orient Xi’an and Orient Petroleum were not made on an arm’s
length basis and 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 adjustments recorded by Orient Petroleum,
which could adversely affect us by (i) increasing Orient Petroleum’s PRC tax
liability without reducing Orient Xi’an’s PRC tax liability, which could further
result in claims being made against us for underpaid PRC taxes; or (ii) limiting
the ability of Orient Xi’an and Orient Petroleum to obtain preferential PRC tax
treatments and/or other financial incentives.
All
of our revenues have been, and will continue to be, generated through Orient
Petroleum, our VIE, and we rely on payments made by Orient Petroleum to Orient
Xi’an, our subsidiary, pursuant to contractual arrangements to make
payments to Orient Xi’an. Any restriction on such payments and any increase
in the amount of PRC taxes applicable to such payments may materially and
adversely affect our business and our ability to pay dividends to our
shareholders.
We
conduct substantially all of our operations through Orient Petroleum, our VIE,
which generates all of our revenues. As Orient Petroleum is not owned by
us, it is not able to make dividend payments to us. Instead, Orient Xi’an, our
subsidiary in China, entered into a number of contracts with Orient Petroleum,
pursuant to which Orient Petroleum pays Orient Xi’an for certain services that
Orient Xi’an provides to Orient Petroleum. However, depending on the nature of
services provided, certain of these payments may be subject to PRC
taxes at different rates, including business taxes and VAT, which effectively
reduce the payments that Orient Xi’an may receive from Orient Petroleum. We
cannot assure you that the PRC government will not impose restrictions on such
payments or change the tax rates applicable to such payments. Any such
restrictions on such payments or increases in the applicable tax rates may
materially and adversely affect our ability to receive payments from Orient
Petroleum or the amount of such payments, and may in turn materially and
adversely affect our business, our net income and our ability to pay dividends
to our shareholders.
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 Orient
Petroleum 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 Orient Petroleum, an
operating company that is owned by PRC citizens and not by us. Accordingly, our
Chinese subsidiary, Orient Xi’an, entered into a series of exclusive contractual
agreements with Orient Petroleum. 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, Orient Petroleum or its owners, 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 combined subsidiaries and affiliated
companies incorporated in the PRC. We rely on dividends paid by these combined
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 entities,
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 entities 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, 2010,
our PRC entities had allocated RMB 31.9 million (approximately $4.4 million) to
these reserves, consisting of general and statutory reserves. Any limitations on
the ability of our PRC entities 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.
31
Because
our assets are located overseas, shareholders may not receive distributions that
they would otherwise be entitled to if we were declared bankrupt or
insolvent.
All of
our assets are located in the PRC. Because our assets are located overseas, our
assets may be outside of the jurisdiction of U.S. courts to administer if we are
the subject of an insolvency or bankruptcy proceeding. As a result, if we
declared bankruptcy or insolvency, our shareholders may not receive the
distributions on liquidation that they would otherwise be entitled to if our
assets were to be located within the U.S., under U.S. Bankruptcy
Law.
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,
Orient Hong Kong, 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.
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.
32
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:
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the
number and importance of state-owned enterprises in the PRC is greater
than in most OECD countries;
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the
level of capital reinvestment is lower in the PRC than in most OECD
countries; and
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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 19.9% appreciation in the
value of the Renminbi against the U.S. dollar between July 21, 2005 and December
31, 2010. 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.
Changes
in foreign exchange regulations in the PRC may affect our ability to pay
dividends in foreign currency or conduct other foreign exchange
business.
33
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, 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.
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
Exchange Agreement we entered into on September 7, 2010.
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.
34
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.
You
may face difficulties in protecting your interests, and your ability to protect
your rights through the U.S. federal courts may be limited, because our
subsidiaries are incorporated in non-U.S. jurisdictions, we conduct
substantially all of our operations in China, and all of our officers reside
outside the United States.
