The following discussion and analysis of our results of operations and financial condition should be read together with our unaudited condensed consolidated financial statements and the notes thereto, which are included elsewhere in this report and our Annual Report on Form 10-K for the fiscal year endedJuly 31, 2019 (the "Annual Report") filed withSEC . Our financial statements have been prepared in accordance withU.S. GAAP. In addition, our financial statements and the financial information included in this report reflect our organizational transactions and have been prepared as if our current corporate structure had been in place throughout the relevant periods. Overview We are engaged in a variety of energy-related businesses through our subsidiaries and controlled entities inChina . One of the businesses is in the field of compressed air energy storage inChina and produces electricity generation systems that combine its compressed air storage technology with photovoltaic ("PV") panels to achieve a continuous supply of power under weather conditions that are unfavorable to the generation of electricity from PV panels alone. The sales and installation of power generation systems and PV systems and the sales of PV panels, air compression equipment and heat pump products have been carried out through the Company's variable interest entities ("VIEs"), formerlySanhe Luck Sky Electrical Engineering Co., Ltd. ("Sanhe Xiangtian") and currentlyXianning Xiangtian Energy Holding Group Co. Ltd. ("Xianning Xiangtian"), formerly known as Xianning Sanhe Power Equipment Manufacturing
Co. Ltd. InMarch 2018 , Xianning Xiangtian formedXiangtian Zhongdian (Hubei) New Energy Co. Ltd. ("Xiangtian Zhongdian"), a joint venture inChina , in which Xianning Xiangtian holds a 70% ownership interest with the remaining 30% ownership held byNanjing Zhongdian Photovoltaic Co. Ltd. Xiangtian Zhongdian is in the business of manufacturing and sales of PV panels. InApril 2018 , Xianning Xiangtian formed a wholly owned subsidiary,Jingshan Sanhe Xiangtian New Energy Technology Co. Ltd. ("Jingshan Sanhe"), which is engaged in the business of researching, manufacturing and sales of high-grade synthetic fuel products. InJune 2018 , Xianning Xiangtian acquiredHubei Jinli Hydraulic Co., Ltd. ("Hubei Jinli"), which is engaged in the business of manufacturing and sales of hydraulic parts and electronic components, and acquiredTianjin Jiabaili Petroleum Products Co. Ltd. ("Tianjin Jiabaili"), which is engaged in the business of manufacturing and sales of petroleum products (Note 3 - Business combinations). InAugust 2018 , Xianning Xiangtian formed a wholly owned subsidiary,Xianning Xiangtian Trade Co. Ltd. ("Xiangtian Trade"), which engaged in trading general merchandise. InDecember 2018 , Xianning Xiangtian acquiredHubei Rongentang Wine Co., Ltd. ("Wine Co. "), which is engaged in the business of manufacturing and sales of wine, and acquiredHubei Rongentang Herbal Wine Co., Ltd. ("Herbal Wine Co. "), which is engaged in the business of manufacturing and sales of herbal wine products.
The table below illustrates the businesses we conduct through our subsidiaries and consolidated affiliated entities:
Subsidiary Principal Business Location
Sanhe Xiangtian Sales of PV panels, air Hebei Province
compression equipment and
heat pump products and
sale and installation of
power generation systems
and PV systems
Xiangtian Zhongdian Manufacture and sales of Hubei Province
PV panels
Jingshan Sanhe Manufacturing and sales of Hubei Province
Synthetic fuel products
Hubei Jinli Manufacture and sales of Hubei Province
hydraulic parts and
electronic components
Tianjin Jiabaili Synthetic fuel production Tianjin
Xianning Xiangtian Manufacturing and sales of Hubei Province
air compression equipment
and heat pump products
Xiangtian Trade Sale of synthetic fuel Hubei Province
products
Rongentang Wine Wine production Hubei Province
Rongentang Herbal Wine Herbal Wine production Hubei Province
40
In September andOctober 2018 ,January 2019 andMarch 2019 , Mr.Jian Zhou , our Chairman and principal shareholder as well as a shareholder of Xianning Xiangtian, andZhou Deng Rong , the Company's former Chief Executive Officer and director, injected an aggregate ofRMB 209,260,000 (approximately$30.8 million ) as capital contribution to Xianning Xiangtian.
