As filed with the Securities and Exchange Commission on February 10, 2006
Registration No. 333-_____
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
----------------------------
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
-----------------------------
CHINA NATURAL GAS, INC.
(Name of small business issuer in its charter)
Delaware 4923 98-0231607
(State or other Jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Incorporation or Classification Code Number) Identification No.)
Organization)
Tang Xing Shu Ma Building, Suite 418
Tang Xing Road
Xian High Tech Area
Xian, Shaanxi Province
China
(Address and telephone number of principal
executive offices and principal place of
business) Minqing Lu, Chief Executive
Officer
China Natural Gas, Inc.
Tang Xing Shu Ma Building, Suite 418
Tang Xing Road
Xian High Tech Area
Xian, Shaanxi Province
China
86-29-88323325
(Name, address and telephone number of agent for service)
Copies to:
Marc J. Ross, Esq.
Thomas A. Rose, Esq.
Sichenzia Ross Friedman Ference LLP
1065 Avenue of the Americas, 21st Flr.
New York, New York 10018
(212) 930-9700
(212) 930-9725 (fax)
APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC:
From time to time after this Registration Statement becomes effective.
If any securities being registered on this Form are to be offered on a delayed
or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other
than securities offered only in connection with dividend or interest
reinvestment plans, check the following box: [ ]
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. ________
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. _________
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. _________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box.
---------
i
CALCULATION OF REGISTRATION FEE
------------------------------- -------------------- ---------------- ------------------ --------------------
Title of each class of Number of Shares Proposed Proposed Amount of
securities to be registered to be registered maximum maximum registration fee
offering aggregate
price per offering price
share
------------------------------- -------------------- ---------------- ------------------ --------------------
Common Stock, $0.0001 par 3,714,428 $4.97 (1) $18,460,707.16 $1,975.30
value
------------------------------- -------------------- ---------------- ------------------ --------------------
Common Stock, $0.0001 par
value issuable upon exercise 1,431,954 $3.60 (2) 5,155,034.40 $ 551.59
of Warrants
------------------------------- -------------------- ---------------- ------------------ --------------------
5,146,382 $23,615,741.56 $2,526.89
------------------------------- -------------------- ---------------- ------------------ --------------------
(1) Estimated solely for purposes of calculating the registration fee in
accordance with Rule 457(c) and Rule 457(g) under the Securities Act of
1933, using the average of the high and low price as reported on the
Over-The-Counter Bulletin Board on February 8, 2006, which was $4.97 per
share.
(2) Calculated in accordance with Rule 457(g)(1).
The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant shall
file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the registration statement shall become
effective on such date as the Securities and Exchange Commission, acting
pursuant to said Section 8(a), may determine.
ii
The information in this Prospectus is not complete and may be changed. The
selling stockholders may not sell these securities until the registration
statement is filed with the Securities and Exchange Commission and becomes
effective. This Prospectus is not an offer to sell these securities and is not
soliciting an offer to buy these securities in any state where the sale is not
permitted.
PRELIMINARY PROSPECTUS SUBJECT TO COMPLETION, DATED FEBRUARY 10, 2006
CHINA NATURAL GAS, INC.
5,146,382 SHARES OF
COMMON STOCK
This prospectus relates to the resale by the selling stockholders of up to
5,146,382 shares of our common stock, including up to 1,431,954 shares of common
stock issuable upon the exercise of common stock purchase warrants. The selling
stockholders may sell common stock from time to time in the principal market on
which the stock is traded at the prevailing market price or in negotiated
transactions. The selling stockholders may be deemed underwriters of the shares
of common stock, which they are offering. We will pay the expenses of
registering these shares.
We are not selling any shares of common stock in this offering and
therefore will not receive any proceeds from the sale of common stock hereunder.
We may receive proceeds from any exercise of outstanding warrants. The warrants
may also be exercised by surrender of the warrants in exchange for an equal
value of shares in accordance with the terms of the warrants.
Our common stock is listed on the Over-The-Counter Bulletin Board under the
symbol "CHNG" The last reported sales price per share of our common stock as
reported by the Over-The-Counter Bulletin Board on February 8, 2006, was $5.05.
Investing in these securities involves significant risks. See "Risk
Factors" beginning on page 7.
No other underwriter or person has been engaged to facilitate the sale of
shares of common stock in this offering. None of the proceeds from the sale of
stock by the selling stockholders will be placed in escrow, trust or any similar
account.
We may amend or supplement this prospectus from time to time by filing
amendments or supplements as required. You should read the entire prospectus and
any amendments or supplements carefully before you make your investment
decision.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
Prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The date of this prospectus is ________, 2006.
Table Of Contents
Prospectus Summary...........................................................3
------------------
Risk Factors.................................................................5
------------
Use Of Proceeds..............................................................10
---------------
Market For Common Equity And Related Stockholder Matters.....................10
--------------------------------------------------------
Business.....................................................................13
--------
Facilities...................................................................16
----------
Employees....................................................................16
---------
Legal Proceedings............................................................16
-----------------
Management...................................................................17
----------
Certain Relationships And Related Transactions...............................19
----------------------------------------------
Security Ownership Of Certain Beneficial Owners And Management...............19
--------------------------------------------------------------
Description Of Securities To Be Registered...................................20
------------------------------------------
Indemnification For Securities Act Liabilities...............................20
----------------------------------------------
Plan Of Distribution.........................................................20
--------------------
Penny Stock..................................................................22
-----------
Selling Stockholders.........................................................23
--------------------
Legal Matters................................................................24
-------------
Experts......................................................................24
-------
Available Information........................................................24
---------------------
2
PROSPECTUS SUMMARY
The following summary highlights selected information contained in this
prospectus. This summary does not contain all the information you should
consider before investing in the securities. Before making an investment
decision, you should read the entire prospectus carefully, including the "risk
factors" section, the financial statements and the notes to the financial
statements. As used throughout this prospectus, the terms "China Natural Gas,"
"CHNG," the "Company," "we," "us," and "our" refer to China Natural Gas, Inc.
CHINA NATURAL GAS, INC.
We primarily engage in the transmission and distribution of natural gas to
commercial, industrial and residential customers.
We were incorporated in the state of Delaware on March 31, 1999, as Bullet
Environmental Systems, Inc. and on May 25, 2000 we changed our name to
Liquidpure Corp. and on February 14, 2002 we changed our name to Coventure
International Inc. On December 6, 2005, we closed a Share Purchase Agreement
with Xian Xilan Natural Gas Co., Ltd., a corporation formed under the laws of
the People's Republic of China on January 8, 2000, and the shareholders of Xian
Xilan Natural Gas Co., Ltd. Pursuant to the Agreement, we acquired all of the
issued and outstanding capital stock of Xian Xilan Natural Gas Co., Ltd. from
the shareholders of Xian Xilan Natural Gas Co., Ltd. On December 19, 2005 we
changed our name to China Natural Gas, Inc.
For the nine month period ended September 30, 2005, we had revenue of
$2,714,042, with gross profits of $1,298,743.
Our executive offices are located at Tang Xing Shu Ma Building, Suite 418,
Tang Xing Road, Xian High Tech Area, Xian, Shaanxi Province, China, and our
telephone number is 86-29-88323325. We are a Delaware corporation.
The Offering
Common stock offered by selling stockholders............. 5,146,382 shares, including up to
1,431,954 shares of common stock
issuable upon the exercise of common
stock purchase warrants at an exercise
price of $3.60 per share
Common stock to be outstanding after the offering........ 25,350,470 shares
Use of proceeds....................................... We will not receive any proceeds from
the sale of the common stock hereunder.
See "Use of Proceeds" for a complete
description.
OTCBB Symbol ............................................ CHNG
Summary of Recent Transactions
------------------------------
Acquisition of Xian Xilan Natural Gas Co., Ltd.
On December 6, 2005, China Natural Gas, Inc., formerly Coventure
International Inc., entered into and closed a Share Purchase Agreement with Xian
Xilan Natural Gas Co., Ltd., a corporation formed under the laws of the People's
Republic of China, and each of Xilan's shareholders. Pursuant to the Agreement,
Coventure acquired all of the issued and outstanding capital stock of Xilan from
the Xilan shareholders in exchange for 4,000,000 shares of Coventure common
stock. Concurrently with the closing of the Purchase Agreement and as a
condition thereof, Coventure entered into an agreement with John Hromyk, its
President and Chief Financial Officer, pursuant to which Mr. Hromyk returned
5,971,178 shares of Coventure common stock to Coventure for cancellation. Mr.
Hromyk was not compensated in any way for the cancellation of his shares of
Coventure Common Stock. Upon completion of the foregoing transactions, Coventure
had an aggregate of 5,051,022 shares of common stock issued and outstanding.
3
Private Offering of Units
January 6, 2006 and January 9, 2006
On January 6, 2006 and January 9, 2006, we entered into securities purchase
agreements with four accredited investors and completed the sale of $5,380,000
of units. The units contained an aggregate of 1,921,572 shares of common stock
and 523,055 common stock purchase warrants. Each common stock purchase warrant
is exercisable for a period of three years at an exercise price of $3.60 per
share. Pursuant to the terms of the warrant, each investor has contractually
agreed to restrict its ability to exercise the warrants to an amount which would
not exceed the difference between the number of shares of common stock
beneficially owned by the holder or issuable upon exercise of the warrant held
by such holder and 9.9% of the outstanding shares of common stock of the
Company. New York Global Securities acted as the placement agent of the
transaction.
In connection with the offering, the Company paid a placement fee of 10% of
the proceeds in cash, together with non-accountable expenses in the amount of 3%
of the proceeds, in cash. In addition, the placement agent was issued warrants
to purchase 298,888 shares of common stock on the same terms and conditions as
the investors.
January 10, 2006 through January 13, 2006
On January 10, 2006 through January 13, 2006, we entered into securities
purchase agreements with four accredited investors and completed the sale of
$2,195,198 of units. The units contained an aggregate of 783,999 shares of
common stock and 213,422 common stock purchase warrants. Each common stock
purchase warrant is exercisable for a period of three years at an exercise price
of $3.60 per share. Pursuant to the terms of the warrant, each investor has
contractually agreed to restrict its ability to exercise the warrants to an
amount which would not exceed the difference between the number of shares of
common stock beneficially owned by the holder or issuable upon exercise of the
warrant held by such holder and 9.9% of the outstanding shares of common stock
of the Company. New York Global Securities acted as the placement agent of the
transaction.
In connection with the offering, the Company paid a placement fee of 10% of
the proceeds in cash, together with non-accountable expenses in the amount of 3%
of the proceeds, in cash. In addition, the placement agent was issued warrants
to purchase 121,955 shares of common stock on the same terms and conditions as
the investors.
January 17, 2006
On January 17, 2006, we entered into securities purchase agreements with an
accredited investor and completed the sale of $2,824,802 of units. The units
contained an aggregate of 1,008,857 shares of common stock and 274,633 common
stock purchase warrants. Each common stock purchase warrant is exercisable for a
period of three years at an exercise price of $3.60 per share. Pursuant to the
terms of the warrant, each investor has contractually agreed to restrict its
ability to exercise the warrants to an amount which would not exceed the
difference between the number of shares of common stock beneficially owned by
the holder or issuable upon exercise of the warrant held by such holder and 9.9%
of the outstanding shares of common stock of the Company.
4
RISK FACTORS
This investment has a high degree of risk. Before you invest you should
carefully consider the risks and uncertainties described below and the other
information in this prospectus. If any of the following risks actually occur,
our business, operating results and financial condition could be harmed and the
value of our stock could go down. This means you could lose all or a part of
your investment.
Risks Related To Our Business
Prices of natural gas can be subject to significant fluctuations, which may
affect our ability to provide supplies to our customers.
While we obtain supplies of natural gas from a government owned entity, our
supply contracts are subject to review every six months and our prices have not
historically fluctuated much. While our management does not expect any issues or
difficulty in continuing to renew the supply contracts going forward and our
costs for natural gas are strictly controlled by the government and have
remained stable over the past 3 years, the price of natural gas can fluctuate in
response to changing national or international market forces. Accordingly, price
levels of natural gas may rise or fall significantly over the short to medium
term due to political events, OPEC actions and other factors, industry economics
over the long term.
We are dependent on supplies of natural gas to deliver to our customers.
We obtain our supplies of natural gas from one supplier, a government owned
entity. The ability to deliver our product is dependent on a sufficient supply
of natural gas and if we are unable to obtain a sufficient natural gas supply it
could prevent us making deliveries to our customers who are dependent on our
supply. While we have a supply contract, we do not control the government owned
supplier, nor are we able to control the amount of time and effort they put
forth on our behalf. It is possible that this supplier may not perform as
expected, and that they may breach or terminate their agreements with us before
completing their work. It is also possible that, after a semi-annual review of
our supply contract, they may choose to provide services to a competitor. Any
failure to obtain supplies of natural gas could prevent us from delivering such
to our customers.
Our business operations are subject to a high degree of risk and insurance may
not be adequate to cover liabilities resulting from accidents or injuries that
occur during our physically demanding events.
Our operations are subject to potential hazards incident to the gathering,
processing, separation and storage of natural gas, such as explosions, product
spills, leaks, emissions and fires. These hazards can cause personal injury and
loss of life, severe damage to and destruction of property and equipment, and
pollution or other environmental damage, and may result in curtailment or
suspension of operations at the affected facility.