Although
we are incorporated in Nevada, all of our business operations are conducted in
China by Orient Petroleum. All of our officers and directors reside in China and
some or all of the assets of those persons are located outside of the United
States. As a result, it may be difficult or impossible for you to bring an
action against us or against these individuals in China in the event that you
believe that your rights have been infringed under the securities laws
or otherwise. Even if you are successful in bringing an action of this
kind, the laws of the PRC may render you unable to enforce a judgment against
our assets or the assets of our directors and officers.
As a
result of all of the above, our public shareholders may have more difficulty in
protecting their interests through actions against our management, directors or
major shareholders than would shareholders of a corporation doing business
entirely within the United States.
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.
35
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.
If
relations between the United States and China worsen, investors may be unwilling
to hold or buy our stock and our stock price may decrease.
At
various times during recent years, the United States and China have had
significant disagreements over political and economic issues. Controversies may
arise in the future between these two countries. Any political or trade
controversies between the United States and China, whether or not directly
related to our business, could reduce the price of our common
stock.
Risks
Related to an Investment in Our Securities
Our
common stock has limited liquidity, if at all.
Our
common stock is listed on the Over-the-Counter Bulletin Board, although
there is currently no trading activities.
Our
stock is categorized as a penny stock. Trading of our stock may be
restricted by the SEC’s penny stock regulations which may limit a shareholder’s
ability to buy and sell our stock.
Our stock
is categorized as a penny stock. The SEC has adopted Rule 15g-9 which generally
defines “penny stock” to be any equity security that has a market price (as
defined) less than $5.00 per share or an exercise price of less than $5.00 per
share, subject to certain exceptions. Our securities are covered by the penny
stock rules, which impose additional sales practice requirements on
broker-dealers who sell to persons other than established customers and
accredited investors. The penny stock rules require a broker-dealer, prior to a
transaction in a penny stock not otherwise exempt from the rules, to deliver a
standardized risk disclosure document in a form prepared by the SEC which
provides information about penny stocks and the nature and level of risks in the
penny stock market. The broker-dealer also must provide the customer with
current bid and offer quotations for the penny stock, the compensation of the
broker-dealer and its salesperson in the transaction and monthly account
statements showing the market value of each penny stock held in the customer’s
account. The bid and offer quotations, and the broker-dealer and salesperson
compensation information, must be given to the customer orally or in writing
prior to effecting the transaction and must be given to the customer in writing
before or with the customer’s confirmation. In addition, the penny stock
rules require that prior to a transaction in a penny stock not otherwise
exempt from these rules; the broker-dealer must make a special written
determination that the penny stock is a suitable investment for the purchaser
and receive the purchaser’s written agreement to the transaction. These
disclosure requirements may have the effect of reducing the level of trading
activity in the secondary market for the stock that is subject to these penny
stock rules. Consequently, these penny stock rules may affect the
ability of broker-dealers to trade our securities. We believe that the penny
stock rules discourage investor interest in and limit the marketability of our
common stock.
FINRA sales
practice requirements may also limit a shareholder’s ability to buy and sell our
stock.
36
In
addition to the “penny stock” rules described above, FINRA has adopted rules
that require that in recommending an investment to a customer, a broker-dealer
must have reasonable grounds for believing that the investment is suitable for
that customer. Prior to recommending speculative low priced securities to their
non-institutional customers, broker-dealers must make reasonable efforts to
obtain information about the customer’s financial status, tax status, investment
objectives and other information. Under interpretations of these rules, FINRA
believes that there is a high probability that speculative low priced securities
will not be suitable for at least some customers. The FINRA requirements make it
more difficult for broker-dealers to recommend that their customers buy our
common stock, which may limit your ability to buy and sell our stock and have an
adverse effect on the market for our shares.
We
expect to experience volatility in our stock price, which could negatively
affect shareholders’ investments.
The
market price for shares of our common stock may be volatile and may fluctuate
based upon a number of factors, including, without limitation, business
performance, news announcements or changes in general market
conditions.