On
OnMay 24, 2019 , our Board of Directors (the "Board"), discussed a plan to pursue the potential sale of all its ownership interest inHerbal Wine Co. andWine Co. in order to shift its business focus on its energy related business. Therefore the result of operations was presented as discontinued operations as of and for the three months endedOctober 31, 2019 unaudited condensed consolidated financial statements. OnJanuary 6, 2020 , the Company entered into an equity transfer agreement with Kairui Tong andHao Huang (the "Buyers"), which the Company agreed to sell its 90% ownership inWine Co. andHerbal Wine Co. to the Buyers for approximately$9.6 million (RMB 67.5 million ), of which, 54% ownership are sold to Kairui Tong, the legal representative and general manager ofWine Co. and Herbal Wine Co, and 36% ownership are sold toHao Huang , an unrelated third party. OnDecember 16, 2019 , the board of directors of Xiangtian Zhongdian made a decision to suspend its current operations temporally and will further make determination on its future sales plan of PV Panels in Xiangtian Zhongdian. In addition, the Company will also be leasing its production equipment while the operations were paused. Reorganization
OnSeptember 30, 2018 , Xiangtian Shenzhen terminated its variable interest entity agreements (the "VIE Agreements") as part of its restructuring to facilitate the shift of business focus between entities controlled by the Company. After the restructuring, the Company's headquarter is located in the city of Xianning,Hubei Province , and Sanhe Xiangtian, the Company's previous headquarter, located in the city of Sanhe,Hebei Province , is restructured as our sales office. The VIE Agreements include the following:
? Framework Agreement on Business Cooperation, dated
between Xiangtian Shenzhen and Sanhe Xiangtian;
? Exclusive Management, Consulting and Training and Technical Service Agreement,
dated
? Exclusive Option Agreement, datedJuly 25, 2014 , by and among Xiangtian
Xiangtian Shareholders");
? Equity Pledge Agreement, dated
Sanhe Xiangtian and the Shanhe Xiangtian Shareholders;
? Know-How Sub-License Agreement, dated
Shenzhen and Sanhe Xiangtian; and
? Powers of Attorney of the Sanhe Xiangtian Shareholders dated
In connection with the termination of the VIE Agreements, onSeptember 30, 2018 , Sanhe Xiangtian transferred its 100% equity interest of Xianning Xiangtian to the Sanhe Xiangtian Shareholders and the Sanhe Xiangtian Shareholders transferred their 100% equity interest of Sanhe Xiangtian to Xianning Xiangtian. As a result of the foregoing equity transfers, Sanhe Xiangtian became a wholly owned subsidiary of Xianning Xiangtian. 41
On the same day, the Company, through Xiangtian Shenzhen and Xiangtian HK, entered into a new series of variable interest entity agreements ("New VIE Agreements"), pursuant to which Xianning Xiangtian became the Company's new contractually controlled affiliate. The New VIE Agreements allow us to:
? exercise effective control over Xianning Xiangtian;
? receive substantially all of the economic benefits of Xianning Xiangtian; and
? have an exclusive option to purchase all or part of the equity interests in
Xianning Xiangtian when and to the extent permitted by the laws of the PRC.
The New VIE Agreements include the following:
? Framework Agreement on Business Cooperation, entered between Xiangtian
Shenzhen and Xianning Xiangtian.
? Agreement of Exclusive Management, Consulting and Training and Technical
Service, entered between Xiangtian Shenzhen and Xianning Xiangtian,.
? Exclusive Option Agreement, entered among Xiangtian HK, Xiangtian Shenzhen,
Fei Wang ,Zhou Jian and Xianning Xiangtian,
? Equity Pledge Agreement, entered among Xiangtian Shenzhen,
Jian, and Xianning Xiangtian,.
? Know-How Sub-License Agreement, entered between Xiangtian Shenzhen and
Xianning Xiangtian, pursuant to which Xiangtian Shenzhen; and
? Powers of Attorney of the Xianning Xiangtian stockholders.
? Spousal Consent Letters of each of the spouses of the Xianning Xiangtian
Shareholders
As a result of the New VIE Agreements, we have become the primary beneficiary of
Xianning Xiangtian, and it treats Xianning Xiangtian as its variable interest
entity under U.S. GAAP. We will continue to consolidate the financial results of
Xianning Xiangtian in our unaudited condensed consolidated financial statements
in accordance with U.S. GAAP. The above reorganization has no effect on the
Company's unaudited condensed consolidated financial statements for the current
period and thereafter.
Key Factors that Affect Operating Results
Our ability to build our brand and expand our sales distribution channel
We market our products through third-party distributors inChina and through employees for direct sales. The distributors sell our products and receive commissions based on the value of the contracts. We utilize three classes of distributors based on the size of their territory - province, city and town. The distributors target factories and power plants, as well as local governments which may encourage local industry to utilize alternative energy sources, for our power generation products. The distributors also target wine retailers, supermarkets for our wine products and target gas stations and automobile repair shops for our synthetic fuel products. Our revenue growth will be affected by our ability to effectively execute our marketing strategies to build our brand and to expand our sales distribution channel through other sources other than through our distributors. PRC economy
Although the PRC economy has grown in recent years, the pace of growth has slowed, and growth rates may continue to decline. According to thePRC National Bureau of Statistics ofChina , the annual rate of growth in the PRC declined from 7.6% in 2014, to 7.0% in 2015, 6.8% in 2016, 6.9% in 2017, 6.8% in 2018 and 6.3% in 2019. A further slowdown in overall economic growth, an economic downturn, a recession or other adverse economic development in the PRC may materially reduce the purchasing power of Chinese consumers and thus lead to a decrease in the demand for our products. Such a decrease in demand may have a materially adverse effect on our business. Seasonality Our financial results for quarters endedJanuary 31 andApril 30 in each year might fluctuate, depending upon the date of theChinese New Year in the period of which it will fall into as theChinese New Year normally would fall in between January and February. Immediately before theChinese New Year , our operating results and revenues tend to be higher as our customers might push us to deliver our products before theChinese New Year holiday and our operating results and revenues tend to be lower during the month after theChinese New Year . In addition, our operating results and revenues in our heat pump product line tend to be higher during the fall and winter seasons and lower during the spring and summer seasons. 42
PRC governmental regulations
We are subject to a variety of governmental regulations related to the storage, use and disposal of hazardous materials. The major environmental regulations applicable to us include the Environmental Protection Law of the PRC, the Law of the PRC on the Prevention and Control of Water Pollution and its implementation rules, the Law of the PRC on the Prevention and Control of Air Pollution and its implementation rules, the Law of PRC on the Prevention and Control of Solid Waste Pollution and the Law of the PRC on the Prevention and Control of Noise Pollution and the PRC Law on Appraising Environment Impacts. In addition, under the Environmental Protection Law of the PRC, the Ministry of Environmental Protection sets national pollutant emission standards. However, provincial governments may set stricter local standards, which are required to be registered at theState Administration for Environmental Protection. Enterprises are required to comply with the stricter of the two standards. Unfavorable changes could affect the delivery timing of our services and products that we provide and could materially and adversely affect the results of operations.
