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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2021

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from_______ to ________

Commission File Number: 001-34864

CHINA HGS REAL ESTATE, INC.

(Exact Name of Registrant as Specified in Its Charter)

Florida

 

33-0961490

(State or Other Jurisdiction of Incorporation)

 

(I.R.S. Employer Identification Number)

6 Xinghan Road, 19th Floor, Hanzhong City

Shaanxi Province, PRC 723000

(Address of Principal Executive Offices, Zip Code)

+(86) 091 - 62622612

(Registrant’s Telephone Number, including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading symbol(s)

Name of each exchange on which
registered

Common Stock, $0.001 par value

HGSH

The NASDAQ Capital Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes   No 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

 

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes   No 

The number of shares outstanding of each of the issuer’s classes of common equity, as of February 22, 2022 is as follows:

Class of Securities

    

Shares Outstanding

 

Common Stock, $0.001 par value

 

25,617,807

 

TABLE OF CONTENTS

Page

PART I

FINANCIAL INFORMATION

3

Item 1.

Unaudited Interim Financial Statements

3

Condensed Consolidated Balance Sheets at December 31, 2021 (unaudited) and September 30, 2021

3

Condensed Unaudited Consolidated Statements of Income and Comprehensive Income for The Three Months Ended December 31, 2021 and 2020

4

Condensed Unaudited Consolidated Statements of Changes in Stockholders’ Equity for The Three Months Ended December 31, 2021 and 2020

5

Condensed Unaudited Consolidated Statements of Cash Flows for The Three Months Ended December 31, 2021 and 2020

6

Notes to Condensed Unaudited Consolidated Financial Statements

7-19

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

21

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

30

Item 4.

Controls and Procedures

30

PART II

OTHER INFORMATION

32

Item 1.

Legal Proceedings

32

Item 1A.

Risk Factors

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

32

Item 3.

Defaults upon Senior Securities

32

Item 4.

Mine Safety Disclosures

32

Item 5.

Other Information

32

Item 6

Exhibits

33

Signatures

34

2

PART I: FINANCIAL INFORMATION

ITEM 1. INTERIM FINANCIAL STATEMENTS

CHINA HGS REAL ESTATE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

    

December 31,

    

September 30,

2021

2021

ASSETS

 

  (Unaudited)

 

  

Cash

$

2,446,011

$

170,001

Restricted cash

 

3,262,677

 

3,295,188

Contract assets

 

13,295,920

 

13,723,793

Real estate property development completed

 

87,665,296

 

88,145,841

Other assets

 

5,587,779

 

8,358,925

Property, plant and equipment, net

 

558,064

 

558,086

Security deposits

 

1,976,924

 

1,955,202

Real estate property under development

 

270,668,466

 

265,769,721

Due from local governments for real estate property development completed

 

3,057,400

 

3,023,806

Total Assets

$

388,518,537

$

385,000,563

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

Construction loans

$

120,965,389

$

119,636,222

Accounts payable

 

13,949,705

 

18,259,151

Other payables

 

9,202,246

 

6,430,992

Construction deposits

 

3,382,079

 

3,344,917

Contract liabilities

 

1,687,087

 

1,886,075

Customer deposits

 

21,801,521

 

19,803,917

Accrued expenses

 

1,222,021

 

1,987,567

Taxes payable

 

23,079,067

 

22,954,011

Total liabilities

 

195,289,115

 

194,302,852

Commitments and Contingencies

 

 

Stockholders’ equity

 

 

Common stock, $0.001 par value, 50,000,000 shares authorized, 25,617,807 shares issued and outstanding at December 31, 2021 and September 30, 2021

 

25,617

 

25,617

Additional paid-in capital

 

136,535,303

 

136,535,303

Statutory surplus

 

11,095,939

 

11,095,939

Retained earnings

 

41,056,265

 

40,691,955

Accumulated other comprehensive income

 

4,516,298

 

2,348,897

Total stockholders’ equity

 

193,229,422

 

190,697,711

Total Liabilities and Stockholders’ Equity

$

388,518,537

$

385,000,563

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

3

CHINA HGS REAL ESTATE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

Three months ended December 31, 

    

2021

    

2020

Real estate sales

$

2,879,215

$

2,755,262

Less: Sales tax

 

(60,221)

 

(23,538)

Cost of real estate sales

 

(1,455,556)

 

(1,853,642)

Gross profit

 

1,363,438

 

878,082

Operating expenses

 

 

Selling and distribution expenses

 

219,787

 

79,345

General and administrative expenses

 

631,927

 

305,925

Total operating expenses

 

851,714

 

385,270

Operating income

 

511,724

 