The occurrence of a significant event for which we are not fully insured or
indemnified, and/or the failure of a party to meet its indemnification
obligations, could materially and adversely affect our operations and financial
condition. Moreover, no assurance can be given that we will be able to maintain
adequate insurance in the future at rates it considers reasonable. To date,
however, we have maintained adequate coverage at reasonable rates and have
experienced no material uninsured losses.
Changes in the regulatory atmosphere could adversely affect our business.
The distribution of natural gas and operations of filling stations are
highly regulated requiring registrations for the issuance of licenses required
by various governing authorities in China. In addition, there are various
standards that must be met for filling stations including handling and storage
of natural gas, tanker handling, and compressor operation which are regulated.
The costs of complying with regulations in the future may harm our business.
Furthermore, future changes in environmental laws and regulations could occur
that result in stricter standards and enforcement, larger fines and liability,
and increased capital expenditures and operating costs, any of which could have
a material adverse effect on our financial condition or results of operations.
5
Because we depend on our senior management's experience and knowledge of the
industry, we would be adversely affected if senior management left.
We are dependent on the continued efforts of our senior management team. We
do not currently have employment contracts with our senior executives. If, for
any reason, senior executives do not continue to be active in management, our
business, financial condition or results of operations could be adversely
affected. In addition, we do not maintain key personnel life insurance on our
senior executives or other key employees.
We may need to raise capital to fund our operations, and our failure to obtain
funding when needed may force us to delay, reduce or eliminate acquisitions and
business development plans.
If in the future, we are not capable of generating sufficient revenues from
operations and our capital resources are insufficient to meet future
requirements, we may have to raise funds to continue the development,
commercialization and marketing of our business.
We cannot be certain that funding will be available on acceptable terms, or
at all. To the extent that we raise additional funds by issuing equity
securities, our stockholders may experience significant dilution. Any debt
financing, if available, may involve restrictive covenants that impact our
ability to conduct our business. If we are unable to raise additional capital if
required or on acceptable terms, we may have to significantly delay, scale back
or discontinue our planned acquisitions or business development plans or obtain
funds by entering into agreements on unattractive terms.
Risks Related To The People's Republic of China
China's economic policies could affect our business.
Substantially all of our assets are located in China and substantially all
of our revenue is derived from our operations in China. Accordingly, our results
of operations and prospects are subject, to a significant extent, to the
economic, political and legal developments in China.
While China's economy has experienced a significant growth in the past
twenty years, growth has been uneven, both geographically and among various
sectors of the economy. The Chinese government has implemented various measures
to encourage economic growth and guide the allocation of resources. Some of
these measures benefit the overall economy of China, but may also have a
negative effect on us. For example, our operating results and financial
condition may be adversely affected by the government control over capital
investments or changes in tax regulations.
The economy of China has been transitioning from a planned economy to a
more market-oriented economy. In recent years the Chinese government has
implemented measures emphasizing the utilization of market forces for economic
reform and the reduction of state ownership of productive assets and the
establishment of corporate governance in business enterprises; however, a
substantial portion of productive assets in China are still owned by the Chinese
government. In addition, the Chinese government continues to play a significant
role in regulating industry development by imposing industrial policies. It also
exercises significant control over China's economic growth through the
allocation of resources, controlling payment of foreign currency-denominated
obligations, setting monetary policy and providing preferential treatment to
particular industries or companies.
Capital outflow policies in The People's Republic of China may hamper our
ability to remit income to the United States.
The People's Republic of China has adopted currency and capital transfer
regulations. These regulations may require that we comply with complex
regulations for the movement of capital. Although we believe that we are
currently in compliance with these regulations, should these regulations or the
interpretation of them by courts or regulatory agencies change we may not be
able to remit all income earned and proceeds received in connection with our
operations or from the sale of our operating subsidiary to the U.S. or to our
stockholders.
6
Although we do not import goods into or export goods out of The People's
Republic of China, fluctuation of the Renminbi may indirectly affect our
financial condition by affecting the volume of cross- border money flow.
The value of the Renminbi fluctuates and is subject to changes in The
People's Republic of China's political and economic conditions. Since July 2005,
the conversion of Renminbi into foreign currencies, including United States
dollars, has been based on rates set by the People's Bank of China, which are
set based upon the interbank foreign exchange market rates and current exchange
rates of a basket of currencies on the world financial markets. As of January 9,
2006, the exchange rate between the Renminbi and the United States dollar was
8.07 Renminbi to every one United States dollar.
We may face obstacles from the communist system in The People's Republic of
China.
Foreign companies conducting operations in The People's Republic of China
face significant political, economic and legal risks. The Communist regime in
The People's Republic of China, including a stifling bureaucracy, may hinder
Western investment.
We may have difficulty establishing adequate management, legal and financial
controls in The People's Republic of China.
The People's Republic of China historically has been deficient in Western
style management and financial reporting concepts and practices, as well as in
modern banking, computer and other control systems. We may have difficulty in
hiring and retaining a sufficient number of qualified employees to work in The
People's Republic of China. As a result of these factors, we may experience
difficulty in establishing management, legal and financial controls, collecting
financial data and preparing financial statements, books of account and
corporate records and instituting business practices that meet Western
standards.
Because our assets and operations are located in China, you may have difficulty
enforcing any civil liabilities against us under the securities and other laws
of the United States or any state.
We are a holding company, and all of our assets are located in the Republic
of China. In addition, our directors and officers are non-residents of the
United States, and all or a substantial portion of the assets of these
non-residents are located outside the United States. As a result, it may be
difficult for investors to effect service of process within the United States
upon these non-residents or to enforce against them judgments obtained in United
States courts, including judgments based upon the civil liability provisions of
the securities laws of the United States or any state.
There is uncertainty as to whether courts of the Republic of China would
enforce:
o Judgments of United States courts obtained against us or these
non-residents based on the civil liability provisions of the
securities laws of the United States or any state; or
o In original actions brought in the Republic of China, liabilities
against us or these non-residents predicated upon the securities laws
of the United States or any state.
Enforcement of a foreign judgment in the Republic of China also may be
limited or otherwise affected by applicable bankruptcy, insolvency, liquidation,
arrangement, moratorium or similar laws relating to or affecting creditors'
rights generally and will be subject to a statutory limitation of time within
which proceedings may be brought.
We may face political and/or judicial corruption in The People's Republic of
China.
Another obstacle to foreign investment is corruption. There is no assurance
that we will be able to obtain recourse, if desired, through The People's
Republic of China's poorly developed and often corrupt judicial systems.
7
The admission of China into the World Trade Organization could lead to increased
foreign competition.
The natural gas industry is regulated by the provincial and central
government authorities for safety and to ensure that all areas receive natural
gas service in an economically sound fashion. However, as a result of China
becoming a member of the World Trade Organization (WTO), restrictions on foreign
investment in the industry may be reduced. With China's need to meet growth in
natural gas demand and the WTO's requirement for a reduction of import tariffs
as restrictions on foreign investment as a condition of membership, such events
could lead to increased competition in the natural gas industry.
Risks Related To This Offering
There Is No Assurance Of An Established Public Trading Market, Which Would
Adversely Affect The Ability Of Investors In Our Company To Sell Their
Securities In The Public Markets.
Although our common stock trades on the Over-the-Counter Bulleting Board
(the "OTCBB"), a regular trading market for the securities may not be sustained
in the future. The NASD has enacted recent changes that limit quotations on the
OTCBB to securities of issuers that are current in their reports filed with the
Securities and Exchange Commission. The effect on the OTCBB of these rule
changes and other proposed changes cannot be determined at this time. The OTCBB
is an inter-dealer, Over-The-Counter market that provides significantly less
liquidity than the NASD's automated quotation system (the "NASDAQ Stock
Market"). Quotes for stocks included on the OTCBB are not listed in the
financial sections of newspapers as are those for The Nasdaq Stock Market.
Therefore, prices for securities traded solely on the OTCBB may be difficult to
obtain and holders of common stock may be unable to resell their securities at
or near their original offering price or at any price. Market prices for our
common stock will be influenced by a number of factors, including:
o the issuance of new equity securities;
o changes in interest rates;
o competitive developments, including announcements by competitors of
new products or services or significant contracts, acquisitions,
strategic partnerships, joint ventures or capital commitments;
o variations in quarterly operating results;
o change in financial estimates by securities analysts;
o the depth and liquidity of the market for our common stock;
o investor perceptions of our company and the technologies industries
generally; and
o general economic and other national conditions.
The Limited Prior Public Market And Trading Market May Cause Volatility In The
Market Price Of Our Common Stock.
Our common stock is currently traded on a limited basis on the OTCBB under
the symbol "CHNG." The quotation of our common stock on the OTCBB does not
assure that a meaningful, consistent and liquid trading market currently exists,
and in recent years such market has experienced extreme price and volume
fluctuations that have particularly affected the market prices of many smaller
companies like us. Our common stock is thus subject to volatility. In the
absence of an active trading market:
o investors may have difficulty buying and selling or obtaining market
quotations;
o market visibility for our common stock may be limited; and
o a lack of visibility for our common stock may have a depressive effect
on the market for our common stock.
Our Common Stock Could Be Considered To Be A "Penny Stock."
Our common stock could be considered to be a "penny stock" if it meets one
or more of the definitions in Rules 15g-2 through 15g-6 promulgated under
Section 15(g) of the Securities Exchange Act of 1934, as amended. These include
but are not limited to the following: (i) the stock trades at a price less than
$5.00 per share; (ii) it is NOT traded on a "recognized" national exchange;
8
(iii) it is NOT quoted on The Nasdaq Stock Market, or even if so, has a price
less than $5.00 per share; or (iv) is issued by a company with net tangible
assets less than $2.0 million, if in business more than a continuous three
years, or with average revenues of less than $6.0 million for the past three
years. The principal result or effect of being designated a "penny stock" is
that securities broker-dealers cannot recommend the stock but must trade in it
on an unsolicited basis.
Broker-Dealer Requirements May Affect Trading And Liquidity.
Section 15(g) of the Securities Exchange Act of 1934, as amended, and Rule
15g-2 promulgated thereunder by the SEC require broker-dealers dealing in penny
stocks to provide potential investors with a document disclosing the risks of
penny stocks and to obtain a manually signed and dated written receipt of the
document before effecting any transaction in a penny stock for the investor's
account.
Potential investors in our common stock are urged to obtain and read such
disclosure carefully before purchasing any shares that are deemed to be "penny
stock." Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve
the account of any investor for transactions in such stocks before selling any
penny stock to that investor. This procedure requires the broker-dealer to (i)
obtain from the investor information concerning his or her financial situation,
investment experience and investment objectives; (ii) reasonably determine,
based on that information, that transactions in penny stocks are suitable for
the investor and that the investor has sufficient knowledge and experience as to
be reasonably capable of evaluating the risks of penny stock transactions; (iii)
provide the investor with a written statement setting forth the basis on which
the broker-dealer made the determination in (ii) above; and (iv) receive a
signed and dated copy of such statement from the investor, confirming that it
accurately reflects the investor's financial situation, investment experience
and investment objectives. Compliance with these requirements may make it more
difficult for holders of our common stock to resell their shares to third
parties or to otherwise dispose of them in the market or otherwise.
Shares Eligible For Future Sale May Adversely Affect The Market Price Of Our
Common Stock, As The Future Sale Of A Substantial Amount Of Our Restricted Stock
In The Public Marketplace Could Reduce The Price Of Our Common Stock.
From time to time, certain of our stockholders may be eligible to sell all
or some of their shares of common stock by means of ordinary brokerage
transactions in the open market pursuant to Rule 144, promulgated under the
Securities Act ("Rule 144"), subject to certain limitations. In general,
pursuant to Rule 144, a stockholder (or stockholders whose shares are
aggregated) who has satisfied a one-year holding period may, under certain
circumstances, sell within any three-month period a number of securities which
does not exceed the greater of 1% of the then outstanding shares of common stock
or the average weekly trading volume of the class during the four calendar weeks
prior to such sale. Rule 144 also permits, under certain circumstances, the sale
of securities, without any limitations, by a non-affiliate of our company that
has satisfied a two-year holding period. Any substantial sale of common stock
pursuant to Rule 144 or pursuant to any resale prospectus may have an adverse
effect on the market price of our securities.
9
USE OF PROCEEDS
We will not receive any proceeds from the sale of shares to be offered by
the selling stockholders. The proceeds from the sale of each selling
stockholders' common stock will belong to that selling stockholder. However, we
may receive the sale price of any common stock we sell to the selling
stockholders upon exercise of outstanding warrants.
Unless otherwise indicated in the applicable prospectus supplement, we
anticipate that any net proceeds from the sale of the securities that we may
offer under this prospectus and any accompanying prospectus supplement will be
used for general corporate purposes. General corporate purposes may include
acquisitions, investments, repayment of debt, capital expenditures, repurchase
of our capital stock and any other purposes that we may specify in any
prospectus supplement. We may invest the net proceeds temporarily until we use
them for their stated purpose.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On March 17, 2004, our common stock was approved for listing on the
Over-the-Counter Bulletin Board under the symbol "CVNI." On December 19, 2005
our symbol was changed to "CHNG" and our fiscal year end was changed to December
31. The following table sets forth, the range of high and low closing bid
quotations for our common stock since our common stock was listed on the
Over-the-Counter Bulletin Board, reflecting the applicable fiscal periods based
on the change in our fiscal year end. The quotations represent inter-dealer
prices without retail markup, markdown or commission, and may not necessarily
represent actual transactions.