In addition, we are subject to a variety of licenses and permits, laws and
regulations in
? Safety Production License, according to Regulation on Work Safety Permits
(2014), the state applies a work safety licensing system to enterprises engaged
in mining, construction, and the production of dangerous chemicals, fireworks
and crackers, and civil explosives.
? Hazardous Chemicals Business License, according to Measures for the
implements a licensing system for the operation of hazardous chemicals.
Enterprises which operate dangerous chemical shall obtain a hazardous chemicals
business license. It is prohibited to operate hazardous chemicals without
obtaining such business license.
? Industrial Product Production License, according to Regulation of the People's
State implements a production license system for enterprises that produce the
industrial products that affect production safety and public safety such as
hazardous chemicals. It is prohibited to produce such products listed without
obtaining such license.
? Good Manufacturing Practice ("GMP") Certificate. A pharmaceutical manufacturer
must meet the Good Manufacturing Practice standards for each of its production
facilities in
produces. GMP standards include staff qualifications, production premises and
facilities, equipment, raw materials, environmental hygiene, production
management, quality control and customer complaint administration. If a
manufacturer meets the GMP standards, the CFDA will issue to the manufacturer a
GMP certificate with a five-year validity period.
? Secrecy Qualification, according to Circular 8 issued by the National Defense
production of classified weapons and equipment are required to implement a
confidentiality qualification examination and certification system and obtain
the corresponding Secrecy Qualification.
? Pursuant to the Product Quality Law of
People's Congress Standing Committee in 1993 and amended in 2018, a seller must
establish and practice a check-for-acceptance system for replenishment of such
seller's inventory, and examine the quality certificates and other marks and
must also adopt measures to keep the products for sale in good quality.
Pursuant to the Product Quality Law of
physical injury to a person or damage to such person's property, the victim may
claim for damages against the manufacturer or the seller of the product. If the
seller pays the damages and it is the manufacturer that should bear the
liability, the seller has a right of recourse against the manufacturer.
Similarly, if the manufacturer pays damages and it is the seller that should
bear the liability, the manufacturer has a right of recourse against the
seller. Violations of the Product Quality Law of
penalties, including the imposition of fines, suspension of business
operations, revocation of business licenses and criminal liabilities.
43
? Pursuant to the Tort Liability Law of
National People's
effective on
in their products and sellers are liable for damages attributable to their
fault. If the defects are caused by the fault of third parties such as the
transporter or storekeeper, producers and sellers have the right to claim for
compensation from these third parties after paying the damages. The producers
and sellers are obligated to take remedial measures such as issuing warnings or
recalling the products in a timely manner if defects are found in products that
are in circulation. If a party knowingly manufactured and sold defective
products that cause death or severe personal injuries, the injured person has
the right to claim punitive damages. Results of Operations
The following discussion should be read in conjunction with the unaudited
condensed consolidated financial statement of the Company for the three months
ended
The Three Months EndedOctober 31, 2019 Compared to the Three Months EndedOctober 31, 2018 For the Three For the Three Months Ended Months Ended October 31, October 31, 2019 2018 Change Change (%) Revenue$ 3,166,836 $ 19,988,438 $ (16,821,602 ) (84.2 )% Cost of revenue 3,773,780 15,792,923 (12,019,143 ) (76.1 )% Gross (loss) profit (606,944 ) 4,195,515 (4,802,459 ) (114.5 )% Operating expenses 3,315,955 1,653,884 1,662,071 100.5 % (Loss) income from operations (3,922,899 ) 2,541,631 (6,464,530 ) (254.3 )% Other income (expenses), net 15,619 (437,278 ) 452,897 103.6 % (Loss) income before income taxes (3,907,280 ) 2,104,353 (6,011,633 ) (285.7 )% Income tax expense (46,196 ) (526,144 ) 479,948 91.2 % (Loss) income from continuing operations (3,953,476 ) 1,578,209 (5,531,685 ) (350.5 )% Net loss from discontinued operations, net of applicable income taxes (174,762 ) - (174,762 ) (100.0 )% Net (loss) income (4,128,238 ) 1,578,209 (5,706,447 ) (361.6 )% Less: Net income (loss) attributable to non-controlling interest from continuing operations (243,029 ) 202,442 (445,471 ) (220.0 )% Less: Net loss attributable to non-controlling interests from discontinued operations (17,476 ) - 17,476 100.0 % Net (loss) income attributable to common stockholders$ (3,867,733 ) $ 1,375,767 $ (5,243,500 ) (381.1 )% Net (loss) income per share attributable to common stockholders Basic and diluted earnings per share - Continuing operations $ (0.01 ) $ 0.00$ (0.01 ) (100.0 )% Basic and diluted earnings per share - Discontinued operations $ (0.00 ) $ 0.00$ (0.00 ) - % 44 Continuing Operations Revenue
Our revenue was derived from the sales of PV panels and others, heat pump
products, high-grade synthetic fuel products, hydraulic parts and electronic
components for the three months ended
Total revenues decreased by$16,821,602 or 84.2%, to$3,166,836 for the three months endedOctober 31, 2019 as compared to$19,988,438 for the same period in 2018. The overall decrease was primarily attributable to the decrease of revenue generated from sales of PV panels and other products, air compression equipment and other components, heat pumps, and high-grade synthetic fuel products. See the table below for a detailed analysis of the decrease in our revenue.