492,812

Interest income, net

 

1,461

 

2,826

Other (expense), net

 

 

(105,858)

Income before income taxes

 

513,185

 

389,780

Provision for income taxes

 

148,875

 

98,193

Net income

 

364,310

 

291,587

Other Comprehensive income

 

 

Foreign currency translation adjustment

 

2,167,401

 

6,991,159

Comprehensive income

$

2,531,711

$

7,282,746

Basic and diluted income per common share

 

 

Basic and diluted

$

0.01

$

0.01

Weighted average common shares outstanding

 

 

Basic and diluted

 

25,617,807

 

22,525,693

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

4

CHINA HGS REAL ESTATE INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

Accumulated

Other

Common Stock

Additional

Statutory

Retained

Comprehensive

    

Shares

    

Amount

    

Paid-in Capital

    

Surplus

    

Earnings

    

(loss) income

    

Total

Balance at September 30, 2020

 

22,525,693

$

22,525

$

129,930,330

$

10,458,395

$

34,070,767

$

(7,039,490)

$

168,325,821

Net income for the period

 

 

 

 

 

291,587

 

 

291,587

Foreign currency translation adjustments

 

 

 

 

 

 

6,991,159

 

6,991,159

Balance at December 31, 2020 (Unaudited)

 

22,525,693

$

22,525

$

129,930,330

$

10,458,395

$

35,245,648

$

(48,331)

$

175,608,567

Balance at September 30,2021

25,617,807

$

25,617

$

136,535,303

$

11,095,939

$

40,691,955

$

2,348,897

$

190,697,711

Net income for the period

364,310

364,310

Foreign currency translation adjustments

2,167,401

2,167,401

Balance at December 31, 2021 (Unaudited)

25,617,807

$

25,617

$

136,535,303

$

11,095,939

$

41,056,265

$

4,516,298

$

193,229,422

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

5

CHINA HGS REAL ESTATE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

Three months ended December 31, 

    

2021

    

2020

Cash flows from operating activities:

 

  

 

  

Net income

$

364,310

$

291,587

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

Depreciation

 

6,203

 

12,253

Changes in operating assets and liabilities:

 

 

Contract assets

578,638

(529,410)

Real estate property development completed

 

1,455,556

 

1,853,642

Real estate property under development

 

(1,940,302)

 

(1,297,396)

Other current assets

 

2,855,590

 

(631,040)

Accounts payables

 

(4,499,033)

 

(111,208)

Other payables

 

698,061

 

229,180

Contract liabilities

 

(219,296)

 

(5,191)

Customer deposits

 

1,772,351

 

1,721,198

Accrued expenses

 

(647,892)

 

Taxes payables

 

177,909

 

(890,500)

Net cash provided by operating activities

 

602,095

 

643,115

Cash flow from financing activities:

 

 

Proceeds from prepaid subscriptions for sale of units

 

2,000,000

 

Net cash provided by financing activities

 

2,000,000

 

Effect of changes of foreign exchange rate on cash and restricted cash

 

(358,596)

 

166,542

Net increase in cash and restricted cash

 

2,243,499

 

809,657

Cash and restricted cash, beginning of period

 

3,465,189

 

3,867,536

Cash and restricted cash, end of period

$

5,708,688

$

4,677,193

Supplemental disclosures of cash flow information:

 

 

Interest paid

$

$

136,674

Income taxes paid

$

$

63,765

Representing:

 

 

Cash, end of period

$

2,446,011

$

1,253,331

Restricted, end of period

$

3,262,677

$

3,423,862

Total cash and restricted cash, end of period

$

5,708,688

$

4,677,193

Cash, beginning of period

$

170,001

$

457,699

Restricted, beginning of period

3,295,188

3,409,837

Total cash and restricted cash, beginning of period

$

3,465,189

$

3,867,536

Non-cash activities:

Reclassification of interest payable to construction loan

$

$

1,608,606

Settlement of accounts payable with real estate property*

$

569,299

$

Settlement of account payables and account receivables*

$

2,758,731

$

*

For the three months ended December 31, 2021, the Company settled accounts payable of $569,299  with a vender by disposal of certain real estate property completed in Hanzhong City Mingzhu Garden Phase II.. In addition, the Company settled certain accounts payable by transferring other assets of $2,758,731 with venders for the three months ended December 31, 2021.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

6

Table of Contents

CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION

China HGS Real Estate, Inc. (“China HGS” or the “Company” or “we”, “us”, “our”), through its subsidiaries and variable interest entity (“VIE”), engages in real estate development, and the construction and sales of residential apartments, parking spaces and commercial properties in Tier 3 and Tier 4 cities and counties in China.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the U.S. generally accepted accounting principles (“GAAP”) and the applicable rules and regulations of the Securities and Exchange Commission for interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended December 31, 2021 and 2020 are not necessarily indicative of the results that may be expected for the full year. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2021 filed with the SEC on January 13, 2022.