Period
------
High* Low*
------------------ ------------------
December 31, 2005 $ 3.60 $ 0.5275
July 31, 2005 $ 6.00 $ 0.50
================== ==================
April 30, 2005 $ 2.90 $ 1.05
================== ==================
January 31, 2005 $ 7.25 $ 0.45
================== ==================
October 30, 2004 $ 0.45 $ 0.45
================== ==================
July 31, 2004 $ 1.50 $ 0.25
================== ==================
April 30, 2004 $ 0.30 $ 0.30
================== ==================
As of February 8, 2006, there were approximately 50 holders of record of
our common stock.
Dividends
There are no restrictions in our articles of incorporation or bylaws that
prevent us from declaring dividends. The Delaware General Corporation Law,
however, does prohibit us from declaring dividends where, after giving effect to
the distribution of the dividend:
1. We would not be able to pay our debts as they become due in the usual
course of business; or
2. Our total assets would be less than the sum of our total liabilities
plus the amount that would be needed to satisfy the rights of shareholders
who have preferential rights superior to those receiving the distribution.
We have never declared or paid any cash dividends on our common stock. We
currently intend to retain future earnings, if any, to finance the expansion of
our business. As a result, we do not anticipate paying any cash dividends in the
foreseeable future.
10
Securities Authorized for Issuance Under Equity Compensation Plans
The following table shows information with respect to each equity
compensation plan under which our common stock is authorized for issuance as of
the fiscal year ended December 31, 2005.
EQUITY COMPENSATION PLAN INFORMATION
------------------------------------ ------------------------ ----------------------- ---------------------------
Plan category Number of securities Weighted average Number of securities
to be issued upon exercise price of remaining available for
exercise of outstanding options, future issuance under
outstanding options, warrants and rights equity compensation plans
warrants and rights (excluding securities
reflected in column (a)
------------------------------------ ------------------------ ----------------------- ---------------------------
(a) (b) (c)
------------------------------------ ------------------------ ----------------------- ---------------------------
Equity compensation plans approved -0- -0- -0-
by security holders
------------------------------------ ------------------------ ----------------------- ---------------------------
------------------------------------ ------------------------ ----------------------- ---------------------------
Equity compensation plans not -0- -0- -0-
approved by security holders
------------------------------------ ------------------------ ----------------------- ---------------------------
------------------------------------ ------------------------ ----------------------- ---------------------------
Total -0- -0- -0-
------------------------------------ ------------------------ ----------------------- ---------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Forward-Looking Statements
The information in this report contains forward-looking statements. All
statements other than statements of historical fact made in this report are
forward looking. In particular, the statements herein regarding industry
prospects and future results of operations or financial position are
forward-looking statements. These forward-looking statements can be identified
by the use of words such as "believes," "estimates," "could," "possibly,"
"probably," anticipates," "projects," "expects," "may," "will," or "should" or
other variations or similar words. No assurances can be given that the future
results anticipated by the forward-looking statements will be achieved.
Forward-looking statements reflect management's current expectations and are
inherently uncertain. Our actual results may differ significantly from
management's expectations.
The following discussion and analysis should be read in conjunction with
our financial statements, included herewith. This discussion should not be
construed to imply that the results discussed herein will necessarily continue
into the future, or that any conclusion reached herein will necessarily be
indicative of actual operating results in the future. Such discussion represents
only the best present assessment of our management.
Corporate History
We were incorporated in the state of Delaware on March 31, 1999, as Bullet
Environmental Systems, Inc. and on May 25, 2000 we changed our name to
Liquidpure Corp. and on February 14, 2002 we changed our name to Coventure
International Inc. On December 6, 2005, we closed a Share Purchase Agreement
with Xian Xilan Natural Gas Co., Ltd., a corporation formed under the laws of
the People's Republic of China on January 8, 2000, and the shareholders of Xian
Xilan Natural Gas Co., Ltd. Pursuant to the Agreement, we acquired all of the
issued and outstanding capital stock of Xian Xilan Natural Gas Co., Ltd. from
the shareholders of Xian Xilan Natural Gas Co., Ltd. On December 19, 2005 we
changed our name to China Natural Gas, Inc.
Nine Months Ended September 30, 2005 Compared To Nine Months Ended September 30,
2004
Revenue. For the nine-month period ended September 30, 2005 as compared to the
nine-month period ended September 30, 2004, we generated net revenues of
$2,714,042 and $701,615 respectively, reflecting an increase of $2,012,427 or
287%. The increase in revenues was due to increased construction and
installation revenue as we signed new residential and commercial customers.
These customers pay approximately 60% of the construction costs up front and the
balance is paid as part of the monthly natural gas bill.
11
Gross profit. We achieved a gross profit of $1,298,743 for the nine months ended
September 30, 2005, an increase of $1,034,828 or 392%, compared to $263,915 for
the nine months ended September 30, 2004. Gross margin, as a percentage of
revenues, increased from 37.6% for the nine months ended September 30, 2004, to
47.9% for the nine months ended September 30, 2005. The increase in gross profit
is due to the increased construction and installation activity. The increase in
gross margin is attributable to the margins that are received during
construction and installation, we work with gross margins that are approximately
50%, mostly due to the low cost of labor.
Operating expenses. We incurred operating expenses of $530,217 for the nine
months ended September 30, 2005, an increase of $39,818 or 10%, compared to
$487,718 for the nine months ended September 30, 2004. This increase represents
our continued development and implementation of our strategy to develop the
filling station business, as well as administering the increased construction
and installation activity. Aggregated selling expenses of $299,352 for the nine
months ended September 30, 2005 and $282,924 for the nine months ended September
30, 2004 account for expenses related to costs associated with sales and
marketing of our products. Operating expenses include general and administrative
expenses of $132,991 and $109,600 for the first nine months of 2005 and the
first nine months of 2004, respectively. Operating expenses relate to cost of
maintaining our facilities, salaries and planning the initial roll out of the
filling station business.
Net income (loss). Our net income was $736,802 for the nine months ended
September 30, 2005, an increase of $865,091 compared to net loss of $128,289 for
the nine months ended September 30, 2004. The increase was fully attributed to
the growth of construction and installation fees.
Twelve Months Ended December 31, 2004 Compared To Twelve Months Ended December
31, 2003
Revenue. We generated revenues of $884,413 for the twelve months ended December
31, 2004, a decrease of $687,880 or -43.8%, compared to $1,572,293 for the
twelve months ended December 31, 2003. The decrease in revenue was due to the
completion of the first phase of construction and installation necessary to
bring new customers into our system. This work was completed ahead of time and
accounts for the relatively minor amount of construction and installation work
in the same period of 2004. Due to the rapid pace of the work completed in 2003,
we were able to focus on signing new customers in 2004, hence the surge in
construction and installations in 2005.
Gross profit. We achieved a gross profit of $370,367 for the twelve months ended
December 31, 2004, a decrease of $143,535 or 28%, compared to $513,902 for the
twelve months ended December 31, 2003. Gross margin, as a percentage of
revenues, decreased from 41.9% for the twelve months ended December 31, 2003, to
32.7% for the twelve months ended December 31, 2004. The decrease in gross
margin was attributed to the 57% decrease in construction and installation
activity in 2004, this segment of our business, although not a monthly recurring
business is highly profitable with gross margins that are nearly 50%.
Operating expenses. We incurred operating expenses of $530,217 for the twelve
months ended December 31, 2004, an increase of $42,499 or 9%, compared to
$487,718 for the twelve months ended December 31, 2003. These operating expenses
are related to increased sales and marketing costs to sign new residential and
commercial customers that were put on line in 2005. In addition we began to
address the filling station strategy, identifying possible locations for the
filling stations and commencing the process of applying to the proper
governmental agencies for all necessary approvals and licenses to construct the
new filling stations.
Net Income (loss). Net loss was $161,768, for twelve months ended December 31,
2004, a decrease of $240,982, from net income of $79,214 for the twelve months
ended December 31, 2003. This loss can be attributed to increased marketing
efforts to new residential and commercial customers as well as the decline in
revenues associated with construction and installation activities that were
completed ahead of schedule.
Liquidity and Capital Resources
As of September 30, 2005 we had $1,001,243 cash and cash equivalents on
hand compared to $65,177 cash and cash equivalents as of September 30, 2004.
During January 2006 we raised $10,400,000 in a private placement of shares of
our common stock and warrants to purchase our common stock and paid an aggregate
of $984,775.74 in fees and expenses to a placement agent in connection with this
offering. Based on past performance and current expectations, we believe our
cash and cash equivalents, cash generated from operations, as well as future
possible cash investments, will satisfy our working capital needs, capital
expenditures and other liquidity requirements associated with our operations. We
had net cash flows provided by operations of $69,256 for the nine month period
ended September 30, 2005 as compared to net cash provided by operations of
$396,079 in the corresponding period last year. The decrease in net cash flows
from operations in the current period as compared to corresponding period last
year was mainly due to an increase in accounts receivables of $297,892 during
the nine month period ended September 30, 2005.
12
Cashflows from investing activities resulted in net usage of $2,671,533 in
the current period as compared to net usage of $374,638 in the corresponding
period last year. The greater usage in the current period was mainly due to
advance payments made to equipment suppliers for investments necessary to
construct and build the filling stations. We had inflows from investment
activities of $3,503,897 during the nine month period ended September 30, 2005,
in connection with shares of common stock issued by Xian Xilan Natural Gas Co.,
Ltd. prior to our acquisition of all of the issued and outstanding capital stock
of Xilan from the Xilan shareholders.
The majority of our revenues and expenses were denominated primarily in
Renminbi ("RMB"), the currency of the People's Republic of China.
There is no assurance that exchange rates between the RMB and the U.S.
Dollar will remain stable. We do not engage in currency hedging. Inflation has
not had a material impact on our business.
BUSINESS
Overview of Business
We primarily engage in the transmission and distribution of natural gas to
commercial, industrial and residential customers.
Business
End User Delivery of Natural Gas
We are the sole authorized provider of natural gas to residential customers
in certain parts of the Xian area, including Lantian County and the Baqiao
District. We are currently supplying natural gas to approximately 50,000
households in the Xian area. Via a connecting point with a high pressure
pipeline network from the government operated Shaanxi Natural Gas Company,
natural gas with much lower pressure is delivered to our residential, commercial
and industrial customers. We own approximately 120 km of high pressure pipeline.
We are the only private company in Shaanxi province to own this type of high
pressure pipeline.
Our management is seeking to expand supply services to the Shangluo and
Ankang areas of Shaanxi province. Upon approval from the government, we would
also have the exclusive right to provide natural gas to residential and
commercial end users in those areas. In order to obtain such approval, we were
required to submit a project proposal for the feasibility of supplying gas to
each area. In Ankang, we applied to the Urban and Rural Construction Bureau. In
Shangluo, applications were made to the Municipal Administration Bureau. The
approval process takes approximately four to six months and is pending.
Wholesale to Filling Stations
We sell compressed natural gas to filling stations on a wholesale basis.
The stations, in turn, sell natural gas to taxis and buses in Xian which operate
on compressed natural gas (CNG) technology. Government statistics indicate that
there are currently 5,000 buses and 20,000 taxis using natural gas in Xian. Each
bus uses an average of 70 cubic meters of CNG per day and taxis use an average
of 30 cubic meters of CNG per day (source: Xian Clean Fuel Vehicles Commission
2005).
In July 2005, we purchased a Compressor Station which is operated in
proximity to our pipeline and which allows us to compress and transport natural
gas via truck to retail gas stations. We also plan to develop a liquefied form
of natural gas (LNG) that can be transported over longer distances by gas tanker
truck and which could expand our geographical sales. We are currently conducting
a feasibility study with regard to LNG production. This study should be
completed in June 2006. In order to construct an appropriate LNG plant, we will
13
require approximately US$19 million (RMB 150 million), with construction of the
plant completed by year end 2006, testing in October 2007 and production
commencing in December 2007, assuming appropriate financing can be obtained. We
can begin the process with our current licenses but in the future will require
approval from Shaanxi Development and Reform Commission for LNG production.
Retail Filling Stations
Based on company estimates, by the end of June 2005, the total demand for
compressed natural gas vehicular fuel in the Xian area was approximately one
million cubic meters per day. We expect demand for natural gas as a transport
fuel to continue to increase based on government clean energy policy as
expressed in the proposal for the Eleventh Ten Year Plan (2006-2010) and the
end-user cost advantages of CNG fuel over gasoline. We estimate that the average
filling station in Xian pumps approximately 12,000 cubic meters of natural gas
per day. Based on a survey we conducted, as of November 1, 2005, there were 31
filling stations in Xian pumping approximately 372,000 cubic meters of CNG fuel
per day, a figure well below estimated total demand.
As of February 9, 2006 we have completed construction and are operating two
natural gas filling stations in the Xian metropolitan area. Currently, we
purchase natural gas for 1.16 RMB/cubic meter and sell each cubic meter for
1.90RMB net of VAT. The construction time for each filling station is 45-60 days
and the cost is approximately US$600,000. The construction of additional
facilities is dependent upon our ability to acquire sufficient additional
capital when needed.
Our management believes that our vertically integrated operation should
allow us to be able to surpass the average sales volume of competing stations,
estimated at 12,000 cubic meters per day, based on our proprietary supply of CNG
from our own pipeline.
