GREEN GIANT INC. The following discussion and analysis of financial condition and results of operations relates to the operations and financial condition reported in the financial statements ofChina HGS Real Estate Inc. for the fiscal years endedSeptember 30, 2019 and 2018 and should be read in conjunction with such financial statements and related notes included in this report.
Preliminary Note Regarding Forward-Looking Statements.
We make forward-looking statements in Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report based on the beliefs and assumptions of our management and on information currently available to us. Forward-looking statements include information about our possible or assumed future results of operations which follow under the headings "Business and Overview," "Liquidity and Capital Resources," and other statements throughout this report preceded by, followed by or that include the words "believes," "expects," "anticipates," "intends," "plans," "estimates" or similar expressions. Forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed in these forward-looking statements, including the risks and uncertainties described below and other factors we describe from time to time in our periodic filings with theSEC . We therefore caution you not to rely unduly on any forward-looking statements. The forward-looking statements in this report speak only as of the date of this report, and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise. These forward-looking statements include, among other things, statements relating to: · our ability to sustain our project development · our ability to obtain additional land use rights at favorable prices; · the market for real estate in Tier 3 and 4 cities and counties; · our ability to obtain additional capital in future years to fund our planned expansion; or · economic, political, regulatory, legal and foreign exchange risks associated with our operations. Our Business Overview We conduct substantially all of our business throughShaanxi Guangsha Investment andDevelopment Group Co., Ltd , in Hanzhong,Shaanxi Province . Since the initiation of our business, we have been focused on expanding our business in certain Tier 3 and Tier 4 cities and counties inChina . For fiscal 2019, our sales, gross profit and net income were approximately$40.0 million ,$9.3 million and$3.7 million , respectively, representing a decrease of approximately 39.0%, 23.8% and 29.4% from fiscal 2018, respectively. The decrease in revenue, gross profit and net income was mainly due to less GFA
sold
during fiscal 2019.
26
For fiscal 2019, our average selling price ("ASP") for real estate projects
(excluding sales of parking spaces) located in Yang County was approximately
$720 per square meter, significantly increased from ASP of $478 per square meter
in fiscal 2018. The ASP of our Hanzhong real estate projects (excluding sales of
parking spaces) was approximately $560 per square meter for fiscal 2019,
decreased by 7.4% as compared to the ASP of $605 per square meter for fiscal
2018.
Market Outlook
In Fiscal 2019, the macro-economic backdrop will continue to be uncertain with
unrelenting downside pressure, while the overall inventory level of properties
will remain high. The central government will continue to adopt policies aimed
to ensure stability, economic growth and improved employment. The details of
implementation by local government will vary among different PRC cities.
In 2020, the Company expects to start the construction of the real estate
projects surrounding the Liangzhou Road area after the approval by the local
government of the road. These projects will comprise of residential for
end-users and upgraders, shopping malls as well as serviced apartments and
offices to satisfy different market demands. Our customers continue to
experience growth of their disposable income. With a lower housing price to
family disposable income ratio and an increasing urbanization level, there is a
growing demand for high quality residential housing. From this perspective, the
Company is positive about the outlook for the local real estate market in a long
term. In the meantime, the Company is diversifying its revenue and developing
more commercial and municipal projects.
We intend to remain focused on our existing construction projects in Hanzhong
City and Yang County, deepening our institutional sales network, enhancing our
cost and operational synergies and improving cash flows and strengthening our
balance sheet. In this respect, we began the construction of the following large
high rise residential projects in Hanzhong City and Yang County:
Liangzhou road related projects
InSeptember 2013 , the Company entered into an agreement ("Liangzhou Agreement") with the Hanzhong local government on theLiangzhou Road reformation and expansion project (Liangzhou Road Project "). Pursuant to the agreement, the Company is contracted to reform and expand the Liangzhou Road, a commercial street in downtown Hanzhong City, with a total length of 2,080 meters and width of 30 meters and to resettle the existing residences in the Liangzhou road area. The government's original road construction budget was approximately$33 million in accordance with the Liangzhou Agreement. The Company, in return, is being compensated by the local government to have an exclusive right on acquiring at least 394.5 Mu land use rights in a specified location of Hanzhong City.The Liangzhou Road Project's road construction started at the end of 2013. In 2014, the original scope and budget on the Liangzhou road reformation and expansion project was extended, because the local government included more area and resettlement residences into the project, which resulted in additional investments from the Company. In return, the Company is authorized by the local government to develop and manage the commercial and residential properties surrounding the Liangzhou Road project. As ofSeptember 30, 2019 , the main Liangzhou road construction is substantially completed, due to the complicated multiple level of government review process, the Company expected to the government's acceptance to be completed before the end of fiscal 2020. The Company's development cost incurred onLiangzhou Road Project is treated as the Company's deposit on purchasing the related land use rights, as agreed by the local government. As ofSeptember 30, 2019 , the actual costs incurred by the Company were$146,958,903 (September 30, 2018 -$135,011,975 ) and the incremental cost related to residence resettlement approved by the local government.