Our revenue from our revenue categories is summarized as follows:
For the For the
Three Months Three Months
Ended Ended
October 31, October 31,
2019 2018 Change Change (%)
RevenueInstallation of power generation systems $ -$ 389,332 $ (389,332 ) (100.0 )% PV panels and others 1,704,797 9,101,844 (7,397,047 ) (81.3 )% Air compression equipment and other components - 1,001,211 (1,001,211 ) (100.0 )% Heat pumps 57,986 4,243,564 (4,185,578 ) (98.6 )% High-grade synthetic fuel 39,976 4,096,752 (4,056,776 ) (99.0 )% Hydraulic parts and electronic components 1,364,077
1,155,735 208,342 18.0 % Total revenue$ 3,166,836 $ 19,988,438 $ (16,821,602 ) (84.2 )% Installation of power generation systems revenue decreased by$389,332 or 100.0% from$389,332 for the three months endedOctober 31, 2018 to$0 for the same period in 2019 because we did not have any new installation projects performed during the three months endedOctober 31, 2019 as we have not been focusing on our power generation systems business. We are no longer focusing on the installation of power generation systems but to sell the PV panels separately. As a result, we do not except our installation of power generation systems will be generating any significant revenues. Sales of PV panels and others decreased by$7,397,047 or 81.3% from$9,101,844 for the three months endedOctober 31, 2018 to$1,704,797 for the same period in 2019. The decrease in sales of PV panels and others was primarily due to significant decrease in sales from Xiangtian Zhongdian. We are currently operating under certain disagreements with our non-controlling shareholder in Xiangtian Zhongdian, which lead to Xiangtian Zhongdian to put the PV panels sales orders on hold. As a result, our sales of PV panels decreased during the three months endedOctober 31, 2019 as compared to the same period in 2018. Currently, our disagreements with the non-controlling shareholder in Xiangtian Zhongdian still has not been resolved. Management is seeking alternative plan by moving this business from Xiangtain Zhongdian to Xianning Xiangtian, our headquarters, which we can generated 100% profit from the sales of PV panels business over 70% of profit in Xiangtian Zhongdian as we will be sharing 30% profit to the non-controlling shareholder in Xiangtian Zhongdian if our PV panels business remained in Xingtian Zhongdian. However, our sales from PV panels is expected to decrease as compared to the prior period due to the non-controlling shareholder in Xiangtian Zhongdian having retained the marketing team in Xiangtian Zhongdian. We will start developing our own PV panels market with our internal sources and retaining our own marketing sources before setting up the joint venture Xiangtian Zhongdian. Sales of air compression equipment and other components decrease by$1,001,211 or 100.0% and the sales of heat pumps decreased by$4,185,578 or 98.6% for the three months endedOctober 31, 2019 as compared to the same period in 2018. The decrease was attributable to significant decrease in sales orders as we lost some large air compression equipment and heat pump customers during the three months endedOctober 31, 2019 as compared to the same period in 2018 which resulted in lesser sales orders in the current period. Our sales from air compression equipment and heat pumps are expected to be decreased as compared to the prior period going forward as we recently did not put a lot of research and development activities to keep up with the latest technology of the air compression and heat pumps products. As a result, our competitors will, in all likelihood gain a greater market share in this industry which will lead to
a
decrease in future sales.
45
Sales of high-grade synthetic fuel decreased by$4,056,776 or 99.0% for the three months endedOctober 31, 2019 as compared to the same period in 2018 mainly due to significant decrease in sales from Jingshan Sanhe. Jingshan Sanhe has expanded its production facilities for the anticipation of the sales orders that we have received of our high-grade synthetic fuel products. During the three months endedOctober 31, 2019 , we were pending final completion and inspection approval of our production facilities expansion inJanuary 2020 , which prevented Jingshan Sanhe's ability to manufacture our high-grade synthetic fuel products during the period. As a result, we took longer time to complete and test our production facilities in order for us to produce a high quality of our products. Our sales of high-grade synthetic fuel is expected to resume back to the normal level upon resuming our production which we anticipate will be inFebruary 2020 .
Sales of hydraulic parts and electronic components increased by$208,342 or 18.0% for the three months endedOctober 31, 2019 as compared to the same period in 2018 due to few large specialty governmental contracts with higher selling price. We are expecting our hydraulic parts and electronic components business will continue to grow gradually as we believe demand of our products from the Chinese military stable. Cost of Revenue
Total cost of revenue decreased by$12,019,143 , or 76.1%, to$3,773,780 for the three months endedOctober 31, 2019 as compared to$15,792,923 for the same period in 2018. The decrease in cost of revenue is in line with the decrease in revenue.