Liquidity

In recent years, the Chinese government has implemented measures to control overheating residential and commercial property prices including but not limited to restrictions on home purchase, increasing the down-payment requirement against speculative buying, development of low-cost rental housing properties to help low-income groups while reducing the demand in the commercial housing market, increasing real estate property taxes to discourage speculation, control of the land supply and slowdown the construction land auction process, etc. In addition, in December 2019, a novel strain of coronavirus (COVID-19) surfaced. COVID-19 has spread rapidly throughout China and worldwide, which has caused significant volatility in the PRC and international markets. There is significant uncertainty around the breadth and duration of business disruptions related to COVID-19, as well as its impact on the PRC and international economies. To reduce the spread of COVID-19, the Chinese government has employed measures including city lockdowns, quarantines, travel restrictions, suspension of business activities and school closures. Due to difficulties resulting from the COVID-19 pandemic, including, but not limited to, the temporary closure of the Company’s facilities and operations beginning in early February through early March 2020, limited support from the Company’s employees, delayed access to construction raw material supplies, reduced customer visits to the Company’s sales office, and inability to promote real estate property sales to customers on a timely basis, The Company is experiencing recovery of its real estate business in fiscal 2021 and the following periods. The Company had real estate sales of approximately $2.9 million for the three months ended December 31, 2021, increased from $2.8 million in the same period of last year. Based on the assessment of the current economic environment, customer demand and sales trends, we believe that consumer spending has been restored in the local real estate market and real estate sales are expected to grow in the coming periods. On the other side, due to the negative impact from the COVID-19 pandemic and its spread, the development period of real estate properties and our operating cycle has been extended and we may not be able to liquidate our large balance of completed real estate properties within the short term as we originally expected. In addition, as of December 31, 2021, we had large construction loans payable of approximately $121.0 million and accounts payable of approximately $13.9 million to be paid to subcontractors. The extent of the impact of COVID-19 on the Company's future financial results will be dependent on future developments such as the length and severity of the crisis, the potential resurgence of the crisis, future government actions in response to the crisis and the overall impact of the COVID-19 pandemic on the local economy and real estate markets, among many other factors, all of which remain highly uncertain and unpredictable. Given this uncertainty, the Company is currently unable to quantify the expected impact of the COVID-19 pandemic on its future operations, financial condition, liquidity and results of operations if the current situation continues. The above mentioned facts raise substantial doubt about the Company's ability to continue as a going concern for at least one year from the date of this filing.

7

Table of Contents

CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION (continued)

In assessing its liquidity, management monitors and analyzes the Company’s cash on-hand, its ability to generate sufficient revenue sources in the future, and its operating and capital expenditure commitments. As of December 31, 2021, our total cash and restricted cash balance was approximately $5.7 million, increased from approximately $3.5 million as of September 30, 2021. With respect to capital funding requirements, the Company budgeted its capital spending based on ongoing assessments of needs to maintain adequate cash. On January 14, 2022, the Company closed a private placement with net proceeds of approximately $24.3 million. As of December 31, 2021, we had approximately $87.7 million of completed residential apartments and commercial units available for sale to potential buyers. Although we reported approximately $13.9 million accounts payable as of December 31, 2021, due to the long-term relationship with our construction suppliers and subcontractors, we were able to effectively manage cash spending on construction and negotiate with them to adjust the payment schedule based on our cash on hand. In addition, most of our existing real estate development projects relate to the old town renovation which are supported by the local government. As of December 31, 2021, we reported approximately $121.0 million of construction loans borrowed from financial institutions controlled by the local government and such loans can only be used on the old town renovation related project development. We expect that we will be able to renew all of the existing construction loans upon their maturity and borrow additional new loans from local financial institutions, when necessary, based on our past experience and the Company’s good credit history. Also, the Company’s cash flows from pre-sales and current sales should provide financial support for our current development projects and operations. For the three months ended December 31, 2021, we had six large ongoing construction projects (see Note 3, real estate properties under development) which were under the preliminary development stage due to delayed inspection and acceptance of the development plans by the local government. In June 2020, we completed the residence relocation surrounding the Liangzhou Road related projects and launched the construction of these projects in December 2020. For the other four projects, we expect we will be able to obtain the government’s approval of the development plans on these projects in the coming fiscal year and start the pre-sale of the real estate properties to generate cash when certain property development milestones have been achieved.