27
Oriental Garden Phase II
Oriental Garden Phase II project is planned
to consist of 8 high-rise residential
buildings and 6 commercial buildings with
total planned GFA of 370,298 square meters.
The project will also include a farmer's
market. [[Image Removed]]
Liangzhou Mansion
Liangzhou Mansion project is planned to
consist of 7 high-rise building and
commercial shops on the first floor with
total planned GFA of 160,000 square meters. [[Image Removed]]
Pearl Commercial Plaza is planned to consist one office building, one service apartment (or hotel), classical architecture style of Chinese traditional houses and shopping malls with total planned GFA of 124,191 square meters. [[Image Removed]]
The Company plans to start these three real estate projects after the road construction passes local government's inspection and approval. These related projects may take 2-3 years to fully complete.
Road Construction Other road construction projects mainly included a Yang CountyEast 2nd Ring Road construction project. The Company was engaged by the Yang County local government to construct theEast 2nd Ring Road with a total length of 2.15 km. The local government is required to repay the Company's project investment costs within 3 years with interest at the interest rate based on the commercial borrowing rate with the similar term published byChina construction bank (September 30, 2019 and 2018 - 4.75%). The local government has approved a refund to the Company by reducing local surcharges or taxes otherwise required in the real estate development. The road construction was substantially completed as ofSeptember 30, 2019 and in process of government review and approval. InSeptember 2012 , the Company was approved by the Hanzhong local government to construct four municipal roads with a total length of approximately 1,192 meters. The project was deferred and then restarted during the quarter endedMarch 31, 2014 . As ofSeptember 30, 2019 , the local government was still in the process of assessing the budget for these projects. Under development: Estimated Completion time of constructionHanzhong City Shijin Project Under planning stageHanzhong City Hanfeng Beiyuan East Road To be delivered to the
government in
2020
Hanzhong City Liangzhou Road related projects The road construction was substantially completed inSeptember 2018 , the other related projects will be completed in later years. Hanzhong City Beidajie project Under planning stage Yang CountyEast 2nd Ring Road To be completed in 2020 28 RESULTS OF OPERATIONS
Year ended
Revenues The following is a breakdown of revenue for the years endedSeptember 30, 2019 and 2018: For the years endedSeptember 30, 2019 2018
Revenue recognized for completed condominium real estate projects
$ 13,400,491 $ 28,833,383 Revenue recognized for condominium real estate projects under development 26,564,065 36,653,913 Total$ 39,964,556 $ 65,487,296
Revenue recognized for completed condominium real estate projects
The following table summarizes our revenue generated by different projects:
For the Years Ended September 30,
2019 2018 Variance
Revenue % Revenue % Variance %
Projects
Yangzhou Pearl Garden
Phase I and II $ 2,726,864 20.3 % $ 365,617 2.7 % $ 2,361,247 645.8 %
Oriental Pearl Garden 2,627,563 19.6 % 12,495,388 59.1 % (9,867,825 ) (79.0 )%
Mingzhu Garden
(Nanyuan and Beiyuan)
Phase I and II 8,046,064 60.0 % 15,972,378 38.0 % (7,926,314 ) (49.6 )%
Total Revenue 13,400,491 100 % 28,833,383 100 % (15,432,892 ) (53.5 )%
Sales Tax (133,803 ) (513,178 ) 379,375 (73.9 )%
Revenue net of sales
tax $ 13,266,688 $ 28,320,205 $ (15,053,517 ) (53.2 )%
Our revenues are derived from the sale of residential buildings, commercial store-fronts and parking spaces in projects that we have developed. Comparing to last year, revenues before sales tax decreased by 53.5% to approximately$13.4 million in fiscal 2019 from approximately$28.8 million in fiscal 2018. The total GFA sold during fiscal 2019 was 22,339 square meters, representing a significant decrease from the 48,108 square meters sold during last year. Currently, our Mingzhu Garden Phase I and Phase II, Yangzhou Pearl Garden Phase I and Phase II and Oriental Garden Phase I have all been completed in prior years as well asYangzhou Palace projects has been completed during the third quarter of fiscal 2019, therefore only limited models are available for customer selection, which resulted in lower sales for current year. The sales tax for fiscal 2019 decreased by 73.9% from fiscal 2018, consistent with the drop in sales.