Our cost of revenue from our revenue categories is summarized as follows:
For the For the
Three Months Three Months
Ended Ended
October 31, October 31,
2019 2018 Change Change (%)
Cost of revenueInstallation of power generation systems $ -$ 357,570 $ (357,570 ) (100.0 )% PV panels and others 2,150,158 8,193,596 (6,043,438 ) (73.8 )% Air compression equipment and other components - 719,026 (719,026 ) (100.0 )% Heat pumps 1,008,232 3,387,445 (2,379,213 ) (70.2 )% High-grade synthetic fuel 35,470 2,518,046 (2,482,576 ) (98.6 )% Hydraulic parts and electronic components 579,920 617,240 (37,320 ) (6.0 )% Total cost of revenue$ 3,773,780 $
15,792,923$ (12,019,143 ) (76.1 )% Gross Profit Our gross profit from our major revenue categories is summarized as follows: For the For the Three Months Three Months Ended Ended October 31, October 31, 2019 2018 Change Change (%) Installation of power generation systems Gross profit margin $ - $ 31,762$ (31,762 ) (100.0 )% Gross profit percentage - % 8.2 % (8.2 )% PV panels and others Gross profit margin$ (445,361 ) $
908,248
(26.1 )% 10.0 % (36.1 )%
Air compression equipment and other components Gross profit margin $ - $
282,185
- % 28.2 % (28.2 )%
Heat pumps Gross (loss) profit margin$ (950,246 ) $
856,119
(1638.8 )% 20.2 % (1659.0 )%
High-grade synthetic fuel Gross profit margin $ 4,506$ 1,578,706 $ (1,574,200 ) (99.7 )% Gross profit percentage 11.3 %
38.5 % (27.2 )%
Hydraulic parts and electronic components Gross profit margin $ 784,157$ 538,495 $ 245,662 45.6 % Gross profit percentage 57.5 % 46.6 % 10.9 %
Total
Gross (loss) profit margin$ (606,944 ) $ 4,195,515 $ (4,802,459 ) (114.5 )% Gross profit percentage (19.2 )% 21.0 % (40.2 )% 46 Our gross profit decreased by$4,802,459 , or 114.5%, to a gross loss of$606,944 during the three months endedOctober 31, 2019 from gross profit of$4,195,515 for the same period in 2018. The decrease in gross profit was primarily due to the significant decrease in revenues from sales of PV panels and other products, heat pumps, and high-grade synthetic fuel products. For the three months endedOctober 31, 2019 and 2018, our overall gross (loss) profit percentage was (19.2 %) and 21.0%, respectively. The decrease of 40.2% was primarily due to the increase in cost of revenue as we provided allowance for aging inventories.
Gross profit percentage for our installation of power generation systems revenue
was 8.2% for the three months ended
Gross profit percentage for PV panels and others revenue was (26.1 %) and 10.0% for the three months endedOctober 31, 2019 and 2018, respectively. The decrease of gross profit percentage was due to the increase in cost of revenue as we provided allowance for aging inventories due to slow moving of our inventories and lack of sales as discussed above. Gross profit percentage for air compression equipment and other components revenue was 28.2% for the three months endedOctober 31, 2018 . We did not sell any air compression equipment and other components during the three months
endedOctober 31, 2019 .
Gross profit percentage for heat pumps revenue was (1,638.8%) and 20.2% for the
three months ended
Gross profit percentage for high-grade synthetic fuel revenue was 11.3% and 38.5% for the three months endedOctober 31, 2019 and 2018, respectively. The decrease in gross profit percentage was primarily due to higher cost in manufacturing our newly developed engine cleaner, Xiangtian No. 5, during the testing phase although the unit selling price for our Xiangtian No. 5 for the three months endedOctober 31, 2019 are higher than our Green Energy No. 1 that were sold during the same period in 2018. Gross profit percentage for hydraulic parts and electronic components revenue was 57.5% and 46.6% for the three months endedOctober 31, 2019 and 2018, respectively. The increase in gross profit percentage was due to our few large specialty governmental contracts with higher selling price, which increased
our
gross profit percentage.
47
Operating Expenses
Total operating expenses increased by$1,662,071 or 100.5% from$1,653,884 during the three months endedOctober 31, 2018 to$3,315,955 during the same period in 2019. The increase in operating expenses was mainly attributable to (i) the increase in selling expenses of$110,230 , (ii) the increase in general and administrative expenses of$172,747 , and (iii) the increase in provision for doubtful accounts of$1,285,018 as we have more aged receivables. The increase in selling expenses of approximately$110,000 was mainly attributable to the increase in marketing expenses of approximately$202,000 to our sales representatives as we have been trying to expand our sales channels to promote our products. The increase in general and administrative expenses of approximately$173,000 was mainly attributable to (i) the increase in salaries, social insurance expenses, and benefits expenses of approximately$249,000 mainly due to the allocation of the production line personnel salary and their related social insurance and benefit into general and administrative expense as we have limited or no production in Xiangtian Zhongdian and Jingshan Sanhe, and (ii) the increase in rent and property management expenses of approximately$245,000 as we leased more factories, equipment, and office space to expand our business. This increase was offset by approximately$226,000 decrease in professional fees including legal fees, audit fees and consulting fees, as we incurred significant professional fees in relation to the acquisition of Hubei Jinli during the three months endedOctober 31, 2018 and we did not incur such professional fees in the same period in 2019. The increase was also offset by approximately$95,000 decrease in other general and administrative expenses including travel, meals and entertainment and other service expenses as we had limited operations in Xingtian Zhongdian due to our disagreements with the non-controlling shareholder in Xiangtian Zhongdian. The decrease in other general and administrative expenses was also due to the limited operations in Jingshan Sanhe as we were pending final completion and inspection approval of our production facilities expansion, which occurred inJanuary 2020 , while we were only performing testing activities during the three months endedOctober 31, 2018 .
The increase of R&D expenses of approximately
Other (Expenses) Income, Net Total other income increased by$452,897 or 103.6% from total other expenses of$437,278 during the three months endedOctober 31, 2018 to total other income of$15,619 during the same period in 2019. The increase in total other income was mainly attributable to the decrease in interest expense as we paid off the third party loans that we obtained in 2018. Income Tax Expense Our current income tax expense was$46,196 and$526,144 for the three months endedOctober 31, 2019 and 2018, respectively. Our income tax expense was incurred by our profitable VIEs and controlled entities in both periods and we have provided 100% allowance on net operating losses for our VIEs and controlled entities which incurred losses.