Other
factors, in addition to the those risks included in this section, that may have
a significant impact on the market price of our common stock include, but are
not limited to:
·
|
receipt
of substantial orders or order cancellations of
products;
|
|
·
|
quality
deficiencies in services or
products;
|
·
|
international
developments, such as technology mandates, political developments or
changes in economic policies;
|
|
·
|
changes
in recommendations of securities
analysts;
|
·
|
shortfalls
in our backlog, revenues or earnings in any given period relative to the
levels expected by securities analysts or projected by
us;
|
|
·
|
government
regulations, including stock option accounting and tax
regulations;
|
·
|
energy
blackouts;
|
|
·
|
acts
of terrorism and war;
|
·
|
widespread
illness;
|
|
·
|
proprietary
rights or product or patent litigation;
|
|
·
|
strategic
transactions, such as acquisitions and divestitures;
|
|
·
|
rumors
or allegations regarding our financial disclosures or practices;
or
|
|
·
|
earthquakes
or other natural disasters concentrated in Shaanxi Province where a
significant portion of our operations are
based.
|
In the
past, securities class action litigation has often been brought against a
company following periods of volatility in the market price of its
securities. Due to changes in the volatility of our common stock
price, we may be the target of securities litigation in the
future. Securities litigation could result in substantial costs and
divert management’s attention and resources.
To
date, we have not paid any cash dividends and no cash dividends will be paid in
the foreseeable future.
We do not
anticipate paying cash dividends on our common stock in the foreseeable future
and we may not have sufficient funds legally available to pay
dividends. Even if the funds are legally available for distribution,
we may nevertheless decide not to pay any dividends. We presently
intend to retain all earnings for our operations.
There
is currently no trading activities for our common shares, and you may be unable
to sell at or near ask prices or at all if you need to sell or liquidate a
substantial number of shares at one time.
37
We cannot
predict the extent to which an active public market for its common stock will
develop or be sustained. However, we do not rule out the possibility
of applying for listing on NASDAQ or the NYSE AlterNet (formerly known as the
American Stock Exchange) or other markets.
Our
common shares are currently traded, but currently with no volume, based on
quotations on the “Over-the-Counter Bulletin Board”, meaning that the number of
persons interested in purchasing our common shares at or near bid prices at any
given time may be relatively small or non-existent. This situation is
attributable to a number of factors, including the fact that we are a small
company which is still relatively unknown to stock analysts, stock brokers,
institutional investors and others in the investment community that generate or
influence sales volume, and that even if we came to the attention of such
persons, they tend to be risk-averse and would be reluctant to follow an
unproven company such as ours or purchase or recommend the purchase of our
shares until such time as we became more seasoned and viable. As a
consequence, there may be periods of several days or more when trading activity
in our shares is minimal or non-existent, as compared to a seasoned issuer which
has a large and steady volume of trading activity that will generally support
continuous sales without an adverse effect on share price. We cannot
give you any assurance that a broader or more active public trading market for
our common stock will develop or be sustained, or that trading levels will be
sustained.
Shareholders
should be aware that, according to SEC Release No. 34-29093, the market for
“penny stocks” has suffered in recent years from patterns of fraud and
abuse. Such patterns include (1) control of the market for the
security by one or a few broker-dealers that are often related to the promoter
or issuer; (2) manipulation of prices through prearranged matching of
purchases and sales and false and misleading press releases; (3) boiler room
practices involving high-pressure sales tactics and unrealistic price
projections by inexperienced sales persons; (4) excessive and undisclosed
bid-ask differential and markups by selling broker-dealers; and (5) the
wholesale dumping of the same securities by promoters and broker-dealers after
prices have been manipulated to a desired level, along with the resulting
inevitable collapse of those prices and with consequent investor
losses. Our management is aware of the abuses that have occurred
historically in the penny stock market. Although we do not expect to
be in a position to dictate the behavior of the market or of broker-dealers who
participate in the market, management will strive within the confines of
practical limitations to prevent the described patterns from being established
with respect to our securities. The occurrence of these patterns or practices
could increase the future volatility of our share price.
Our
corporate actions are substantially controlled by our principal shareholders and
affiliated entities.