Revenue recognized for condominium real estate projects under development
For the year ended September 30, 2019
Accumulated
Revenue
recognized
Average Qualified under
Percentage of Contract Revenue Percentage of
Total GFA(3) Completion(1) Sales(2) Recognized completion
Real estate properties
located in Yang County
Yangzhou Palace 297,450 100 % $ 77,979,739 $ 26,564,065 $ 77,979,739
29
We started to recognize revenue under the percentage of completion method for
Yangzhou Palace real estate property since second quarter of fiscal 2017. For
Yangzhou Palace real estate property under development, total qualified contract
sales as of September 30, 2019 were $77,979,739 (2018 - $58,534,656 ). Total GFA
sold under qualified contract sales as of September 30, 2019 was 153,451 square
meters (September 30, 2018 - 79,913). The average unit price under contract
sales was $508 per square meters (September 30, 2018 - $504 ).
For the
year ended
Accumulated
Revenue Revenue
Recognized recognized
Average Qualified under under
Percentage of Contract Percentage of Percentage of
Total GFA Completion(1) Sales(2) Completion completion
Real estate properties under
development located in Yang
County
Yangzhou Palace 297,450 90 % $ 58,534,656 $ 36,653,913 $ 52,681,190 (1) Percentage of Completion progress is calculated by dividing total costs
incurred by total estimated costs for the relevant buildings in each real
estate building , estimated as of the date of our financial statements as of
and for the year indicated.
(2) Qualified contract sales only include all contract sales with customer
deposits balance as of
of contract sales amount and related individual of buildings were sold over
20%.
(3) The actual GFA will be re-measured when the real estate project iscompleted, which could be slightly different from the estimated GFA at the
beginning of the real estate projects.
Cost of sales
The following table sets forth a breakdown of our cost of revenues for the years
indicated.
For the Years Ended September 30,
2019 2018
Cost Percentage Cost Percentage Variance Variance %
Land use rights $ 2,692,563 8.9 % $ 4,339,910 8.9 % $ (1,647,347 ) (38.0 )%
Construction costs 27,560,950 91.1 % 44,302,482 91.1 % (16,741,532 ) (37.8 )% Total$ 30,253,513 100 %$ 48,642,392 100 %$ (18,388,879 ) (37.8 )% Our cost of sales consists primarily of costs associated with land use rights and construction costs. Cost of sales are capitalized and allocated to development projects using a specific identification method. Costs are allocated to specific units within a project based on the ratio of the sales area of units to the estimated total sales area of the project or phase of the project times the total cost of the project or phase of the project. Cost of sales was approximately$30.3 million for the year endedSeptember 30, 2019 compared to$48.6 million for the year endedSeptember 30, 2018 . The$18.4 million decrease in cost of sales was mainly attributable to the decrease in total GFA sold for Oriental Pearl Garden, Mingzhu Garden (Nanyuan and Beiyuan) Phase I and II andYang County Yangzhou Palace project during fiscal 2019 which led to decreased revenue and cost of sales during fiscal 2019. 30
Land use rights cost: The cost of land use rights includes the land premium we pay to acquire land use rights for our property development sites, plus taxes. Our land use rights cost varies for different projects according to the size and location of the site and the minimum land premium set for the site, all of which are influenced by government policies, as well as prevailing market conditions. Costs for land use rights for the year endedSeptember 30, 2019 were approximately$2.7 million , as compared to$4.3 million for the year endedSeptember 30, 2018 , representing a decrease of$1.6 million from last year. The decrease in costs of land use rights was due to less GFA sold during fiscal 2019. Construction cost: We outsource the construction of all of our projects to third party contractors, whom we select through a competitive tender process. Our construction contracts provide a fixed payment which covers substantially all labor, materials and equipment costs, subject to adjustments for some types of excess, such as design changes during construction or changes in government-suggested steel prices, which are paid over the construction period based on specified milestones. In addition, we purchase and supply a limited range of fittings and equipment, including elevators, window frames and door frames. Our construction costs