Marketing
We market the end user delivery of the natural gas segment of the business
through advertising in the general media and direct solicitation of real estate
development companies and government officials. We participate in trade shows
and conferences such as the 7th Xian Global Gas Fuels Technology Equipment and
Auto Service Station Exhibition which was held in June 2005. For the retail
filling station segment of the business, we will target advertising to taxi
drivers, who are the largest segment of end-users of the company's CNG fuel
product. A discount loyalty card will be made available to the professional
driving community including taxi and bus drivers. Brochures, radio and newspaper
advertisements and point of sale displays will also be utilized.
Suppliers
Currently, we have only one natural gas supplier, the Shaanxi Natural Gas
Co., Ltd., a government owned enterprise. In the past, contracts were renewed on
an annual basis. However, as the volume of usage has increased, Shaanxi Natural
Gas has revised their policies, and contract terms are now six months and
subject to review prior to renewal. Our management reports that we do not expect
any issues or difficulty in continuing to renew the supply contracts going
forward. Price points for natural gas are strictly controlled by the government
and have remained stable over the past 3 years.
Customers
Residential/Commercial
We supply natural gas to approximately 50,000 residential customers in
Lantian County, Lintong and Baqiao Districts in the jurisdiction of Xian. These
residences include apartment blocks and small estates. Commercial customers
include small businesses like restaurants and office buildings.
Industrial
Within the Xian region there are several industries to which we supply
natural gas as a raw material for their production process including the Xiwei
Aluminum Company.
14
Wholesale to Filling Stations
Currently, we supply natural gas to several of the privately owned and
operated CNG filling stations in the Xian area. Upon the completion of
construction of our company-owned filling stations, we will also supply our own
filling stations for sales to retail end users.
Industry Overview
China's rapidly expanding economy is stretching the limits of its energy
resources. Currently, only 3% of China's total energy usage is natural gas,
while the world's average consumption of natural gas is 24% of total energy
usage. (source: US Energy Information Administration ("EIA"), August 2005) Over
the next 5 years, China's use of natural gas is generally expected to double.
China's domestic reserve of natural gas was estimated to be 53.3 trillion cubic
feet (tcf) at the beginning of 2005 (source: EIA August 2005). The country's
largest reserves are located in western and north central China, including the
Province of Shaanxi, the home of Xilan.
In order to meet the growth in natural gas demand, the PRC government has
encouraged private companies to invest in and build the natural gas
infrastructure. On December 27, 2002, the Ministry of Construction issued a
memorandum stating that regulation of the public utility industry (including gas
distribution) should be liberalized and foreign and private investment
participation should be encouraged and welcomed. The memorandum encouraged
private investment in the sector and provided a legal framework for private
urban natural gas distribution.
Intellectual Property
We have applied for a service mark on the "Xilan" name, which is used in
connection with all services.
Research and Development
We have not had any material research and development expenses over the
past two years. We project expenditures of approximately $100,000 for research
and development in 2006. The funding source for all research and development
expenses is expected to come from operating cash flows.
Governmental and Environmental Regulation
To date, we have been compliant with all registrations and requirements for
the issuance and maintenance of all licenses required by the applicable
governing authorities in China. These licenses include:
o Qualified Urban Fuel Operator Business License authorized by the
Shaanxi Construction Bureau, the local office of the Ministry of
Construction, effective from January 2, 2004 to January 2, 2009.
(License number SHAANRANZHI 166)
o License to Supply, Install Equipment and Maintain Gas Fuel Lines
issued by the local Gas Fuels for Heating Bureau, an agency of the
Ministry of Construction and the Xian Natural Gas Management Bureau.
(License number: XIRAN 136)
o Safety and Inspection Regulation for Special Equipment Safety
Inspection Standards for High Pressure Pipeline and Technical Safety
Inspection Regulations from the Shaanxi Quality and Technology
Inspection Bureau for compressor stations and pressure storage tank
system. (Approval letter reference: 2004SHAANGUOCHUHAN033)
o Annual Safety Inspection of Lightning Conductor Equipment approved by
the Shaanxi Meteorology Bureau. (Certificate number 0005274)
The Citygate and Compressor Stations are approved by the local office of
the Ministry of Construction.
Fuel service station standards are subject to regulation by the Ministry of
Construction, the General Administration of Quality Supervision, and the Bureau
of Inspection and Quarantine of the People's Republic of China. Certificates
will be issued upon satisfactory inspection of service stations.
15
There are various standards that must be met for filling stations including
handling and storage of gas, tanker handling, and compressor operation. These
standards are regulated by the Local Ministry of Construction and the Gas Field
Operation Department of the Municipal Administration Committee. Inspections will
be carried out by the Municipal Development and Reform Commission which will
issue a certificate for the handling of dangerous chemical agents.
Standards for the design and construction of filling stations must conform
to GB50156-2202 and technology standard BJJ84-2000.
Competition
The three largest state owned energy companies, CNPC (China National
Petroleum Corporation) Group, SINOPEC, and CNOOC are principally engaged in the
upstream supply of energy and are major players in exploration and
transportation of oil and gas. They build much of the country's high pressure
pipeline infrastructure. Natural gas is distributed to smaller regional firms
that redistribute the gas to the end user, either through lower pressure
pipeline networks, or via tankers in the form of liquid natural gas (LNG).
We are aware of two privately owned companies in China which may be
considered to be our direct competitors: Xinjiang Guanghui LNG Development
Corporation Ltd and Xin'Ao Gas Field Ltd. Xinjiang Guanghui LNG Development
Corporation Ltd is primarily involved in the transportation of LNG via tanker
truck to storage facilities from natural gas wells. Xin'Ao Gas Field Ltd. is a
publicly owned company traded on the Hong Kong Exchange, distributing natural
gas via pipeline, doing business in 13 provinces and municipalities that have a
combined population of 31 million. Neither Xinjiang Guanghui nor Xin'Ao is
approved to supply natural gas to any area in which Xilan is currently
operating.
Currently, there are approximately 31 filling stations in Xian City.
Thirteen of these stations are state owned enterprises. The other 18 stations
are privately owned with the majority of these being single station operators.
We believe that we can effectively compete with the stations based upon our
organization, experience and financial resources.
FACILITIES
Our principal executive offices are located at Tang Xing Shu Ma Building,
Suite 418, Tang Xing Road, Xian High Tech Area, Xian, Shaanxi Province, China.
Office #1 consists of approximately 137.9 square meters which are rented on a
monthly basis for $510.11 and office #2 consists of approximately 265.59 square
meters which are rented on a monthly basis for $982.45.
Our properties are located in Lantian county, Baqiao District and Gaoxin
District of Xian, Shaanxi province. We own a 120km high-pressure underground
pipeline network and two Citygate stations (terminals) with accompanying
buildings and equipment. We lease the main office building where we are
headquartered and three filling station sites.
We believe that current facilities are adequate for our current and
immediately foreseeable operating needs. We do not have any policies regarding
investments in real estate, securities or other forms of property.
EMPLOYEES
As of January 31, 2006 we had a total of 208 employees in the following
capacities: 14 in management; 9 in administrative; 81 in operations; 4 in sales
department; 16 in R&D ; 9 in finance and 75 employees at the retailing filling
station. We have not experienced any work stoppages and we consider relations
with our employees to be good. We are not a party to any collective bargaining
agreements.
LEGAL PROCEEDINGS
From time to time, we may become involved in various lawsuits and legal
proceedings, which arise in the ordinary course of business. We are not
currently aware of any such legal proceedings or claims.
16
MANAGEMENT
Executive Officers and Directors
Below are the names and certain information regarding our executive
officers and directors:
----------------------------- ------- ----------------------------------------
Name Age Position
----------------------------- ------- ----------------------------------------
Minqing Lu 43 Chief Executive Officer and Director
----------------------------- ------- ----------------------------------------
Xiaogang Zhu 51 Chief Financial Officer
----------------------------- ------- ----------------------------------------
Yuman Chen 35 Vice President - Marketing
----------------------------- ------- ----------------------------------------
Liangzhong Li 44 Vice President - Construction
----------------------------- ------- ----------------------------------------
Qinan Ji 48 Chairman of the Board
----------------------------- ------- ----------------------------------------
Bo Chen 48 Vice Chairman of the Board
----------------------------- ------- ----------------------------------------
Officers are elected annually by the Board of Directors, at our annual
meeting, to hold such office until an officer's successor has been duly
appointed and qualified, unless an officer sooner dies, resigns or is removed by
the Board.
Background of Executive Officers and Directors
Qinan Ji, Chairman of the Board of Directors - Mr. Ji joined Xilan as the
Chairman of the Board of Directors in 2005. In 1996, he founded the Anxian Hotel
in Weinan City in Shaanxi Province. In 2001, he formed the Xian Sunway
Technology and Industry Co., Ltd. He has more than 20 years experience in the
energy and petroleum industries in operational, administrative, management and
government relations roles. He received a Bachelor of Economy Management from
North West University (Shaanxi).
Bo Chen, Vice Chairman of the Board of Directors - Mr. Chen was named Vice
Chairman of the Board of Directors of Xilan in October 2005. He is currently the
President of Bodisen Biotech, Inc., a publicly listed company on the AMEX
(symbol: BBC), and is one of its original founders and stockholders having
joined that company in 2000. From August 1997 to August 2001, Mr. Chen was Chief
Operations Officer and Chief Technology Officer of Shaanxi Bodisen Chemical Co.,
Ltd. From July 1994 to December 1997, he was the Chief Executive Officer and
President of Yang Ling Shikanglu Chemical Technology Development Co., Ltd. He
received his Bachelor of Science degree from Shaanxi Normal College in July
1984.
Minqing Lu, Chief Executive Officer, Member of the Board of Directors - Mr. Lu
joined Xilan in February 2005. He is Chief Executive Officer and serves on the
Board of Directors. From February 1999 to May 2002, he was the executive
director of Beijing Peixinkenu Investment Consultancy Company. From May 2002 to
July 2004, he was President of Fenghua Aidi Air Service Company in Beijing. He
received a Certificate of Management in July 1994 from Central Party College.
Xiaogang Zhu, Chief Financial Officer - Mr. Zhu joined Xilan as the Chief
Financial Officer in January 2005. He spent 16 years working at the Ministry of
General Logistics 3546 Company and his last position there was manager of the
Finance Department. From September 2000 to December 2004, Mr. Zhu was the Vice
General Manager and CFO of Xian Dapeng Biotech Co., Ltd. He received a Bachelor
of Accounting degree from Xian Jiaotong University.
Yuman Chen, Vice President, Marketing - Ms. Chen joined Xilan in the beginning
of 2000. She has spent the last five years at Xilan serving in the finance
department until January 2001 when she became the manager of the Operations
Department. In January 2005, she became the Vice President of Marketing
Development and Customer Support. She received a Bachelors Degree in Management
from North West University (Shaanxi) in July 1996.
Liangzhong Li, Vice President, Construction - Mr. Li joined Xilan in February
2005. He has 15 years experience in the natural gas industry. He is Vice
President of Construction and oversees the construction pipeline networks and
installation of gas fittings. From 1999 to 2002, he was Vice General Manager of
Leqing Pipeline of Liquefied Oil Gas Company in Zhejiang Province. From 2002 to
2004, he was Vice General Manager and Manager of Construction Department in
Leqing Natural Gas Company. He received a certificate of literature from North
West University (Shaanxi) in July 1986.
17
Board of Directors
Our Directors are elected by the vote of a plurality in interest of the
holders of our voting stock and hold office for a term of one year and until a
successor has been elected and qualified.
A majority of the authorized number of directors constitutes a quorum of
the Board for the transaction of business. The directors must be present at the
meeting to constitute a quorum. However, any action required or permitted to be
taken by the Board may be taken without a meeting if all members of the Board
individually or collectively consent in writing to the action.
Directors may receive compensation for their services and reimbursement for
their expenses as shall be determined from time to time by resolution of the
Board.
Executive Compensation
The following table sets forth all compensation paid in respect of our
Chief Executive Officer and those individuals who received compensation in
excess of $100,000 per year (collectively, the "Named Executive Officers") for
our last three completed fiscal years.
SUMMARY COMPENSATION TABLE
---------------------------------------------------------------------- -----------------------------------------------------------
Long Term Compensation
---------------------------------------------------------------------- -----------------------------------------------------------
Annual Compensation Awards Payouts
---------------------------------------------------------------------- ------------------------------ ----------------------------
Securities
Other Restricted Under-
Name And Annual Stock Lying LTIP All Other
Principal Salary Bonus Compensation Compensation Options/ Payouts Compensation
Position Year ($) ($) ($) ($) SARs (#) ($) ($)
-------------------- -------- ----------- ----------- ---------------- ----------------- ------------ ---------- -----------------
-------------------- -------- ----------- ----------- ---------------- ----------------- ------------ ---------- -----------------
Minqing Lu, 2005 7,500 0 0 0 0 0 0
Chief Executive
Officer and Director
-------------------- -------- ----------- ----------- ---------------- ----------------- ------------ ---------- -----------------
-------------------- -------- ----------- ----------- ---------------- ----------------- ------------ ---------- -----------------
Huai'pu Zhang, 2004 5,000 -0- -0- -0- -0- -0- -0-
Former President, 2003 5,000 -0- -0- -0- -0- -0- -0-
Chief Executive
Officer and
Director
-------------------- -------- ----------- ----------- ---------------- ----------------- ------------ ---------- -----------------
-------------------- -------- ----------- ----------- ---------------- ----------------- ------------ ---------- -----------------
EQUITY COMPENSATION PLAN INFORMATION
There has been no common stock authorized for issuance with respect to any
equity compensation plan as of the fiscal year ended December 31, 2005.