(Loss) Income from Continuing Operations
Our net loss from continuing operations increased by$5,531,685 , or 350.5%, to net loss of$3,953,476 for the three months endedOctober 31, 2019 , from a net income of$1,578,209 for the same period in 2018. Such change was the result of the combination of the changes discussed above. Discontinued Operations
Net Loss from Discontinued Operations
Our net loss from discontinued operations increased by$174,762 , or 100.0%, to net loss of$174,762 for the three months endedOctober 31, 2019 , from a net loss of$0 for the three months endedOctober 31, 2018 . The increase in loss from discontinued operations was predominantly due to the expenses generated byHerbal Wine Co. andWine Co. which considered as discontinued operations since the board discussed a plan to pursue the potential sale of all its ownership interest inHerbal Wine Co. andWine Co. in order to shift its business focus on its energy related business. See Note 4 - Discontinued operations. HerbalWine Co. andWine Co. were acquired during the second quarter of 2019. OnJanuary 6, 2020 , we entered into an equity transfer agreement with Kairui Tong andHao Huang (the "Buyers"), which we agreed to sell its 90% ownership inWine Co. andHerbal Wine Co. to the Buyers for approximately$9.6 million (RMB 67.5 million ), of which, 54% ownership are sold to Kairui Tong, the legal representative and general manager ofWine Co. and Herbal Wine Co, and 36% ownership are sold toHao Huang , an unrelated third party. As of the date of this report, we received approximately$5.7 million (RMB 40.0 million ) of the transaction. 48 Net (Loss) Income
Our net loss increased by$5,706,447 , or 361.6%, to net loss of$4,128,238 for the three months endedOctober 31, 2019 from a net income of$1,578,209 for the three months endedOctober 31, 2018 . Such change was the result of the combination of the changes discussed above.
Liquidity and Capital Resources
Capital Resources
In assessing our liquidity, we monitor and analyze our cash on-hand and our operating and capital expenditure commitments. Our liquidity needs are to meet our working capital requirements, operating expenses and capital expenditure obligations. Debt financing from related parties has been utilized to finance the working capital requirements of the Company and acquisitions of businesses. As ofOctober 31, 2019 , the Company's working deficit was approximately$8.3 million and the Company had cash of approximately$3.2 million . Excluding other payable to related parties and director of approximately$6.9 million , the Company's working deficit was approximately$1.4 million . Although we believe that we can realize our current assets in the normal course of business, our ability to repay our current obligations will depend on the future realization of our current assets and the future operating revenues generated from our operations. Our management has considered whether there is a going concern issue due to our recurring losses from operations. Management has determined there is substantial doubt about our ability to continue as a going concern. If we are unable to generate significant revenue, we may be required to cease or curtail our operations. Management is trying to alleviate the going concern risk through the following sources:
? we will continuously seek equity financing to support its working capital;
? other available sources of financing from PRC banks and other financial
institutions;
? financial support and credit guarantee commitments from the Company's related
parties.
We also expect to raise additional capital through financing offerings with the proceeds to be used for 1) leasing additional production facilities for synthetic fuel and related products, 2) adding a new packaging line for our synthetic fuel and related products in Jingshan Sanhe, and 3) general corporate purpose.
The Company is not currently seeking to raise additional capital and there is no guaranty that the Company will be able to raise any capital in the future.
49
The following summarizes the key components of our cash flows for the three
months ended
For the Three Months Ended
October 31,
2019 2018Net cash (used in) provided by operating activities from continuing operations
$
(538,655 )
(243,265 ) -
Net cash used in investing activities from continuing operations (1,166,338 ) (2,421,015 ) Net cash used in investing activities from discontinued operations
(3,549 ) -
Net cash provided by (used in) financing activities from continuing operations
550,374 (2,328,060 ) Net cash used in financing activities from discontinued operations
(11,502 ) -
Effect of exchange rate change on cash and restricted cash (126,588 ) (480,518 )
Net change in cash and restricted cash $ (1,539,523 ) $ 11,636,220 As of
Operating Activities Net cash used in operating activities from continuing operations was approximately$0.5 million for the three months endedOctober 31, 2019 , which was mainly due to net loss from continuing operations of approximately$4.1 million , the increase in inventories of approximately$0.7 million , and the decrease in other payables and taxes payable of approximately$0.4 million . The net cash used in operating activities was partially offset by non-cash effects of depreciation and amortization expense of approximately$0.4 million , amortization of right-of-use assets of approximately$0.2 million , bad debt allowance of approximately$1.1 million , impairment of inventories of approximately$1.4 million , the decrease in advances to suppliers of approximately$0.8 million , the decrease in other receivables as we collected approximately$0.3 million , and the increase in accounts payable of approximately$0.4 million . Net cash provided by operating activities for the three months endedOctober 31, 2018 was mainly due to net income of approximately$1.6 million , the decrease in notes receivable as we collected bank notes of approximately$0.8 million , the decrease in accounts receivable as we collected approximately$2.4 million , and the increase of advance from customers of approximately$17.3 million as we have received significant sales orders for our high-grade synthetic fuel products which require customer deposits. The net cash provided by operating activities was offset by the increase in advance to suppliers of approximately$3.7 million as we prepaid for more purchase in the anticipation of sales productions and the decrease in accounts payable as we paid off approximately$1.7 million to our vendors as the payments became due. Investing Activities Net cash used in investing activities from continuing operations was approximately$1.2 million for the three months endedOctober 31, 2019 , which was mainly comprised of the partial investment payments of approximately$0.1 million that we made in relation to the acquisition of Hubei Jinli and the purchase of property and equipment of approximately$1.0 million for our business expansion. Net cash used in investing activities for the three months endedOctober 31, 2018 was mainly due to the partial investment payments of approximately$3.7 million that we made in relation to the acquisition of Hubei Jinli andTianjin Jiabaili, the purchase of property and equipment of approximately$0.5 million for our business expansion offset by the collection of loan receivable of approximately$1.8 million . Financing Activities
Net cash provided by financing activities from continuing operations was
approximately
Net cash used in financing activities for the three months endedOctober 31, 2018 was due to the payments of short-term bank loan, third party loan, and related party loan of approximately$0.5 million ,$0.2 million and 19.0 million, respectively offset by the borrowings from related parties and directors of approximately$0.8 million , capital contribution from shareholders of approximately$14.5 million , and proceeds from related party loans of approximately$2.0 million . 50 Commitments and Contingencies In the normal course of business, we are subject to loss contingencies, such as legal proceedings and claims arising out of its business, that cover a wide range of matters, including, among others, government investigations and tax matters. In accordance with ASC No. 450-20, "Loss Contingencies", we will record accruals for such loss contingencies when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. Contractual Obligations
As of
Payments Due In
Less than 1 - 3 3 - 5
Contractual obligations Total 1 year years years ThereafterOperating leases liabilities$ 2,388,708 $ -$ 2,387,007 $ 850 $ 851 Long-term debt obligations* 499,752 243,857 255,895 - - Due to related parties and third party 6,912,433 6,912,433
- - -
Total $ 9,800,893 $ 7,156,290 $ 2,642,902 $ 850 $ 851 * Represent future value of acquisition payments in relation to our acquisitions
of Hubei Jinli and Tianjin Jiabaili.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements including arrangements that would affect our liquidity, capital resources, market risk support and credit risk support or other benefits.