for the year endedSeptember 30, 2019 were approximately$27.6 million as compared to approximately$44.3 million for the year endedSeptember 30, 2018 , representing a decrease of$16.7 million . The decrease in construction cost was due to the decrease in units sold in fiscal 2019. The total cost of sales as a percentage of real estate sales before sales tax for the year endedSeptember 30, 2019 and 2018 was consistently around 75.7% and 74.3%, respectively. Gross profits Gross profit was approximately$9.3 million for the year endedSeptember 30, 2019 as compared to approximately$15.6 million for the year endedSeptember 30, 2018 , representing a decrease of approximately$6.3 million , which was mainly attributable to less GFA sold in Oriental Pearl Garden, Mingzhu Garden (Nanyuan and Beiyuan) Phase I and II andYang County Yangzhou Palace project during fiscal 2019. We have only limited models available for customer selection in the Mingzhu Garden Phase I and II projects, Oriental Pearl Garden project and Yangzhou Pearl Garden project, therefore, the sales from these completed projects decreased from last year. For fiscal 2019, our average selling price ("ASP") for real estate projects (excluding sales of parking spaces) located in Yang County was approximately$720 per square meter, significantly increased from the ASP of$478 per square meter for fiscal 2018, due to the fact that most of units sold in Yangzhou Pearl Garden Phase I and II project were commercial units . The ASP of our Hanzhong real estate projects (excluding sales of parking spaces) was approximately$560 per square meter for fiscal 2019, slightly decreased by 7.4% as compared to the ASP of$605 per square meter for fiscal 2018. The decreased average selling price reduced the gross margin. The overall gross profit as a percentage of real estate sales before sales tax slightly decreased to 23.3% for the year endedSeptember 30, 2019 from 23.8% for the year endedSeptember 30, 2018 , was mainly due to the fact that the average selling price for the Mingzhu Garden (Mingzhu Nanyuan and Beiyuan) Phase I and II in Hanzhong was lower in fiscal 2019 to promote the sales. For the Year Ended September 30 2019 2018 Gross Gross Variance Project Gross Profit Margin Gross Profit Margin Variance % Yangzhou Pearl Garden
Phase I and II$ 1,619,575 59 %$ 168,390 46 %$ 1,451,185 862 % Yangzhou Palace 5,210,427 20 % 7,996,210 22 % (2,785,783 ) (35 )% Mingzhu Garden (Mingzhu Nanyuan and Beiyuan) Phase I and II 2,105,274 26 % 5,402,159 34 % (3,296,885 ) (61 )% Oriental Garden 775,767 30 % 3,278,145 26 % (2,502,378 ) (76 )% Sales Tax (389,406 ) (1,248,230 ) 858,824 (69 )% Total Gross Profit$ 9,321,637 23 %$ 15,596,674 24 %$ (6,275,037 ) (40 )% Total Revenue$ 39,964,556 $ 65,487,296
$ (25,522,740 ) (39 )% 31 Operating expenses
Total operating expenses decreased by 3.5% or approximately$0.1 million to approximately$3.2 million for the year endedSeptember 30, 2019 from approximately$3.4 million for the year endedSeptember 30, 2018 , as a result of lower selling expense of approximately$0.3 million , but offset with an increase in general and administrative expense of$0.1 million . The Company incurred more marketing expense in fiscal 2018 to promote the sales inYangzhou Palace project, which resulted higher selling expense in last year. The$0.1 million increase in general and administrative expense was due to additional office and consulting expenses incurred in fiscal 2019. For the years ended September 30, 2019 2018 General and administrative expenses$ 2,661,578 $ 2,530,269 Selling expenses 494,646 843,813 Total Operating expenses$ 3,156,224 $ 3,374,082
Percentage of Revenue before sales tax 7.9 %
6.4 % Interest expense, net Net interest expense was approximately$0.1 million for the year endedSeptember 30, 2019 , comparing to$0.5 million in last year, due to less loan balance