NOTE 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of consolidation

The unaudited condensed consolidated financial statements include the financial statements of China HGS Real Estate Inc. (the “Company” or “China HGS”), China HGS Investment Inc. (“HGS Investment”), Shaanxi HGS Management and Consulting Co., Ltd. (“Shaanxi HGS”) and its variable interest entity (“VIE”), Shaanxi Guangsha Investment and Development Group Co., Ltd. (“Guangsha”). All inter-company transactions and balances between the Company and its subsidiaries and VIE have been eliminated upon consolidation.

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.

Fair value of financial instruments

The Company follows the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures.” It clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.

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CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Level 2-Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data.

Level 3-Inputs are unobservable inputs which reflect the reporting entity’s own assumptions or what assumptions the market participants would use in pricing the asset or liability based on the best available information.

The carrying amounts reported in the accompanying consolidated balance sheets for cash, restricted cash and all other current assets, security deposits for land use rights, loans and all current liabilities approximate their fair value based on the short-term maturity of these instruments. The fair value of the customer, construction and security deposits approximate their carrying amounts because the deposits are received in cash. It was impractical to estimate the fair value of the amount due from the local government and the other payables.

Revenue recognition

The Company follows FASB ASC Topic 606 “Revenue from Contracts with Customers” (“ASC 606”). Under ASC 606, revenue is recognized in accordance with the transfer of goods and services to customers at an amount that reflects the consideration that the Company expects to be entitled to for those goods and services. The Company determines revenue recognition through the following steps:

identification of the contract, or contracts, with a customer;
identification of the performance obligations in the contract;
determination of the transaction price, including the constraint on variable consideration;
allocation of the transaction price to the performance obligations in the contract; and
recognition of revenue when (or as) the Company satisfies a performance obligation.

Most of the Company’s revenue is derived from real estate sales of condominiums and commercial properties in the PRC. The majority of the Company’s contracts contain a single performance obligation involving significant real estate development activities that are performed together to deliver a real estate property to its 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 (“percentage completion method”). Otherwise, revenue is recognized at a point in time when the customer obtains control of the asset.For the three months ended December 31, 2021 and 2020, the Company did not have any construction in progress recognized under the percentage of completion method.

Disaggregation of Revenues

Disaggregated revenues are as follows:

For the three months ended December 31, 

    

2021

    

2020

(Unaudited)

(Unaudited)

Revenue recognized for completed condominium real estate projects, net of sales taxes

$

2,818,994

$

2,731,724

Revenue recognized for condominium real estate projects under development, net of sales taxes

 

 

Total revenue, net of sales taxes

$

2,818,994

$

2,731,724

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CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Revenue recognition (continued)

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 the passage of time. Contract liabilities include cash collected in advance and in excess of revenue recognized. Customer deposits are excluded from contract liabilities.

The Company immediately expenses sales commissions (included under selling expenses) because sales commission is not expected to be recovered.

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 Ownership 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.

Foreign currency translation

The Company’s financial information is presented in U.S. dollars. The functional currency of the Company’s operating VIE is Renminbi (“RMB”), the currency of the PRC. The consolidated financial statements of the Company have been translated into U.S. dollars in accordance with ASC Topic 830-30 “Translation of Financial Statements”. The financial information is first prepared in RMB and then is translated into U.S. dollars at period-end exchange rates as to assets and liabilities and average exchange rates as to revenue, expenses and cash flows. Capital accounts are translated at their historical exchange rates when the capital transactions occurred. The effects of foreign currency translation adjustments are included as a component of accumulated other comprehensive income in stockholders’ equity.

For three months ended

December 31,

September 30,

    

2021

    

2020

    

2021

(Unaudited)

(Unaudited)

Period end RMB:USD exchange rate

6.3726

6.5250

6.4434

Period average RMB:USD exchange rate

 

6.3914

 

6.6235

 

6.5072

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 U.S. dollars at the rates used in translation.

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CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

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.

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 its 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 reviews 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 three months ended December 31, 2021 and 2020, the Company did not recognized any impairment loss for its real estate properties.

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. For the three months ended December 31, 2021 and 2020, the total interest capitalized in the real estate property development was $1,733,224 and $1,769,564, respectively.

Impairment of long-lived assets

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through the estimated undiscounted cash flows expected to result from the use and eventual disposition of the assets. Whenever any such impairment exists, an impairment loss will be recognized for the amount by which the carrying value exceeds the fair value.