18
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In July 2005, we loaned $77,169 to Qinan Ji, Chairman of the Board. The
loan was made on a interest free basis and was repaid in its entirety in October
2005.
In July 2005, we loaned $94,393 to Xian Sunway Technology & Industry Co.,
Ltd., one of our principal shareholders. The loan was made on an interest free
basis and was repaid in its entirety on November 2005.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information, as of February 8, 2006
with respect to the beneficial ownership of the outstanding common stock by (i)
any holder of more than five (5%) percent; (ii) each of our named executive
officers and directors; and (iii) our directors and executive officers as a
group. Except as otherwise indicated, each of the stockholders listed below has
sole voting and investment power over the shares beneficially owned.
------------------------------------------------------------------------------------------------------------
Name of Beneficial Owner (1) Number of Percentage of Shares Beneficially
Shares Owned (2)
Beneficially
Owned
----------------------------------------------------- ----------------- ------------------------------------
Minqing Lu 695,652 2.9%
----------------------------------------------------- ----------------- ------------------------------------
Xiaogang Zhu 0 *
----------------------------------------------------- ----------------- ------------------------------------
Yuman Chen 0 *
----------------------------------------------------- ----------------- ------------------------------------
Liangzhong Li 0 *
----------------------------------------------------- ----------------- ------------------------------------
Qinan Ji 5,931,596(3) 24.8%
----------------------------------------------------- ----------------- ------------------------------------
Bo Chen 2,063,768(4) 8.6%
----------------------------------------------------- ----------------- ------------------------------------
Yangling Bodisen Biotech Development Co, Ltd. 2,063,768(4) 8.6%
----------------------------------------------------- ----------------- ------------------------------------
Xiang Ji 1,456,232 6.1%
----------------------------------------------------- ----------------- ------------------------------------
Shaohu Jia 1,080,580 4.5%
----------------------------------------------------- ----------------- ------------------------------------
Xian Sunway Technology & Industry Co., Ltd 2,875,364(3) 12.0%
----------------------------------------------------- ----------------- ------------------------------------
Amaranth LLC 1,363,096 5.6%
----------------------------------------------------- ----------------- ------------------------------------
All officers and directors as a group (6 persons) 8,691,016(3)(4) 36.3%
----------------------------------------------------- ----------------- ------------------------------------
* Less than 1%.
(1) Except as otherwise indicated, the address of each beneficial owner is
c/o Xian Xilan Natural Gas Co., Ltd., Tang Xing Shu Ma Building, Suite
418, Tang Xing Road, Xian High Tech Area, Xian, Shaanxi Province,
China.
(2) Applicable percentage ownership is based on 23,918,516 shares of
common stock outstanding as of February 8, 2006, together with
securities exercisable or convertible into shares of common stock
within 60 days of February 8, 2006 for each stockholder. Beneficial
ownership is determined in accordance with the rules of the Securities
and Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of common stock that are
currently exercisable or exercisable within 60 days of February 8,
2006 are deemed to be beneficially owned by the person holding such
securities for the purpose of computing the percentage of ownership of
such person, but are not treated as outstanding for the purpose of
computing the percentage ownership of any other person.
(3) Of which 2,875,364 shares are owned by Xian Sunway Technology &
Industry Co., Ltd. ("Sunway"). Qinan Ji owns 42.1% of Xian Sunway and
may be deemed to beneficially own such shares.
(4) Of which 2,063,768 shares are owned by Yangling Bodisen Biotech
Development Co, Ltd. ("Bodisen"). Mr. Chen is President, a member of
the Board of Directors and a 23% stockholder of Bodisen and may be
deemed to beneficially own such shares.
No Director, executive officer, affiliate or any owner of record or
beneficial owner of more than 5% of any class of voting securities of the
Company is a party adverse to the Company or has a material interest adverse to
the Company.
19
DESCRIPTION OF SECURITIES TO BE REGISTERED
COMMON STOCK
Our authorized capital stock consists of 100,000,000 shares of common stock
at a par value of $0.0001 per share and 5,000,000 shares of preferred stock, par
value $.0001. As of February 8, 2006, there were 23,918,516 shares of our common
stock issued and outstanding and no shares of preferred stock outstanding.
Holders of our common stock are entitled to one vote for each share on all
matters submitted to a stockholder vote. Holders of common stock do not have
cumulative voting rights. Therefore, holders of a majority of the shares of
common stock voting for the election of directors can elect all of the
directors. Holders of our common stock representing a majority of the voting
power of our capital stock issued, outstanding and entitled to vote, represented
in person or by proxy, are necessary to constitute a quorum at any meeting of
stockholders. A vote by the holders of a majority of our outstanding shares is
required to effectuate certain fundamental corporate changes such as
liquidation, merger or an amendment to our articles of incorporation.
Holders of our common stock are entitled to share in all dividends that the
board of directors, in its discretion, declares from legally available funds. In
the event of liquidation, dissolution or winding up, each outstanding share
entitles its holder to participate pro rata in all assets that remain after
payment of liabilities and after providing for each class of stock, if any,
having preference over the common stock. Our common stock has no pre-emptive
rights, no conversion rights and there are no redemption provisions applicable
to our common stock.
INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
The Company's directors and executive officers are indemnified as provided
by the Delaware General Corporation Law and the Company's Bylaws. These
provisions state that the Company's directors may cause the Company to indemnify
a director or former director against all costs, charges and expenses, including
an amount paid to settle an action or satisfy a judgment, actually and
reasonably incurred by him as a result of him acting as a director. The
indemnification of costs can include an amount paid to settle an action or
satisfy a judgment. Such indemnification is at the discretion of the Company's
board of directors and is subject to the Securities and Exchange Commission's
policy regarding indemnification.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers or persons controlling the
Company pursuant to the foregoing provisions, or otherwise, the Company has been
advised that in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Securities Act of
1933 and is, therefore, unenforceable.
PLAN OF DISTRIBUTION
The selling stockholders and any of their respective pledgees, donees,
assignees and other successors-in-interest may, from time to time, sell any or
all of their shares of common stock on any stock exchange, market or trading
facility on which the shares are traded or in private transactions. These sales
may be at fixed or negotiated prices. The selling stockholders may use any one
or more of the following methods when selling shares:
o ordinary brokerage transactions and transactions in which the
broker-dealer solicits the purchaser;
o block trades in which the broker-dealer will attempt to sell the
shares as agent but may position and resell a portion of the block as
principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
o an exchange distribution in accordance with the rules of the
applicable exchange;
o privately-negotiated transactions;
o short sales that are not violations of the laws and regulations of any
state or the United States;
o broker-dealers may agree with the selling stockholders to sell a
specified number of such shares at a stipulated price per share;
o through the writing of options on the shares;
o a combination of any such methods of sale; and
o any other method permitted pursuant to applicable law.
20
The selling stockholders may also sell shares under Rule 144 under the
Securities Act, if available, rather than under this prospectus. The selling
stockholders shall have the sole and absolute discretion not to accept any
purchase offer or make any sale of shares if they deem the purchase price to be
unsatisfactory at any particular time.
The selling stockholders may also engage in short sales against the box,
puts and calls and other transactions in our securities or derivatives of our
securities and may sell or deliver shares in connection with these trades.
The selling stockholders or their respective pledgees, donees, transferees
or other successors in interest, may also sell the shares directly to market
makers acting as principals and/or broker-dealers acting as agents for
themselves or their customers. Such broker-dealers may receive compensation in
the form of discounts, concessions or commissions from the selling stockholders
and/or the purchasers of shares for whom such broker-dealers may act as agents
or to whom they sell as principal or both, which compensation as to a particular
broker-dealer might be in excess of customary commissions. Market makers and
block purchasers purchasing the shares will do so for their own account and at
their own risk. It is possible that a selling stockholder will attempt to sell
shares of common stock in block transactions to market makers or other
purchasers at a price per share which may be below the then market price. The
selling stockholders cannot assure that all or any of the shares offered in this
prospectus will be issued to, or sold by, the selling stockholders. The selling
stockholders and any brokers, dealers or agents, upon effecting the sale of any
of the shares offered in this prospectus, may be deemed to be "underwriters" as
that term is defined under the Securities Act of 1933, as amended, or the
Securities Exchange Act of 1934, as amended, or the rules and regulations under
such acts. In such event, any commissions received by such broker-dealers or
agents and any profit on the resale of the shares purchased by them may be
deemed to be underwriting commissions or discounts under the Securities Act.
We are required to pay all fees and expenses incident to the registration
of the shares, including fees and disbursements of counsel to the selling
stockholders, but excluding brokerage commissions or underwriter discounts.
The selling stockholders, alternatively, may sell all or any part of the
shares offered in this prospectus through an underwriter. No selling stockholder
has entered into any agreement with a prospective underwriter and there is no
assurance that any such agreement will be entered into.
The selling stockholders may pledge their shares to their brokers under the
margin provisions of customer agreements. If a selling stockholder defaults on a
margin loan, the broker may, from time to time, offer and sell the pledged
shares. The selling stockholders and any other persons participating in the sale
or distribution of the shares will be subject to applicable provisions of the
Securities Exchange Act of 1934, as amended, and the rules and regulations under
such act, including, without limitation, Regulation M. These provisions may
restrict certain activities of, and limit the timing of purchases and sales of
any of the shares by, the selling stockholders or any other such person. In the
event that the selling stockholders are deemed affiliated purchasers or
distribution participants within the meaning of Regulation M, then the selling
stockholders will not be permitted to engage in short sales of common stock.
Furthermore, under Regulation M, persons engaged in a distribution of securities
are prohibited from simultaneously engaging in market making and certain other
activities with respect to such securities for a specified period of time prior
to the commencement of such distributions, subject to specified exceptions or
exemptions. In regards to short sells, the selling stockholder can only cover
its short position with the securities they receive from us upon conversion. In
addition, if such short sale is deemed to be a stabilizing activity, then the
selling stockholder will not be permitted to engage in a short sale of our
common stock. All of these limitations may affect the marketability of the
shares.
We have agreed to indemnify the selling stockholders, or their transferees
or assignees, against certain liabilities, including liabilities under the
Securities Act of 1933, as amended, or to contribute to payments the selling
stockholders or their respective pledgees, donees, transferees or other
successors in interest, may be required to make in respect of such liabilities.
If the selling stockholders notify us that they have a material arrangement
with a broker-dealer for the resale of the common stock, then we would be
required to amend the registration statement of which this prospectus is a part,
and file a prospectus supplement to describe the agreements between the selling
stockholders and the broker-dealer.
21
PENNY STOCK
The Securities and Exchange Commission has adopted Rule 15g-9 which
establishes the definition of a "penny stock," for the purposes relevant to us,
as any equity security that has a market price of less than $5.00 per share or
with an exercise price of less than $5.00 per share, subject to certain
exceptions. For any transaction involving a penny stock, unless exempt, the
rules require:
o that a broker or dealer approve a person's account for transactions in
penny stocks; and
o the broker or dealer receive from the investor a written agreement to
the transaction, setting forth the identity and quantity of the penny
stock to be purchased.
In order to approve a person's account for transactions in penny stocks,
the broker or dealer must
o obtain financial information and investment experience objectives of
the person; and
o make a reasonable determination that the transactions in penny stocks
are suitable for that person and the person has sufficient knowledge
and experience in financial matters to be capable of evaluating the
risks of transactions in penny stocks.
The broker or dealer must also deliver, prior to any transaction in a penny
stock, a disclosure schedule prescribed by the Commission relating to the penny
stock market, which, in highlight form:
o sets forth the basis on which the broker or dealer made the
suitability determination; and
o that the broker or dealer received a signed, written agreement from
the investor prior to the transaction.
Disclosure also has to be made about the risks of investing in penny stocks
in both public offerings and in secondary trading and about the commissions
payable to both the broker-dealer and the registered representative, current
quotations for the securities and the rights and remedies available to an
investor in cases of fraud in penny stock transactions. Finally, monthly
statements have to be sent disclosing recent price information for the penny
stock held in the account and information on the limited market in penny stocks.
22
SELLING STOCKHOLDERS
The following table sets forth the common stock ownership of the selling
stockholders as of Fenruary 8, 2006. The selling stockholders acquired their
securities through a private placement offering which closed on January 17,
2006.
We will not receive any proceeds from the resale of the common stock by the
selling stockholders. Assuming all the shares registered below are sold by the
selling stockholders, none of the selling stockholders will continue to own any
shares of our common stock. Other than as set forth in the following table, the
selling stockholders have not held any position or office or had any other
material relationship with us or any of our predecessors or affiliates within
the past three years. In addition, except as set forth below, the selling
stockholders are not registered broker-dealers.