in fiscal 2019. Income taxesU.S. Taxes China HGS is aFlorida corporation. However, all of our operations are conducted solely by our subsidiaries in the PRC. No income is earned inthe United States and we do not repatriate any earnings outside the PRC. As a result, we did not generate anyU.S. taxable income for the years endedSeptember 30, 2019 and 2018. For the year endedSeptember 30, 2019 , the current income tax provision was approximately$0.7 million , decreased from approximately$3.1 million in fiscal 2018 due to less income before tax. For the year endedSeptember 30, 2019 , the deferred tax provision was approximately$1.3 million , decreased from approximately$2.0 million in fiscal 2018 due to less revenue reported under real estate project under development. The overall income taxes provision in fiscal 2019 significantly reduced from fiscal 2018 as a result of less income before tax reported in fiscal 2019. RecentU.S. federal tax legislation, commonly referred to as the Tax Cuts and Jobs Act (the "U.S. Tax Reform"), was signed into law onDecember 22, 2017 . TheU.S. Tax Reform significantly modified theU.S. Internal Revenue Code by, among other things, reducing the statutoryU.S. federal corporate income tax rate from 35% to 21% for taxable years beginning afterDecember 31, 2017 ; limiting and/or eliminating many business deductions; migrating theU.S. to a territorial tax system with a one-time transition tax on a mandatory deemed repatriation of previously deferred foreign earnings of certain foreign subsidiaries; subject to certain limitations, generally eliminatingU.S. corporate income tax on dividends from foreign subsidiaries; and providing for new taxes on certain foreign earnings. Taxpayers may elect to pay the one-time transition tax over eight years or in a single lump sum. TheU.S. Tax Reform also includes provisions for a new tax on GILTI effective for tax years of foreign corporations beginning afterDecember 31, 2017 . The GILTI provisions impose a tax on foreign income in excess of a deemed return on tangible assets of controlled foreign corporations ("CFCs"), subject to the possible use of foreign tax credits and a deduction equal to 50 percent to offset the income tax liability, subject to some limitations. For the year endedSeptember 30, 2018 , the Company recognized a one-time transition toll tax of approximately$2.3 million that represented management's estimate of the amount ofU.S. corporate income tax based on the deemed repatriation tothe United States of the Company's share of previously deferred earnings of certain non-U.S. subsidiaries and VIE of the Company mandated by theU.S. Tax Reform. The Company's estimate of the onetime transition toll Tax is subject to the finalization of management's analysis related to certain matters, such as developing interpretations of the provisions of the Tax Act and amounts related to the earnings and profits of certain foreign VIEs and the filing of our tax returns.U.S. Treasury regulations, administrative interpretations or court decisions interpreting the Tax Act may require further adjustments and changes in our estimates. As ofSeptember 30, 2019 , the Company provided an additional$0.8 million provision due to delinquentU.S. tax return fillings. 32 PRC Taxes Our Company is governed by the Enterprise Income Tax Law ofthe People's Republic of China concerning private-run enterprises, which are generally subject to tax at a statutory rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments. For years endedSeptember 30, 2019 and 2018, the Company is subject to income tax rate of 25% on taxable income. Although the possibility exists for reinterpretation of the application of the tax regulations by higher tax authorities in the PRC, potentially overturning the decision made by the local tax authority, the Company has not experienced any reevaluation of the income taxes for prior years. The PRC tax rules are different from the local tax rules and the Company is required to comply with local tax rules. The difference between the two tax rules will not be a liability of the Company. There will be no further tax payments for the difference. Net income
We reported approximately
Other comprehensive income
We operate primarily in the PRC and the functional currency of our operating
subsidiary is the Chinese Renminbi ("RMB"). The RMB is not freely convertible
into foreign currency and all foreign exchange transactions must take place
through authorized institutions. No representation is made that the RMB amounts
could have been, or could be, converted into USD at the rates used in
translation.
Translation adjustments amounted to approximately negative $6.7 million and $5.5
million for the years ended September 30, 2019 and 2018, respectively. The
balance sheet amounts with the exception of equity at September 30, 2019 were
translated at 7.1477 RMB to 1.00 USD as compared to 6.8680 RMB to 1.00 USD at
September 30, 2018 . The equity accounts were stated at their historical rate.
The average translation rates applied to the income statements accounts for the
years ended September 30, 2019 and 2018 were 6.8753 RMB to 1.00 USD and 6.5368
RMB to 1.00 USD , respectively.