Critical Accounting Policies and Estimates
The preparation of unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted inthe United States requires our management to make assumptions, estimates and judgments that affect the amounts reported, including the notes thereto, and related disclosures of commitments and contingencies, if any. We have identified certain accounting policies that are significant to the preparation of our financial statements. These accounting policies are important for an understanding of our financial condition and results of operation. Critical accounting policies are those that are most important to the portrayal of our financial conditions and results of operations and require management's difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Certain accounting estimates are particularly sensitive because of their significance to financial statements and because of the possibility that future events affecting the estimate may differ significantly from management's current judgments. While our significant accounting policies are more fully described in Note 2 to our unaudited condensed consolidated financial statements included elsewhere in this report, we believe the following critical accounting policies involve the most significant estimates and judgments used in the preparation of our unaudited condensed consolidated financial statements.
Use of Estimates and Assumptions
The preparation of unaudited condensed consolidated financial statements in conformity withU.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the periods presented. Significant accounting estimates reflected in the Company's unaudited condensed consolidated financial statements include the estimated cost used to calculate the percentage of completion recognized in the Company's revenues, the useful lives of property, plant and equipment, impairment of long-lived assets, right-of-use assets, lease classification and liabilities, allowance for accounts receivable doubtful accounts, allowance for other accounts receivable doubtful accounts, allowance for inventory obsolescence reserve, allowance for deferred tax assets, fair value of the assets and the liabilities of the entities acquired through its business combination, valuation of warranty reserves, and the accrual of potential liabilities. Actual results could differ from these estimates. 51 Leases
EffectiveAugust 1, 2019 , the Company adopted ASU 2016-02, "Leases" (Topic 842), and elected the practical expedients that does not require us to reassess: (1) whether any expired or existing contracts are, or contain, leases, (2) lease classification for any expired or existing leases and (3) initial direct costs for any expired or existing leases. For lease terms of twelve months or fewer, a lessee is permitted to make an accounting policy election not to recognize lease assets and liabilities. We also adopted the practical expedient that allows lessees to treat the lease and non-lease components of a lease as a single lease component. We recognized approximately$2.6 million right of use ("ROU") assets and approximately$2.3 million lease liabilities based on the present value of the future minimum rental payments of leases, using incremental borrowing rate of 4.75% and 4.90% based on duration of lease terms. The weighted average remaining lease term is 3.15 years. Operating lease ROU assets and lease liabilities are recognized at the adoption date ofAugust 1, 2019 or the commencement date, whichever is earlier, based on the present value of lease payments over the lease term. Since the implicit rate for our leases is not readily determinable, we use our incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The incremental borrowing rate is the rate of interest that we would have to pay to borrow, on a collateralized basis, an amount equal to the lease payments, in a similar economic environment and over a similar term.