Total
Shares Owned
and Issuable Number of Percentage of
Upon Exercise Shares Owned Common Stock
of Warrants Number of After Owned After
Before Shares Offered Completion of Completion of
Name Offering for Sale Offering (1) Offering (2)
-------------------------------------------- ------------ --------------- ---------------- ----------------
Amaranth LLC(3) 1,363,096 1,363,096 0 0%
SovGem Limited(4) 454,365 454,365 0 0%
MidSouth Investor Fund LP(5) 181,889 181,889 0 0%
Jayhawk China Fund (Cayman) Ltd.(6) 445,278 445,278 0 0%
T2 Capital Management, LLC(7) 36,349 36,349 0 0%
Broadlawn Master Fund, Ltd.(8) 22,718 22,718 0 0%
Jon D. Gruber and Linda Gruber Trust(9) 68,152 68,152 0 0%
Gruber & McBaine International(10) 77,243 77,243 0 0%
J. Patterson McBaine 22,721 22,721 0 0%
Lagunitas Partners(11) 286,250 286,250 0 0%
Primarius China Fund, LP(12) 227,182 227,182 0 0%
Nite Capital LP(13) 68,154 68,154 0 0%
Antoine de Sejournet 63,611 63,611 0 0%
Philippe de Cock de Rameye 11,450 11,450 0 0%
Vision Opportunity Master Fund, Ltd.(14) 90,874 90,874 0 0%
Citizens Security Life Insurance Co.(15) 22,718 22,718 0 0%
Peijian Sun 636,111 636,111 0 0%
Jiakuan Wang 647,379 647,379 0 0%
New York Global Securities (16) 420,843 420,843 0 0%
TOTAL 5,146,382 5,146,382 0 0%
* Less than 1%.
(1) Assumes that all securities registered will be sold.
(2) Applicable percentage ownership is based on 23,918,516 shares of
common stock outstanding as of February 8, 2006, together with
securities exercisable or convertible into shares of common stock
within 60 days of February 8, 2006 for each stockholder. Beneficial
ownership is determined in accordance with the rules of the Securities
and Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of common stock that are
currently exercisable or exercisable within 60 days of February 8,
2006 are deemed to be beneficially owned by the person holding such
securities for the purpose of computing the percentage of ownership of
such person, but are not treated as outstanding for the purpose of
computing the percentage ownership of any other person.
(3) Amaranth Advisors L.L.C., the trading advisor for Amaranth LLC,
exercises voting and dispositive power rights over the shares held by
Amaranth LLC. Nicholas M. Maounis is the managing member of Amaranth
Advisors L.L.C. Each of Amaranth Advisors L.L.C. and Amaranth Global
Securities Inc., affiliates of Amaranth LLC, is a broker-dealer
registered pursuant to Section 15(b) of the Securities Exchange Act of
1934 and is a member of the National Association of Securities
Dealers, Inc. Neither of such broker-dealers is authorized to engage
in securities offerings either as an underwriter or as a selling group
participant and neither of such broker-dealers actually engages in any
such activity.
(4) Peter Charles St. George has the voting and dispositive rights over
the shares held by SovGem Limited.
(5) Lyman O. Heidtke has the voting and dispositive rights over the shares
held by MidSouth Investor Fund LP.
23
(6) Kent C. McCarthy has the voting and dispositive rights over the shares
held by Jayhawk China Fund (Cayman) Ltd.
(7) Richard Taney has the voting and dispositive rights over the shares
held by T2 Capital Management, LLC.
(8) Jon Bloom has the voting and dispositive rights over the shares held
by Broadlawn Master Fund, Ltd.
(9) Jon D. Gruber has the voting and dispositive rights over the shares
held by Jon D. Gruber and Linda Gruber Trust.
(10) Gruber & McBaine Capital Management is the general partner and has the
voting and dispositive rights over the shares held by Gruber & McBaine
International and Jon D. Gruber and J. Patterson McBaine oversee all
voting and investment activity of Gruber & McBaine Capital Management.
(11) Gruber & McBaine Capital Management is the general partner and has the
voting and dispositive rights over the shares held by Lagunitas
Partners and Jon D. Gruber and J. Patterson McBaine oversee all voting
and investment activity of Gruber & McBaine Capital Management.
(12) Patrick Lin has the voting and dispositive rights over the shares held
by Primarius China Fund, LP.
(13) Keith Goodman, a manager of the general partner of Nite Capital LP,
has the voting and dispositive rights over the shares held by Nite
Capital LP.
(14) Adam Benowtiz has the voting and dispositive rights over the shares
held by Vision Opportunity Master Fund, Ltd.
(15) Darrell Wells has the voting and dispositive rights over the shares
held by Citizens Security Life Insurance Co.
(16) Scott Morrison has the voting and dispositive rights over the shares
held by New York Global Securities.
LEGAL MATTERS
Sichenzia Ross Friedman Ference LLP, New York, New York will issue an
opinion with respect to the validity of the shares of common stock being offered
hereby.
EXPERTS
Our financial statements as of December 31, 2004 and 2003 and the related
consolidated statements of operations, stockholders' equity and cash flows for
the period of December 31, 2004 and 2003, appearing in this prospectus and
registration statement have been audited by Kabani & Company, Inc., independent
registered public accountants, as set forth on their report thereon appearing
elsewhere in this prospectus, and are included in reliance upon such report
given upon the authority of such firm as experts in accounting and auditing.
AVAILABLE INFORMATION
We have filed with the SEC a registration statement on Form SB-2 to
register the securities offered by this prospectus. For future information about
us and the securities offered under this prospectus, you may refer to the
registration statement and to the exhibits filed as a part of the registration
statement.
In addition, after the effective date of this prospectus, we will be
required to file annual, quarterly, and current reports, or other information
with the SEC as provided by the Securities Exchange Act. You may read and copy
any reports, statements or other information we file at the SEC's public
reference facility maintained by the SEC at 100 F Street, N.E., Washington, D.C.
20549. You can request copies of these documents, upon payment of a duplicating
fee, by writing to the SEC. Please call the SEC at 1-800-SEC-0330 for further
information on the operation of the public reference room. Our SEC filings are
also available to the public through the SEC Internet site at http\\www.sec.gov.
24
CHINA NATURAL GAS, INC.
(FORMERLY XI'AN XILAN NATURAL GAS CO., LTD)
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm F-1
Balance Sheet F-2
Statements of Operations F-3
Statements of Stockholders' Equity F-4
Statements of Cash Flows F-5
Notes to Financial Statements F-6
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors
Xi'an Xilan Natural Gas Company, LTD.
We have audited the accompanying balance sheet of Xi'an Xilan Natural Gas
Company, LTD. (the "Company") as of December 31, 2004 and the related statements
of operations, stockholders' equity and cash flows for the years ended December
31, 2004 and 2003. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audit of these statements in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Xi'an Xilan Natural Gas
Company, LTD as of December 31, 2004 and the results of its operations and its
cash flows for the years ended December 31, 2004 and 2003, in conformity with
accounting principles generally accepted in the United States of America.
KABANI & COMPANY, INC.
CERTIFIED PUBLIC ACCOUNTANTS
Los Angeles, California
November 13, 2005
F-1
XI'AN XILAN NATURAL GAS CO., LTD
BALANCE SHEET
DECEMBER 31, 2004 AND SEPTEMBER 30, 2005 (UNAUDITED)
ASSETS
------
December 31, September 30,
2004 2005
(unaudited)
CURRENT ASSETS:
Cash & cash equivalents $ 62,998 $ 1,001,243
Accounts receivable, net 4,944 308,065
Other receivable 23,405 57,902
Receivable from related party - 171,563
Inventory 46,442 25,864
Advances to suppliers 725 297,712
Prepaid expense 200 16,961
-------------- --------------
Total current assets 138,712 1,879,311
PROPERTY AND EQUIPMENT, net 5,267,344 5,405,515
CONTRACT IN PROGRESS: 377,497 -
OTHER ASSET: - 2,491,411
-------------- --------------
$ 5,783,554 9,776,237
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable & accrued expense $ 97,238 $ 163,974
Other payable 60,666 261,772
Unearned revenue 931,440 215,724
-------------- --------------
Total current liabilities 1,089,344 641,470
STOCKHOLDERS' EQUITY:
Common stock;
10,000,000 registered and 30,000,000 unregistered
shares issued and outstanding 4,832,396
69,000,000 registered shares issued and outstanding 8,336,893
Cumulative translation adjustment 572 199,859
Accumulated deficit (142,215) 515,582
Statutory reserve 3,457 82,433
-------------- --------------
Total stockholders' equity 4,694,210 9,134,767
-------------- --------------
$ 5,783,554 $ 9,776,237
============== ==============
F-2
XI'AN XILAN NATURAL GAS CO., LTD
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (UNAUDITED)
For the Years For the Nine Months
Ended December 31, Ended September 30,
(unaudited)
2004 2003 2005 2004
------------- -------------- --------------- --------------
Revenue
Natural gas revenue $ 306,306 $ 237,312 $ 1,065,017 $ 211,990
Construction / installation revenue 578,107 1,334,981 1,649,025 489,625
------------- -------------- --------------- --------------
Total revenue 884,413 1,572,293 2,714,042 701,615
Cost of revenue
Natural gas cost 226,944 94,617 830,527 157,065
Construction / installation cost 287,102 963,775 584,772 280,635
------------- -------------- --------------- --------------
514,046 1,058,392 1,415,299 437,700
Gross profit 370,367 513,902 1,298,743 263,915
Operating expenses
Selling expenses 387,768 344,242 299,352 282,924
General and administrative expenses 142,449 143,476 132,991 109,600
------------- -------------- --------------- --------------
Total operating expenses 530,217 487,718 432,343 392,525
------------- -------------- --------------- --------------
Income (loss) from operations (159,850) 26,183 866,400 (128,609)
Non-operating income (expense):
Gain on conversion of debt - 82,763 - -
Interest expense - (13,396) - -
Interest income 1,618 524 894 541
Other expense (3,535) (242) (468) (221)
------------- -------------- --------------- --------------
Total non-operating income (expense) (1,918) 69,649 426 321
------------- --------------- -------------- --------------
Net income (loss) before income tax (161,768) 95,833 866,826 (128,289)
Income tax - 16,618 130,024 -
------------- -------------- --------------- --------------
------------- -------------- --------------- --------------
Net income (loss) $ (161,768) $ 79,214 $ 736,802 $ (128,289)
============= ============== =============== ==============
Basic and diluted weighted average shares outstanding 40,000,000 10,082,192 69,000,000 40,000,000
============= ============== =============== ==============
Basic and diluted net income (loss) per share $ (0.00) $ 0.01 $ 0.01 $ (0.00)
============= ============== =============== ==============
F-3
XI'AN XILAN NATURAL GAS CO., LTD
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
Common Cumulative Total
stock translation Statutory Accumulated stockholders'
shares Amount adjustment Reserve deficit equity
---------- ----------- ------------ ---------- ---------- ------------
Balance, December 31, 2002 10,000,000 $ 1,207,729 $ - $ - $ (56,204) $ 1,151,525
Net income for the year ended December 31, 2003 - - - - 79,214 79,214
Conversion of debt to equity 30,000,000 3,624,667 - - - 3,624,667
Statutory reserve - - - 3,457 (3,457) -
---------- ----------- ------------ ---------- ---------- ------------
Balance, December 31, 2003 40,000,000 4,832,396 - 3,457 19,553 4,855,406
Cumulative translation adjustment - - 572 - - 572
Net loss for the year ended December 31, 2004 - - - - (161,768) (161,768)
---------- ----------- ------------ ---------- ------------ ------------
Balance December 31, 2004 40,000,000 $ 4,832,396 $ 572 $ 3,457 $ (142,215) $ 4,694,210
========== =========== ============ ========== ============ ============
F-4
XI'AN XILAN NATURAL GAS CO., LTD
STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (UNAUDITED)
For the Years For the Nine Months
Ended December 31, Ended September 30,
(unaudited)
2004 2003 2005 2004
------------- ------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (161,768) $ 79,214 $ 736,802 $ (128,289)
Adjustments to reconcile net income (loss) to net cash
provided in operating activities:
Gain on conversion of debt - (82,763) - -
Loss on disposal of property 3,242 - - -
Depreciation and amortization 314,453 260,765 204,426 235,757
(Increase) / decrease in assets:
Accounts receivable (4,943) 1,482 (297,892) (16,543)
Inventory (46,440) - 21,271 (56,848)
Other receivable (6,525) (5,715) (33,390) 4,193
Receivable from related party - - (168,666) -
Advances to suppliers 14,982 15,500 (291,955) 15,706
Prepaid expense (99) (101) (16,474) (597)
Contract in progress 118,537 (363,523) 379,584 496,014
Increase / (decrease) in current liabilities:
Accounts payable (64,344) (1,590,145) (1,128,496) 26,814
Payable to related party (917,642) 4,501,535 - (120,818)
Other payable (2,854) (1,999,673) 1,388,554 (6,271)
Unearned revenue 777,436 (174,197) (724,508) (53,040)
------------- ------------- ------------- -------------
Net cash provided by operating activities 24,035 642,379 69,256 396,079
------------- ------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Payment on purchase of equipment (5,981) (282,917) (222,195) (374,638)
Advance payment on purchase of equipment - other asset - - (2,449,338) -
Proceeds from disposal of property 1,208 - - -
------------- ------------- ------------- -------------
Net cash used in investing activities (4,773) (282,917) (2,671,533) (374,638)
------------- ------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on short-term loan - (362,441) - -
Stock issued for cash - - 3,503,897 -
------------- ------------- ------------- -------------
Net cash provided by in financing activities - (362,441) 3,503,897 -
------------- ------------- ------------- -------------
Effect of exchange rate changes on cash and cash equivalents - - 36,625 -
NET INCREASE (DECREASE) IN CASH & CASH EQUIVALENTS 19,262 (2,980) 938,245 21,441
CASH & CASH EQUIVALENTS, BEGINNING BALANCE 43,736 46,716 62,998 43,736
------------- ------------- ------------- -------------
CASH & CASH EQUIVALENTS, ENDING BALANCE $ 62,998 $ 43,736 $ 1,001,243 $ 65,177
============= ============= ============= =============
F-5
XI'AN XILAN NATURAL GAS CO., LTD
NOTES TO THE FINANCIAL STATEMENTS
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
Xi'an Xilan Natural Gas Co, Ltd. (The "Company") was incorporated on January 8,
2000 in Xi'an city in the Shaanxi province, China. The core business of the
Company is distribution of natural gas to commercial, industrial and residential
customers, construction of pipeline networks, and installation of natural gas
fittings and parts for end-users. The Company has an exclusive permit to provide
gas utility service in Lantian County and Baqiao District of Xi'an city, China.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash and cash equivalents
Cash and cash equivalents include cash on hand and cash in time deposits,
certificates of deposit and all highly liquid debt instruments with original
maturities of three months or less.