Liquidity and Capital Resources
Current Assets and Liabilities
Our principal need for liquidity and capital resources is to maintain working capital sufficient to support our operations and to make capital expenditures to finance the growth of our business. Historically we mainly financed our operations primarily through cash flows from operations and borrowings from
our principal shareholder. As ofSeptember 30, 2019 , the Company had an approximately$29.7 million negative working capital and total cash and restricted cash balance decreased to approximately$4.2 million as ofSeptember 30, 2019 as compared to approximately$6.8 million as ofSeptember 30, 2018 . With respect to capital funding requirements, the Company budgeted our capital spending based on ongoing assessments of needs to maintain adequate cash. Due to the long term relationship with our construction suppliers, we were able to effectively manage cash spending on construction, meantime, we are able to obtain additional funding support from local banks and financial institutions. Also, the Company's cash flows from pre-sales and current sales should provide financial support for our current developments and operations. For the both years endedSeptember 30, 2019 and 2018, the Company had positive cash flow from operating. In addition, our principal shareholder, Mr.Xiaojun Zhu has been providing and will continue to provide his personal funds, if necessary, to support the Company on an as needed basis. The Company believes it has sufficient working capital for the next twelve months. In order to fully implement our business plan and sustain continued growth, we may also need to raise capital from outside investors. Our expectation, therefore, is that we will seek to access the capital markets in both theU.S. andChina to obtain the funds as needed. At the present time, however, we do not have commitments of funds from any third party. 33 OnJune 26, 2015 andMarch 10, 2016 , the Company signed phase I and Phase II agreements withHanzhong Urban Construction Investment Development Co., Ltd , a state owned Company, to borrow up to approximately$108.4 million (RMB 775,000,000 ) for a long term loan at 4.75% interest per year to developLiangzhou Road Project . As ofSeptember 30, 2019 , the Company borrowed approximately$90.2 million under this credit line. The loan is guaranteed by Hanzhong City Hantai District Municipal Government and pledged by the Company'sYang County Yangzhou Palace project with carrying value of$52.3 million as ofSeptember 30, 2019 . The Company also was required to provide a security deposit for the loan received. As ofSeptember 30, 2019 , the security deposits paid were approximately$5.2 million . InDecember 2016 , the Company signed a loan agreement withHantai District Urban Construction Investment Development Co., Ltd , a state owned Company, to borrow up to approximately$16.6 million (RMB 119,000,000 ) for the development ofHanzhong City Liangzhou Road project. As ofSeptember 30, 2019 , the Company received all the proceeds. The loan carries interest at a fixed interest of 1.2% and is due onJune 20, 2031 . The Company pledged the assets of Liangzhou Road related projects with carrying value of approximately$147.0 million as collateral for the loan. Cash Flow
Year ended
Comparison of cash flows results for the fiscal year ended
For the years ended September 30,
2019 2018 VarianceNet cash provided by operating activities$ 8,937,581 $ 3,382,233 $ 5,555,348 Net cash used in provided by financing activities$ (11,337,359 ) $ (1,064,020 ) $ (10,354,385 ) Effect of changes of foreign exchange rate on cash $ (173,682 )$ (259,240 ) $ 166,604 Net increase (decrease) in cash$ (2,573,460 )
$ 2,058,973 $ (4,632,433 ) Operating activities Net cash provided by operating activities during fiscal 2019 was approximately$8.9 million , consisting of net income of approximately$3.7 million , noncash adjustments of approximately$1.4 million and net changes in our operating assets and liabilities, which mainly included an increase in real estate property completed of approximately$45.8 million and a decrease in real estate property under development of approximately$51.0 million due to the completion ofYangzhou Palace real estate project during the year and reclassification from real estate property under development to real estate property completed, an increase of accounts payable of$8.0 million due to continuous spending on the real estate under developments, an increase of$1.2 million in tax payable, offset by a reduction of customer deposits of$4.3 million and reduction of contract balance of$3.9 million due to recognition of revenue. Net cash provided by operating activities during fiscal 2018 was approximately$2.5 million , consisting of net income of approximately$5.2 million , noncash adjustments of approximately$2.1 million and net changes in our operating assets and liabilities, which mainly included a decrease in real estate property completed of approximately$18.8 million mainly due to sales of residential units inMingzhu Pearl Garden , Yangzhou Pearl Garden and Oriental Garden real estate projects during the year, an increase in real estate property under development of approximately$17.0 million for continuous spending on Liangzhou Road related projects andYang County Yangzhou Palace , a decrease in accounts payable of approximately$2.9 million due to more payments to our contractors and suppliers, a decrease of customer deposit of approximately$4.1 million as the related sales was recognized during fiscal 2018 and a decreased in taxes payable of approximately$1.4 million due to payments of taxes in fiscal 2018. 34 Financing activities
Net cash used in financing activities was approximately
Net cash used in financing activities was approximately$1.1 million for fiscal 2018, which included a net repayment of shareholder loan of approximately$0.2 million , proceeds from other loans of approximately$5.2 million and offset by repayment of other loans of approximately$6.1 million .