Immediately
after the Exchange, our principal shareholders, which includes our officers and
directors, and their affiliated entities, own approximately 62.40% of our
outstanding shares of common stock. These shareholders, acting individually or
as a group, could exert substantial influence over matters such as electing
directors and approving mergers or other business combination
transactions. In addition, because of the percentage of ownership and
voting concentration in these principal shareholders and their affiliated
entities, elections of our board of directors will generally be within the
control of these shareholders and their affiliated entities. While all of our
shareholders are entitled to vote on matters submitted to our shareholders for
approval, the concentration of shares and voting control presently lies with
these principal shareholders and their affiliated entities. As such, it would be
difficult for shareholders to propose and have approved proposals not supported
by management. There can be no assurances that matters voted upon by our
officers and directors in their capacity as shareholders will be viewed
favorably by all of our shareholders.
The
elimination of monetary liability against our directors, officers and employees
under Nevada law and the existence of indemnification rights to our directors,
officers and employees may result in substantial expenditures by our company and
may discourage lawsuits against our directors, officers and
employees.
Our
Articles of Incorporation, as amended, contain a provision permitting us to
eliminate the liability of our directors for monetary damages to our company and
shareholders to the extent provided by Nevada law. We may also have contractual
indemnification obligations under our employment agreements with our officers.
The foregoing indemnification obligations could result in our company incurring
substantial expenditures to cover the cost of settlement or damage awards
against directors and officers, which we may be unable to
recoup. These provisions and resultant costs may also discourage our
company from bringing a lawsuit against directors and officers for breaches of
their fiduciary duties, and may similarly discourage the filing of derivative
litigation by our shareholders against our directors and officers even though
such actions, if successful, might otherwise benefit our company and
shareholders.
Legislative
actions, higher insurance costs and potential new accounting pronouncements may
impact our future financial position and results of operations.
38
There
have been regulatory changes, including the Sarbanes-Oxley Act of 2002, and
there may potentially be new accounting pronouncements or additional regulatory
rulings that will have an impact on our future financial position and results of
operations. The Sarbanes-Oxley Act of 2002 and other rule changes as well as
proposed legislative initiatives following the Enron bankruptcy are likely to
increase general and administrative costs and expenses. In addition, insurers
are likely to increase premiums as a result of high claims rates over the past
several years, which we expect will increase our premiums for insurance
policies. Further, there could be changes in certain accounting
rules. These and other potential changes could materially increase
the expenses we report under generally accepted accounting principles, and
adversely affect our operating results.
If
we fail to maintain an effective system of internal controls, we may not be able
to accurately report our financial results or prevent material
misstatements.
We are
subject to reporting obligations concerning our internal controls, under the
U.S. securities laws. The SEC, as required by Section 404 of the
Sarbanes-Oxley Act of 2002, adopted rules requiring every public company to
include a management report on such company’s internal controls over financial
reporting in its annual report, which contains management’s assessment of the
effectiveness of our internal controls over financial reporting. In
addition, an independent registered public accounting firm must report on the
effectiveness of these controls beginning in 2009. Our management may
conclude that our internal controls over our financial reporting are not
effective. Moreover, even if our management concludes that our
internal controls over financial reporting are effective, our independent
registered public accounting firm may issue a report that is qualified if it is
not satisfied with our controls or the level at which our controls are
documented, designed, operated or reviewed. Our reporting obligations
as a public company will place a significant strain on our management,
operational and financial resources and systems for the foreseeable
future. Effective internal controls, particularly those related to
sales revenue recognition, are necessary for us to produce reliable financial
reports and are important to help prevent material misstatements, or in certain
extreme cases, fraud. As a result, our failure to achieve and
maintain effective internal controls over financial reporting could result in
the loss of investor confidence in the reliability of our financial statements,
which in turn could harm our business and negatively impact the trading price of
our stock. Furthermore, we anticipate that we will incur considerable costs and
use significant management time and other resources in an effort to comply with
Section 404 and other requirements of the Sarbanes-Oxley Act.
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
This
information has been previously disclosed in our previously filed current
reports on Form 8-K. Reference is made to our current report on Form 8-K
filed on September 9, 2010, which is hereby incorporated by reference
herein, for a description of our recent sales of unregistered securities during
the period covered by this quarterly report on Form 10-Q.