Accounts and other receivable
Accounts and other receivable are recorded at net realizable value consisting of
the carrying amount less an allowance for uncollectible accounts, as needed.
The Company maintains reserves for potential credit losses on accounts
receivable. Management reviews the composition of accounts receivable and
analyzes historical bad debts, customer concentrations, customer credit
worthiness, current economic trends and changes in customer payment patterns to
evaluate the adequacy of these reserves. Reserves are recorded primarily on a
specific identification basis.
Advances to suppliers
The Company advances to certain vendors for purchase of its material. The
advances to suppliers are interest free and unsecured.
Inventory
Inventory is stated at the lower of cost, as determined on a first-in, first-out
basis, or market. Management compares the cost of inventories with the market
value, and allowance is made for writing down the inventories to their market
value, if lower. Inventory consists of material used in the construction of
pipelines.
F-6
XI'AN XILAN NATURAL GAS CO., LTD
NOTES TO THE FINANCIAL STATEMENTS
Property, equipment
Property and equipment are stated at cost. Expenditures for maintenance and
repairs are charged to earnings as incurred; additions, renewals and betterments
are capitalized. When property and equipment are retired or otherwise disposed
of, the related cost and accumulated depreciation are removed from the
respective accounts, and any gain or loss is included in operations.
Depreciation of property and equipment is provided using the straight-line
method for substantially all assets with estimated lives as follows:
Office equipment 5 years
Operating equipment 5-20 years
Vehicles 5 years
Buildings 30 years
At December 31, 2004, the following are the details of the property and
equipment:
Office equipment $ 17,419
Operating equipment 5,798,308
Vehicles 57,416
Buildings 167,274
Less: Accumulated depreciation (773,073)
------------
Net book value $ 5,267,344
============
September 30, 2005, the following are the details of the property and equipment
(unaudited):
Office equipment $ 19,775
Operating equipment 5,930,510
Vehicles 158,616
Buildings 189,073
Construction in process 106,178
Less: Accumulated depreciation (998,637)
-----------
Net book value $ 5,405,515
===========
Long-lived assets
Effective January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS 144"), which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets and supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," and the accounting and reporting provisions of APB Opinion No.
30, "Reporting the Results of Operations for a Disposal of a Segment of a
Business." The Company periodically evaluates the carrying value of long-lived
assets to be held and used in accordance with SFAS 144. SFAS 144 requires
impairment losses to be recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying amounts. In
that event, a loss is recognized based on the amount by which the carrying
amount exceeds the fair market value of the long-lived assets. Loss on
long-lived assets to be disposed of is determined in a similar manner, except
that fair market values are reduced for the cost of disposal. Based on its
review, the Company believes that, as of December 31, 2004 there were no
significant impairments of its long-lived assets.
F-7
XI'AN XILAN NATURAL GAS CO., LTD
NOTES TO THE FINANCIAL STATEMENTS
Contracts-in progress
Contracts in progress consist of cost of construction of pipelines for
customers.
Fair value of financial instruments
Statement of financial accounting standard No. 107, Disclosures about fair value
of financial instruments, requires that the Company disclose estimated fair
values of financial instruments. The carrying amounts reported in the statements
of financial position for current assets and current liabilities qualifying as
financial instruments are a reasonable estimate of fair value.
Revenue Recognition
The Company's revenue recognition policies are in compliance with Staff
accounting bulletin (SAB) 104. Revenue is recognized when services are rendered
to customers when a formal arrangement exists, the price is fixed or
determinable, the delivery is completed, no other significant obligations of the
Company exist and collectibility is reasonably assured. Payments received before
all of the relevant criteria for revenue recognition are satisfied are recorded
as unearned revenue. Revenue from gas sales is recognized when gas is pumped
through pipelines to the end users. Revenue from construction and installation
of pipelines is recorded when the contract is completed and accepted by the
customers. The construction contracts are usually completed within one to two
months time.
Deferred revenue
Deferred revenue represents prepayments by customers for gas purchases and
advance payments on construction and installation of pipeline contracts. The
Company records such prepayment as unearned revenue when the payments are
received.
Advertising Costs
The Company expenses the cost of advertising as incurred or, as appropriate, the
first time the advertising takes place. Advertising costs for the year ended
December 31, 2004 and 2003 were insignificant.
Stock-based compensation
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation". SFAS No. 123 prescribes accounting and reporting standards for
all stock-based compensation plans, including employee stock options, restricted
stock, employee stock purchase plans and stock appreciation rights. SFAS No. 123
requires compensation expense to be recorded (i) using the new fair value method
or (ii) using the existing accounting rules prescribed by Accounting Principles
Board Opinion No. 25, "Accounting for stock issued to employees" (APB 25) and
related interpretations with proforma disclosure of what net income and earnings
per share would have been had the Company adopted the new fair value method. The
Company uses the intrinsic value method prescribed by APB 25 and has opted for
the disclosure provisions of SFAS No.123. No options have been granted for the
years ended December 31, 2004 and 2003 and for the nine months ended September
30, 2005.
F-8
XI'AN XILAN NATURAL GAS CO., LTD
NOTES TO THE FINANCIAL STATEMENTS
Income Taxes
The Company utilizes SFAS No. 109, "Accounting for Income Taxes," which requires
the recognition of deferred tax assets and liabilities for the expected future
tax consequences of events that have been included in the financial statements
or tax returns. Under this method, deferred income taxes are recognized for the
tax consequences in future years of differences between the tax bases of assets
and liabilities and their financial reporting amounts at each period end based
on enacted tax laws and statutory tax rates applicable to the periods in which
the differences are expected to affect taxable income. Valuation allowances are
established, when necessary, to reduce deferred tax assets to the amount
expected to be realized. At December 31, 2004 and September 30, 2005, there was
no significant book to tax differences.
LOCAL PRC INCOME TAX
Pursuant to the tax laws of China, general enterprises are subject to income tax
at an effective rate of 33%. The Company is in the natural gas industry whose
development is encouraged by the government. According to the income tax
regulation, any company engaged in the natural gas industry enjoys a favorable
tax rate. Accordingly, the Company's income is subject to a reduced tax rate of
15%.
At December 31, 2004, the Company had net operating loss of approximately
$162,000 all of which was generated in the Peoples Republic of China (PRC).
Under PRC income tax rules, net operating losses can be carried forward for 5
years. The Company has recorded a 100% valuation allowance on the gross amount
of deferred tax assets of $25,000 based on the uncertainty of its realization at
December 31, 2004. There were no other book to tax differences at December 31,
2004 and 2003.
A reconciliation of tax at United States federal statutory rate to provision for
income tax recorded in the financial statements is as follows:
For the Years For the Nine Months
Ended December 31, Ended September 30,
(unaudited)
2004 2003 2005 2004
------------- -------------- ----------- ------------
Tax provision (credit) at statutory rate (34%) 34% 34% (34%)
Foreign tax rate difference 19% (19%) (19%) 19%
Change in valuation allowance 15% - - 15%
Other 2%
------------- -------------- ----------- ------------
- 17% 15% -
============= ============== =========== ============
Foreign Currencies Translation
Assets and liabilities in foreign currency are recorded at the balance sheet
date at the rate prevailing on that date. Items of income statement are recorded
at the average exchange rate. Gain or loss on foreign currency transactions are
reflected on the income statement. Gain or loss on financial statement
translation from foreign currency are recorded as a separate component in the
equity section of the balance sheet as component of comprehensive income. The
functional currency of the Company is Chinese Renminbi.
F-9
XI'AN XILAN NATURAL GAS CO., LTD
NOTES TO THE FINANCIAL STATEMENTS
Basic and diluted net loss per share
Net loss per share is calculated in accordance with the Statement of financial
accounting standards No. 128 (SFAS No. 128), "Earnings per share". SFAS No. 128
superseded Accounting Principles Board Opinion No.15 (APB 15). Net loss per
share for all periods presented has been restated to reflect the adoption of
SFAS No. 128. Basic net loss per share is based upon the weighted average number
of common shares outstanding. Diluted net loss per share is based on the
assumption that all dilutive convertible shares and stock options were converted
or exercised. Dilution is computed by applying the treasury stock method. Under
this method, options and warrants are assumed to be exercised at the beginning
of the period (or at the time of issuance, if later), and as if funds obtained
thereby were used to purchase common stock at the average market price during
the period.
Statement of Cash Flows:
In accordance with Statement of Financial Accounting Standards No. 95,
"Statement of Cash Flows," cash flows from the Company's operations is
calculated based upon the local currencies. As a result, amounts related to
assets and liabilities reported on the statement of cash flows will not
necessarily agree with changes in the corresponding balances on the balance
sheet.
Supplemental Disclosure to Cash Flows
During the year ended December 31, 2003 cash from financing and operating
activities exclude the effect of the conversion of debt to equity for $3,624,667
and gain on conversion of debt of 82,763.
Segment Reporting
Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosure
About Segments of an Enterprise and Related Information" requires use of the
"management approach" model for segment reporting. The management approach model
is based on the way a company's management organizes segments within the company
for making operating decisions and assessing performance. Reportable segments
are based on products and services, geography, legal structure, management
structure, or any other manner in which management disaggregates a company. SFAS
131 has no effect on the Company's consolidated financial statements as the
Company consists of one reportable business segment. All revenue is from
customers in People's Republic of China. All of the Company's assets are located
in People's Republic of China.
Recent Pronouncements
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections." This statement applies to all voluntary changes in accounting
principle and requires retrospective application to prior periods' financial
statements of changes in accounting principle, unless this would be
impracticable. This statement also makes a distinction between "retrospective
application" of an accounting principle and the "restatement" of financial
statements to reflect the correction of an error. This statement is effective
for accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. We are evaluating the effect the adoption of this
interpretation will have on its financial position, cash flows and results of
operations.
F-10
XI'AN XILAN NATURAL GAS CO., LTD
NOTES TO THE FINANCIAL STATEMENTS
In December 2004, the FASB issued FASB Statement No. 123R, "Share-Based Payment,
an Amendment of FASB Statement No. 123" ("FAS No. 123R"). FAS No. 123R requires
companies to recognize in the statement of operations the grant- date fair value
of stock options and other equity-based compensation issued to employees. FAS
No. 123R is effective beginning in the Company's first quarter of fiscal 2006.
In June 2005, the EITF reached consensus on Issue No. 05-6, Determining the
Amortization Period for Leasehold Improvements ("EITF 05-6.") EITF 05-6 provides
guidance on determining the amortization period for leasehold improvements
acquired in a business combination or acquired subsequent to lease inception.
The guidance in EITF 05-6 will be applied prospectively and is effective for
periods beginning after June 29, 2005. EITF 05-6 is not expected to have a
material effect on its consolidated financial position or results of operations.
The Company believes that the adoption of this standard will have no material
impact on its financial statements.
3. OTHER ASSET
Other asset consists of advance payments for purchases of certain equipment.
4. OTHER PAYABLE
Other payable consists of the following as of December 31, 2004:
Other accounts payable $ 26,360
Welfare payable 14,673
Tax payable 18,874
Other levies 759
----------
Total $ 60,666
==========
Other payable consists of the following as of September 30, 2005 (unaudited):
Other accounts payable $ 24,659
Welfare payable 13,433
Tax payable 220,280
Other levies 3,400
----------
Total $ 261,772
==========
5. SHAREHOLDERS' EQUITY
On January 1, 2003, the Company had 10,000,000 registered shares issued and
outstanding.
On December 30, 2003, the Company converted $ 3,624,667 of debt in to 30,000,000
shares of common stock. The Company recorded a gain on conversion of $82,763 as
a result of this transaction. The shares were recorded as paid in capital since
the shares were not registered.
The Company did not have any issuances of its stock in the year ended December
31, 2004.
During the nine months ended September 30, 2005, the Company issued 29,000,000
shares of common stock for $3,503,897 cash contribution (unaudited).
F-11
XI'AN XILAN NATURAL GAS CO., LTD
NOTES TO THE FINANCIAL STATEMENTS
6. EMPLOYEE WELFARE PLAN
The Company has established its own employee welfare plan in accordance with
Chinese law and regulations. The Company makes annual contributions of 14% of
all employees' salaries to employee welfare plan. The total expense for the
above plan was $10,045 and $9,485 and $8,360 and $7,528 for the years ended
December 31, 2004 and 2003 and for nine month periods ended September 30, 2005
and 2004 (unaudited), respectively.