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
As an industry practice, the Company provides guarantees to PRC banks with respect to loans procured by the purchasers of the Company's real estate properties for the total mortgage loan amount until the completion of obtaining the "Certificate of Ownership" of the properties from the government, which generally takes six to twelve months. Because the banks provide loan proceeds without getting the "Certificate of Ownership" as loan collateral during this six to twelve months' period, the mortgage banks require the Company to maintain, as restricted cash, 5% to 10% of the mortgage proceeds as security for the Company's obligations under such guarantees. If a purchaser defaults on its payment obligations, the mortgage bank may deduct the delinquent mortgage payment from the security deposit and require the Company to pay the excess amount if the delinquent mortgage payments exceed the security deposit. If the delinquent mortgage payments exceed the security deposit, the banks may require us to pay the excess amount. If multiple purchasers default on their payment obligations at around the same time, we will be required to make significant payments to the banks to satisfy our guarantee obligations. If we are unable to resell the properties underlying defaulted mortgages on a timely basis or at prices higher than the amounts of our guarantees and related expenses, we will suffer financial losses. The Company has made necessary reserves in its restricted cash account to cover any potential mortgage defaults as required by the mortgage lenders. For the years endedSeptember 30, 2019 and 2018, the Company has not experienced any delinquent mortgage loans and has not experienced any losses related to this guarantee. As ofSeptember 30, 2019 and 2018, our outstanding guarantees in respect of our customers' mortgage loans amounted to approximately$78 million and$70 million , respectively. As ofSeptember 30, 2019 and 2018, the amount of security deposits provided for these guarantees was approximately$3.9 million and$3.5 million respectively and the Company believes that such reserves are sufficient. Inflation
Inflation has not had a material impact on our business and we do not expect inflation to have a material impact on our business in the near future.
Critical Accounting Policies and Management Estimates
Revenue recognition Most of the Company's revenue is derived from real estate sales of condominiums and commercial property in the PRC. The majority of the Company's contracts contain a single performance obligations involving significant real estate development activities that are performed together to deliver a real estate property to customers. Revenues arising from real estate sales are recognized when or as the control of the asset is transferred to the customer. The control of the asset may transfer over time or at a point in time. For the sales of individual condominium units in a real estate development project, the Company has an enforceable right to payment for performance completed to date, revenue is recognized over time by measuring the progress towards complete satisfaction of that performance obligation. Otherwise, revenue is recognized at a point in time when the customer obtains control of the asset.
Under percentage completion method, revenue and profit from the sales of long term real estate development properties is recognized by the percentage of completion method on the sale of individual units when all the following criteria are met:
a. Construction is beyond a preliminary stage.
b. The buyer is committed to the extent of being unable to require a refund
except for non-delivery of the unit or interest.
c. Sufficient units have already been sold to assure that the entire property
will not revert to rental property.
d. Sales prices are collectible.
e. Aggregate sales proceeds and costs can be reasonably estimated.
If any of the above criteria is not met, proceeds shall be accounted for as deposits until the criteria are met.
Under the percentage of completion method, revenues from individual real estate condominium units sold under development and related costs are recognized over the course of the construction period, based on the completion progress of a project. The progress towards complete satisfaction of the performance obligation is measured based on the Company's efforts or inputs to the satisfaction of the performance obligation, by reference to the contract costs incurred up to the end of reporting period as a percentage of total estimated costs for each contract. In relation to any project, revenue is determined by calculating the ratio of incurred costs, including land use rights costs and construction costs, to total estimated costs and applying that ratio to the contracted sales amounts. Cost of sales is recognized by determining the ratio of contracted sales during the period to total estimated sales value, and applying that ratio to the incurred costs. Current period amounts are calculated based on the difference between the life-to-date project totals and the previously recognized amounts. Any changes in significant judgments and/or estimates used in determining construction and development revenue could significantly change the timing or amount of construction and development revenue recognized. Changes in total estimated project costs or losses, if any, are recognized in the period in
which
they are determined.
35
Revenue from the sales of completed real estate condominium units is recognized
at the time of the closing of an individual unit sale. This occurs when the
customer obtains the physical possession, the legal title, or the significant
risks and rewards of ownership of the assets and the Company has present right
to payment and the collection of the consideration is probable. For municipal
road construction projects, fees are generally recognized at the time of the
projects are completed.
Contract balances
Timing of revenue recognition may differ from the timing of billing and cash
receipts from customers. The Company records a contract asset when revenue is
recognized prior to invoicing, or a contract liability when cash is received in
advance of recognizing revenue. A contract asset is a right to consideration
that is conditional upon factors other than the passage of time. Contract assets
include billed and billable receivables, which are the Company's unconditional
rights to consideration other than to the passage of time. Contract liabilities
include cash collected in excess of revenues. Customer deposit are excludedfrom contract liabilities.