Item
3.
|
Defaults
Upon Senior Securities
|
None.
Item
4.
|
Reserved
|
Item
5.
|
Other
Information
|
None.
39
Item
6.
|
Exhibits
|
INDEX TO
EXHIBITS
Exhibit
No.
|
|
Description
|
2.1
|
Share
Exchange Agreement by and among Xtreme Link, Inc. (the “Registrant”), Hong
Gao, Orient New Energy Investments Limited (“Orient”) and the shareholders
of Orient dated September 7, 2010 (2)
|
|
3.1
|
Articles
of Incorporation of the Registrant (1)
|
|
3.2
|
By-Laws
of the Registrant (1)
|
|
3.3
|
Text
of Amendment to Bylaws of the Registrant (2)
|
|
31.1
|
Certifications
pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act
of 1934, as amended, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002*
|
|
31.2
|
Certifications
pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act
of 1934, as amended, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002*
|
|
32.1
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002*
|
|
32.2
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002*
|
|
99.1
|
Consulting
Services Agreement entered into between Orient New Energy Xi’an Ltd.
(“Orient Xi’an”) and Xi’an Orient Petroleum Group Co., Ltd. (“Orient
Petroleum”) on August 12, 2010 (2)
|
|
99.2
|
Operating
Agreement entered into among Orient Xi’an, Orient Petroleum and the owners
of Orient Petroleum on August 12, 2010 (2)
|
|
99.3
|
Equity
Pledge Agreement entered into between Orient Xi’an and the owners of
Orient Petroleum on August 12, 2010 (2)
|
|
99.4
|
Option
Agreement entered into between Orient Xi’an and the owners of Orient
Petroleum on August 12, 2010 (2)
|
|
99.5
|
Voting
Rights Proxy Agreement entered into between Orient Xi’an and the owners of
Orient Petroleum on August 12, 2010 (2)
|
|
99.6
|
Call
Option Agreement entered into between Jia Rosales Yao and the owners of
Orient Petroleum on August 12, 2010 (2)
|
|
99.7
|
Entrustment
Agreement entered into between Jia Rosales Yao and the owners of Orient
Petroleum on August 12, 2010 (2)
|
|
99.8
|
Oil
Storage Depot Lease Agreement entered into between Orient Petroleum and
Shaanxi Wanjie Trade Co., Ltd. on March 24, 2008 (2)
|
|
99.9
|
Loan
Agreement between Orient Petroleum and China Construction Bank dated April
26, 2009 (2)
|
|
99.10
|
Loan
Agreement between Orient Petroleum and EverBright Bank dated September 6,
2009 (2)
|
|
99.11
|
Purchase
Agreement between Orient Petroleum and Yulin Gas Chemical Co., Ltd. dated
December 15, 2009 (2)
|
|
99.12
|
Purchase
Agreement between Orient Petroleum and Huawei Commerce Co., Ltd. dated
December 20, 2009 (2)
|
|
99.13
|
Purchase
Agreement between Orient Petroleum and Xi’an Putian Petroleum Co., Ltd.
dated December 20, 2009 (2)
|
|
99.14
|
Purchase
Agreement between Orient Petroleum and Shaanxi Yanchang Petroleum (Group)
Co., Ltd. dated December 23, 2009 (2)
|
|
99.15
|
|
Form
of Orient Petroleum’s Gas Station Lease Agreement
(2)
|
*
|
|
Filed
herewith.
|
(1)
|
Filed
as an Exhibit to the Registration Statement on Form SB-2 filed with the
SEC on December 17, 2007.
|
|
(2)
|
Filed
as an Exhibit to the Current Report on Form 8-K filed with the SEC on
September 9, 2010.
|
40
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
ORIENT PETROLEUM AND
ENERGY INC.
Date:
February 14, 2011
|
By:
|
/s/ Anping
Yao
|
|
Anping
Yao
|
|||
Chief Executive Officer
|
|||
Date:
February 14, 2011
|
By:
|
/s/ Bin
Fu
|
|
Bin
Fu
|
|||
Chief Financial Officer
|
41