7. STATUTORY COMMON WELFARE FUND
As stipulated by the Company Law of the People's Republic of China (PRC) as
applicable to Chinese companies with foreign ownership, net income after
taxation can only be distributed as dividends after appropriation has been made
for the following:
(i) Making up cumulative prior years' losses, if any;
(ii) Allocations to the "Statutory surplus reserve" of at least 10% of income
after tax, as determined under PRC accounting rules and regulations, until
the fund amounts to 50% of the Company's registered capital;
(iii)Allocations of 5-10% of income after tax, as determined under PRC
accounting rules and regulations, to the Company's "Statutory common
welfare fund", which is established for the purpose of providing employee
facilities and other collective benefits to the Company's employees; and
(iv) Allocations to the discretionary surplus reserve, if approved in the
shareholders' general meeting.
The Company has appropriated $78,976 as reserve for the statutory surplus
reserve and welfare fund for the nine months ended September 30, 2005
(unaudited) and $3,547 for the year ended December 31, 2003. No allocation was
made for the year ended December 31, 2004 as the company had net loss from
operations.
8. EARNINGS PER SHARE
Earnings per share for the years ended December 31, 2004 and 2003 and for the
nine months ended September 30, 2005 and 2004 (unaudited) are determined by
dividing net income for the periods by the weighted average number of both basic
and diluted shares of common stock and common stock equivalents outstanding. At
December 31, 2004 and 2003 and September 30, 2005 and 2004, there were no
dilutive securities.
9. CURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS
The Company purchases all of the natural gas for resale from one vendor. No
amount was owing to this vendor at December 31, 2004 or at September 30, 2005.
Three major customers accounted for 84%, 92% and 82% of the construction revenue
for the years ended December 31, 2004 and 2003 and for the nine months ended
September 30, 2004 (unaudited), respectively. One customer accounted for 87% of
the construction revenue for the nine months ended September 30, 2005.
The Company's operations are carried out in the People's Republic of China.
Accordingly, the Company's business, financial condition and results of
operations may be influenced by the political, economic and legal environments
in the People's Republic of China, by the general state of the People's Republic
of China`s economy. The Company's business may be influenced by changes in
governmental policies with respect to laws and regulations, anti-inflationary
measures, currency conversion and remittance abroad, and rates and methods of
taxation, among other things.
F-12
10. RELATED PARTY TRANSACTIONS
The Company has receivable from related parties - shareholders of the Company in
the amount of $171,563 as of September 30, 2005 (unaudited).
11. SUBSEQUENT EVENT
The Company entered in to an agreement with one of its customer under which, the
Company will acquire certain equipment for $2,765,200 (RMB 22,300,000). The
Company paid $ 1,240,000 (RMB 10,000,000) on April 22, 2005. At September 30,
2005, $308,668 ( RMB 2,489,262) is included in accounts receivable from this
customer, which will be adjusted against the purchase price at the date of
transfer of title to the equipment. The agreement stipulates that 100 days after
the advance payment, the equipment will be transferred to the Company. The
remaining unpaid balance will be paid by the Company through delivery of natural
gas to this customer at a specified price per cubic meter of gas.
F-13
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Company's directors and executive officers are indemnified as provided
by the Delaware General Corporation Law and the Company's Bylaws. These
provisions state that the Company's directors may cause the Company to indemnify
a director or former director against all costs, charges and expenses, including
an amount paid to settle an action or satisfy a judgment, actually and
reasonably incurred by him as a result of him acting as a director. The
indemnification of costs can include an amount paid to settle an action or
satisfy a judgment. Such indemnification is at the discretion of the Company's
board of directors and is subject to the Securities and Exchange Commission's
policy regarding indemnification.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers or persons controlling the
Company pursuant to the foregoing provisions, or otherwise, the Company has been
advised that in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Securities Act of
1933 and is, therefore, unenforceable.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, if any, payable by the Registrant
relating to the sale of common stock being registered. All amounts are estimates
except the SEC registration fee.
SEC registration fee $ 2,526.89
Printing and engraving expenses $ 5,000.00
Legal fees and expenses $ 50,000.00
Accounting fees and expenses $ 10,000.00
Miscellaneous expenses $ 10,000.00
Total................................................ $ 77,526.89
The Registrant has agreed to bear expenses incurred by the selling
stockholders that relate to the registration of the shares of common stock being
offered and sold by the selling stockholders.
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES.
On January 17, 2006, the Company entered into securities purchase
agreements with an accredited investor and completed the sale of $2,824,802 of
units. The units contained an aggregate of 1,008,857 shares of common stock and
274,633 common stock purchase warrants. Each common stock purchase warrant is
exercisable for a period of three years at an exercise price of $3.60 per share.
Pursuant to the terms of the warrant, each investor has contractually agreed to
restrict its ability to exercise the warrants to an amount which would not
exceed the difference between the number of shares of common stock beneficially
owned by the holder or issuable upon exercise of the warrant held by such holder
and 9.9% of the outstanding shares of common stock of the Company.
On January 10, 2006 through January 13, 2006 the Company entered into
securities purchase agreements with four accredited investors and completed the
sale of $2,195,198 of units. The units contained an aggregate of 783,999 shares
of common stock and 213,422 common stock purchase warrants. Each common stock
purchase warrant is exercisable for a period of three years at an exercise price
of $3.60 per share. Pursuant to the terms of the warrant, each investor has
contractually agreed to restrict its ability to exercise the warrants to an
amount which would not exceed the difference between the number of shares of
common stock beneficially owned by the holder or issuable upon exercise of the
warrant held by such holder and 9.9% of the outstanding shares of common stock
of the Company. New York Global Securities acted as the placement agent of the
transaction and received warrants to purchase 121,955 shares of common stock on
the same terms and conditions as the investors.
II-1
On January 6, 2006 and January 9, 2006, the Company entered into securities
purchase agreements with four accredited investors and completed the sale of
$5,380,000 of units. The units contained an aggregate of 1,921,572 shares of
common stock and 523,055 common stock purchase warrants. Each common stock
purchase warrant is exercisable for a period of three years at an exercise price
of $3.60 per share. Pursuant to the terms of the warrant, each investor has
contractually agreed to restrict its ability to exercise the warrants to an
amount which would not exceed the difference between the number of shares of
common stock beneficially owned by the holder or issuable upon exercise of the
warrant held by such holder and 9.9% of the outstanding shares of common stock
of the Company. New York Global Securities acted as the placement agent of the
transaction and received warrants to purchase 298,888 shares of common stock on
the same terms and conditions as the investors.
* All of the above offerings and sales were deemed to be exempt under
Section 4(2) of the Securities Act of 1933, as amended. No advertising or
general solicitation was employed in offering the securities. The offerings and
sales were made to a limited number of persons, all of whom were accredited
investors, business associates of our company or executive officers of our
company, and transfer was restricted by our company in accordance with the
requirements of the Securities Act of 1933. In addition to representations by
the above-referenced persons, we have made independent determinations that all
of the above-referenced persons were accredited or sophisticated investors, and
that they were capable of analyzing the merits and risks of their investment,
and that they understood the speculative nature of their investment.
Furthermore, all of the above-referenced persons were provided with access to
our Securities and Exchange Commission filings.
Pursuant to a Share Purchase Agreement, which closed on December 6, 2005,
we issued an aggregate 4,000,000 shares of common stock to former shareholders
of Xian Xilan Natural Gas Co., Ltd. These shares were issued in reliance upon
the exemption from registration provided by Regulation S under the Securities
Act of 1933, as amended
Except as expressly set forth above, the individuals and entities to whom
we issued securities as indicated in this section of the registration statement
are unaffiliated with us.
ITEM 27. EXHIBITS.
Exhibit
Number Description of Exhibit
--------------------------------------------------------------------------------
3.1 Articles of Incorporation (incorporated by reference to same exhibit
filed with the Company's Form 10SB Registration Statement filed
September 15, 2000, SEC file no. 000-31539).
3.2 Certificate of Ownership of Coventure international Inc. and China
Natural Gas, Inc., dated December 12, 2005
3.3 Registrant's By-Laws (incorporated by reference to same exhibit filed
with the Company's Form 10SB Registration Statement filed September
15, 2000, SEC file no. 000-31539).
5.1 Opinion of Sichenzia Ross Friedman Ference LLP
10.1 Share Purchase Agreement made as of December 6, 2005 among Coventure
International Inc., Xian Xilan Natural Gas Co., Ltd. and each of
Xilan's shareholders. (incorporated by reference to the exhibits to
Registrants Form 8-K filed on December 9, 2005).
10.2 Return to Treasury Agreement between Coventure International Inc. and
John Hromyk, dated December 6, 2005. (incorporated by reference to the
exhibits to Registrants Form 8-K filed on December 9, 2005).
10.3 Purchase Agreement made as of December 19, 2005 between China Natural
Gas, Inc. and John Hromyk (incorporated by reference to the exhibits
to Registrants Form 8-K filed on December 23, 2005).
10.4 Form of Securities Purchase Agreement (incorporated by reference to
the exhibits to Registrants Form 8-K filed on January 12, 2006).
10.5 Form of Common Stock Purchase Agreement (incorporated by reference to
the exhibits to Registrants Form 8-K filed on January 12, 2006).
10.6 Form of Registration Rights Agreement (incorporated by reference to
the exhibits to Registrants Form 8-K filed on January 12, 2006).
21.1 List of Subsidiaries
23.1 Consent of Kabani & Company, Inc.
23.2 Consent of Sichenzia Ross Friedman Ference LLP (contained in Exhibit
5.1)
II-2
ITEM 28. UNDERTAKINGS.
The undersigned Company hereby undertakes to:
(1) File, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement to:
(i) Include any prospectus required by Section 10(a)(3) of the Securities Act of
1933, as amended (the "Securities Act");
(ii) Reflect in the prospectus any facts or events which, individually or
together, represent a fundamental change in the information in the registration
statement. Notwithstanding the foregoing, any increase or decrease in volume of
securities offered (if the total dollar value of the securities offered would
not exceed that which was registered) and any deviation from the low or high end
of the estimated maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b) under the
Securities Act if, in the aggregate, the changes in volume and price represent
no more than a 20% change in the maximum aggregate offering price set forth in
the "Calculation of Registration Fee" table in the effective registration
statement, and
(iii) Include any additional or changed material information on the plan of
distribution.
(2) For determining liability under the Securities Act, treat each
post-effective amendment as a new registration statement of the securities
offered, and the offering of the securities at that time to be the initial bona
fide offering.
(3) File a post-effective amendment to remove from registration any of the
securities that remain unsold at the end of the offering.
(4) For determining liability of the undersigned small business issuer under the
Securities Act to any purchaser in the initial distribution of the securities,
the undersigned undertakes that in a primary offering of securities of the
undersigned small business issuer pursuant to this registration statement,
regardless of the underwriting method used to sell the securities to the
purchaser, if the securities are offered or sold to such purchaser by means of
any of the following communications, the undersigned small business issuer will
be a seller to the purchaser and will be considered to offer or sell such
securities to such purchaser:
(i) Any preliminary prospectus or prospectus of the undersigned small business
issuer relating to the offering required to be filed pursuant to Rule 424;
(ii) Any free writing prospectus relating to the offering prepared by or on
behalf of the undersigned small business issuer or used or referred to by the
undersigned small business issuer;
(iii) The portion of any other free writing prospectus relating to the offering
containing material information about the undersigned small business issuer or
its securities provided by or on behalf of the undersigned small business
issuer; and
(iv) Any other communication that is an offer in the offering made by the
undersigned small business issuer to the purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the Company
pursuant to the foregoing provisions, or otherwise, the Company has been advised
that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities
(other than the payment by the Company of expenses incurred or paid by a
director, officer or controlling person of the Company in the successful defense
of any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
Company will, unless in the opinion of its counsel the matter has been settled
by controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.
II-3
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements of filing on Form SB-2 and authorizes this registration
statement to be signed on its behalf by the undersigned, in Xian, China, on
February 10, 2006.
CHINA NATURAL GAS, INC.
By: /s/ Minqing Lu
--------------------------
Minqing Lu
Chief Executive Officer (Principal Executive
Officer)
By: /s/ Xiaogang Zhu
--------------------------
Xiaogang Zhu
Chief Financial Officer
(Principal Financial and Accounting Officer)
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Minqing Lu and Xiaogang Zhu his true and lawful
attorneys-in-fact, with full power of substitution and resubstitution, for him
and in his name, place and stead, in any and all capacities to sign any and all
amendments (including post-effective amendments) to this registration statement
and to sign a registration statement pursuant to Section 462(b) of the
Securities Act of 1933, and to file the same with all exhibits thereto, and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact or his substitute or substitutes, may lawfully do or cause to
be done by virtue hereof.
In accordance with the requirements of the Securities Act of 1933, this
registration statement was signed by the following persons in the capacities and
on the dates stated: Pursuant to the requirements of the Securities Act of 1933,
as amended, this Registration Statement has been signed by the following persons
in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
------------- ----------------------------------- ------------------
/s/ Oinan Ji
------------ Chairman of the Board February 10, 2006
Qinan Ji
/s/ Bo Chen
------------ Vice Chairman of the Board February 10, 2006
Bo Chen
/s/ Minqing Lu
-------------- Chief Executive Officer and Director February 10, 2006
Minqing Lu
/s/ Xiaogang Zhu
---------------- Chief Financial Officer February 10, 2006
Xiaogang Zhu
II-4