Lease terms used to calculate the present value of lease payments generally do not include any options to extend, renew, or terminate the lease, as we do not have reasonable certainty at lease inception that these options will be exercised. We generally consider the economic life of its operating lease ROU assets to be comparable to the useful life of similar owned assets. We have elected the short-term lease exception, therefore operating lease ROU assets and liabilities do not include leases with a lease term of twelve months or less. Our leases generally do not provide a residual guarantee. The operating lease ROU asset also excludes lease incentives. Lease expense is recognized on a straight-line basis over the lease term. We review the impairment of its ROU assets consistent with the approach applied for our other long-lived assets. We review the recoverability of our long-lived assets when events or changes in circumstances occur that indicate that the carrying value of the asset may not be recoverable. The assessment of possible impairment is based on its ability to recover the carrying value of the asset from the expected undiscounted future pre-tax cash flows of the related operations. We have elected to include the carrying amount of operating lease liabilities in any tested asset group and include the associated operating lease payments in the undiscounted future pre-tax cash flows. Discontinued operations In accordance with ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, a disposal of a component of an entity or a group of components of an entity is required to be reported as discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results when the components of an entity meet the criteria in paragraph 205-20-45-1E to be classified as discontinued operations. When all of the criteria to be classified as discontinued operations are met, including management having the authority to approve the action and committing to a plan to sell the entity, the major current assets, other assets, current liabilities, and noncurrent liabilities shall be reported as components of total assets and liabilities separate from the balances of the continuing operations. At the same time, the results of operations discontinued operations, less applicable income taxes (benefit), shall be reported as components of net income (loss) separate from the net income (loss) of continuing operations in accordance with ASC 205-20-45. See Note 4 - Discontinued operations. Revenue Recognition OnAugust 1, 2018 , we adopted Accounting Standards Update ("ASU") 2014-09 Revenue from Contracts with Customers (ASC Topic 606) using the modified retrospective method for contracts that were not completed as ofJuly 31, 2018 . This did not result in an adjustment to the retained earnings upon adoption of this new guidance as our revenue was recognized based on the amount of consideration expected to receive in exchange for satisfying the performance obligations. 52 The core principle underlying the revenue recognition ASU is that we will recognize revenue to represent the transfer of goods and services to customers in an amount that reflects the consideration to which we expect to be entitled in such exchange. This will require us to identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time, based on when control of goods and services transfers to a customer. Our revenue streams are recognized over time for our sale and installation of power generation systems and are recognized at a point in time for our sale of products.
The ASU requires the use of a new five-step model to recognize revenue from customer contracts. The five-step model requires us to (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will not occur, (iv) allocate the transaction price to the respective performance obligations in the contract, and (v) recognize revenue when (or as) we satisfy the performance obligation. The application of the five-step model to the revenue streams compared to the prior guidance did not result in significant changes in the way we record our revenue. Upon adoption, we evaluated our revenue recognition policy for all revenue streams within the scope of the ASU under previous standards and using the five-step model under the new guidance and confirmed that there were no differences in the pattern of revenue recognition.
Sale and installation of power generation systems
Sales of power generation systems in conjunction with system installation are generally recognized based on our efforts or inputs to the satisfaction of a performance obligation using an input measure method, which essentially the same as the percentage of completion method prior toAugust 1, 2018 for its installation project. Therefore, take into account the costs, estimated earnings and revenue to date on contracts not yet completed. Revenue recognized is that percentage of the total contract price that costs expended to date bear to anticipated final total costs, based on current estimates of costs to complete. Contract costs include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor and supplies. Adjustments to the original estimates of the total contract revenue, total contract costs, or the extent of progress toward completion are often required as work progresses. Such changes and refinements in estimation are reflected in reported results of operations as they occur; if material, the effects of changes in estimates are disclosed in the notes to the unaudited condensed consolidated financial statements. The key assumptions used in the estimate of costs to complete relate to the unit material cost, the quantity of materials to be used, the installation cost and those indirect costs related to contract performance. The estimate of unit material cost is reviewed and updated on a quarterly basis, based on the updated information available in the supply markets. The estimate of material quantity to be used for completion and the installation cost is also reviewed and updated on a quarterly basis, based on the updated information on the progress of project execution. If the supply market conditions or the progress of project execution were different, it is likely that materially different amounts of contract costs would be used in the percentage of completion method of accounting. Thus the uncertainty associated with those estimates may impact our unaudited condensed consolidated financial statements. Selling, general, and administrative costs are charged to expense as incurred. At the time a loss on a contract becomes known, the entire amount of the estimated ultimate loss is recognized in the unaudited condensed consolidated financial statements. Claims for additional contract costs are recognized upon a signed change order from the customer. The installation revenues and sales of equipment and system component are combined and considered as one performance obligation. The promises to transfer the equipment and system component and installation are not separately identifiable, which is evidencing by the fact that we provide a significant service of integrating the goods and services into a power generation system for which the customer has contracted. We currently do not have any modification of contract and the contract currently does not have any variable consideration. Sales of products
We continue to derive our revenues from sales contracts with our customers with revenues being recognized upon delivery of products. Persuasive evidence of an arrangement is demonstrated via sales contract and invoice; and the sales price to the customer is fixed upon acceptance of the sales contract and there is no separate sales rebate, discount, or other incentive. Such revenues are recognized at a point in time after all performance obligations are satisfied and based on when control of goods transfer to a customer, which is generally similar to when its delivery has occurred prior toAugust 1, 2018 . 53
Gross versus Net Revenue Reporting
In the normal course of the Company's business, the Company orders products directly from its suppliers and drop ships the products directly to its customers. In these situations, the Company generally collects the sales proceeds directly from its customers and pays for the inventory purchases to its suppliers separately. The determination of whether revenues should be reported on a gross or net basis is based on the Company's assessment of whether it is the principal or an agent in the transaction. In determining whether the Company is the principal or an agent, the Company follows the accounting guidance for principal-agent considerations. Because the Company is not the primary obligor and is not responsible for (i) fulfilling the resale products delivery, (ii) establishing the selling prices for delivery of the resale products, (iii) performing all billing and collection activities including retaining credit risk and (iv) baring the back-end risk of inventory loss with respect to any product return from its customer, the Company has concluded that it is the agent in these arrangements, and therefore reports revenues and cost of revenues on
a net basis. Warranty We generally provide limited warranties for work performed under our contracts. At the time a sale is recognized, we record estimated future warranty costs under ASC 460. Such estimated costs for warranties are estimated at completion and these warrants are not service warranties separately sold by us. Generally, the estimated claim rates of warranty are based on actual warranty experience or our best estimate.
Recent Accounting Pronouncements
See Note 2 of our notes to unaudited condensed consolidated financial statements for a discussion of recently issued accounting standards.
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