The Company has elected to apply the optional practical expedient for costs to obtain a contract which allows the Company to immediately expense sales commissions (included under selling expenses) because the amortization period of the asset that the Company otherwise would have used is one year or less. Contract assets and liabilities are generally classified as current based on our contract operating cycle.
The Company provides "mortgage loan guarantees" only with respect to buyers who
make down-payments of 20%-50% of the total purchase price of the property. The
period of the mortgage loan guarantee begins on the date the bank approves the
buyer's mortgage and we receive the loan proceeds in our bank account and ends
on the date the "Certificate of Ownership" evidencing that title to the property
has been transferred to the buyer. The procedures to obtain the Certificate of
Ownership take six to twelve months (the "Mortgage Loan Guarantee Period"). If,
after investigation of the buyer's income and other relevant factors, the bank
decides not to grant the mortgage loan, our mortgage-loan based sales contract
terminates and there will be no guarantee obligation. If, during the Mortgage
Loan Guarantee Period, the buyer defaults on his or her monthly mortgage payment
for three consecutive months, we are required to return the loan proceeds back
to the bank, although we have the right to keep the customer's deposit and
resell the property to a third party. Once the Certificate of Property has been
issued by the relevant government authority, our loan guarantee terminates. If
the buyer then defaults on his or her mortgage loan, the bank has the right to
take the property back and sell it and use the proceeds to pay off the loan. The
Company is not liable for any shortfall that the bank may incur in this event.
To date, no buyer has defaulted on his or her mortgage payments during the
Mortgage Loan Guarantee Period and the Company has not returned any loan
proceeds pursuant to its mortgage loan guarantees.
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Use of estimates
The preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes, and disclosure of
contingent liabilities at the date of the consolidated financial statements.
Estimates are used for, but not limited to, the assumptions and estimates used
by management in recognizing development revenue under the percentage of
completion method, the selection of the useful lives of property and equipment,
provision necessary for contingent liabilities, revenue recognition, taxes and
budgeted costs. Management believes that the estimates utilized in preparing its
consolidated financial statements are reasonable and prudent. Actual results
could differ from these estimates.
Real estate property development completed and under development
Real estate property consists of finished residential unit sites, commercial offices and residential unit sites under development. The Company leases the land for the residential unit sites under land use right leases with various terms from the PRC government. The cost of land use rights is included in the development cost and allocated to each project. Real estate property development completed and real estate property under development are stated at the lower of cost or fair value.
Expenditures for land development, including cost of land use rights, deed tax,
pre-development costs, and engineering costs, exclusive of depreciation, are
capitalized and allocated to development projects by the specific identification
method. Costs are allocated to specific units within a project based on the
ratio of the sales area of units to the estimated total sales area of the
project (or phase of the project) multiplied by the total cost of the project
(or phase of the project). Cost of amenities transferred to buyers is allocated
to specific units as a component of total construction cost. The amenity cost
includes landscaping, road paving, etc. Once the projects are completed, the
amenities are under control of the property management companies.
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Real estate property development completed and real estate property under
development are reclassified on the balance sheet into current and non-current
portions based on the estimated date of construction completion and sales. The
real estate property development completed classification is based on the
estimated date that each property is expected to be sold within the Company's
normal operating cycle of the business and the Company's sales plan. Real estate
property development completed is classified as a current asset if the property
is expected to be sold within the normal operating cycle of the business.
Otherwise, it is classified as a non-current asset. The majority of real estate
projects the Company has completed in the past were multi-layer or sub-high-rise
real estate projects. The Company considers its normal operating cycle is 12
months.
Real estate property development completed and under development are subject to
valuation adjustments when the carrying amount exceeds fair value. An impairment
loss is recognized only if the carrying amount of the assets is not recoverable
and exceeds fair value. The carrying amount is not recoverable if it exceeds the
sum of the undiscounted cash flows expected to be generated by the assets. The
Company reviewed all of its real estate projects for future losses and
impairment by comparing the estimated future undiscounted cash flows for each
project to the carrying value of such project. For the years ended September 30,
2019 and 2018, the Company did not recognize any impairment for real estate
property under development or completed.
Capitalization of Interest
Interest incurred during and directly related to real estate development projects is capitalized to the related real estate property under development during the active development period, which generally commences when borrowings are used to acquire real estate assets and ends when the properties are substantially complete or the property becomes inactive. Interest is capitalized based on the interest rate applicable to specific borrowings or the weighted average of the rates applicable to other borrowings during the period. Interest capitalized to real estate property under development is recorded as a component of cost of real estate sales when related units are sold. All other interest is expensed as incurred.
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