Assets are grouped and evaluated at the lowest level for their identifiable cash flows that are largely independent of the cash flows of other groups of assets. The Company considers historical performance and future estimated results in its evaluation of potential impairment and then compares the carrying amount of the asset to the future estimated cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds estimated expected undiscounted future cash flows, the Company measures the amount of impairment by comparing the carrying amount of the asset to its fair value. The estimation of fair value is generally determined by using the asset's expected future discounted cash flows or market value. The Company estimates fair value of the assets based on certain assumptions such as budgets, internal projections, and other available information as considered necessary. There was no impairment of long-lived assets for the three months ended December 31, 2021 and 2020.

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CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Income taxes

In accordance with FASB ASC Topic 740 “Income Taxes,” deferred tax assets and liabilities are 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. A valuation allowances is established, when necessary, to reduce net deferred tax assets to the amount expected to be realized.

ASC 740-10-25 prescribes a more-likely-than-not threshold for consolidated financial statement recognition and measurement of a tax positions taken (or expected to be taken) in a tax return. It also provides guidance on the recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, years open for tax examination, accounting for income taxes in interim periods and income tax disclosures. There are no material uncertain tax positions as of December 31, 2021 and September 30, 2021.

The Company is a corporation organized under the laws of the State of Florida. However, all of the Company’s operations are conducted solely by its subsidiaries and VIE in the PRC. No income is earned in the United States and the management does not repatriate any earnings outside the PRC. As a result, the Company did not generate any U.S. taxable income for the three months ended December 31, 2021 and 2020. As of December 31, 2021, the Chinese entities’ income tax returns filed in China for the years ended December 31, 2020, 2019, 2018, 2017 and 2016 are subject to examination by the Chinese taxing authorities.

The parent Company, China HGS Real Estate Inc.’s both U.S. federal tax returns and Florida state tax returns are delinquent since 2009. Its tax years ended September 30, 2009 through September 30, 2021 remain open for statutory examination by U.S. federal and state tax authorities.

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Act”) was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a U.S. corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, the transition of U.S international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017. Due to the complexity involved in applying the provisions of the Tax Act, we made reasonable estimates of the effects and recorded accrued amounts in our consolidated financial statements as of December 31, 2021 and September 30, 2021, including approximately $2.3 million provision on the deemed repatriation of undistributed foreign earnings and an additional $1.3 million provision for delinquent U.S. and State tax fillings. The Company plans to engage a tax professional to file its delinquent tax returns in 2022. Failure to furnish any income tax and information returns with respect to any foreign business entity required, within the time prescribed by the IRS, subjects the Company to civil penalties.

Land appreciation tax (“LAT”)

In accordance with the relevant taxation laws in the PRC, the Company is subject to LAT based on progressive rates on the appreciation of land value, which is calculated as the proceeds of sales of properties less deductible expenditures including borrowing costs and all property development expenditures. LAT is exempted if the appreciation values do not exceed certain thresholds specified in the relevant tax laws.

The whole project must be completed before the LAT obligation can be assessed. Accordingly, the Company should record the liability and the total related expense at the completion of a project unless the tax authorities impose an assessment at an earlier date. The methods to implement this tax law vary among different geographic areas. Hanzhong, where the projects Mingzhu Garden, Nan Dajie and Central Plaza are located, implements this tax rule by requiring real estate companies prepay the LAT based upon customer deposits received. The tax rate in Hanzhong is 1%. Yang County, where the Yangzhou Pearl Garden and Yangzhou Palace projects are located, has a tax rate of 0.5%.

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CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Comprehensive income (loss)

In accordance with ASC 220-10-55, comprehensive income (loss) is defined as all changes in equity except those resulting from investments by owners and distributions to owners. The Company’s only components of other comprehensive income (loss) for the three months ended December 31, 2021 and 2020 were net income and foreign currency translation adjustments.

Basic and diluted earnings (loss) per share

The Company computes earnings (loss) per share (“EPS”) in accordance with the ASC 260, “Earnings per share”, which requires companies to present basic and diluted EPS. Basic EPS is measured as net income (loss) divided by the weighted average common shares outstanding for the period. Diluted EPS is similar to basic EPS but presents the dilutive effect on a per share basis of potential common shares (e.g., convertible securities, options and warrants) as if they had been converted at the beginning of the periods presented, or issuance date, if later. Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS. There were no anti-dilutive shares for the three months ended December 31, 2021 and 2020.

Concentration risk

The Company's operations are carried out in the PRC. Accordingly, the Company's business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC's economy. The Company's operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America. The Company's results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittances abroad, and rates and methods of taxation, among other things. Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. The Company's cash and restricted cash were on deposit at financial institutions in the PRC, which the management believes are of high credit quality. In May, 2015, China's new Deposit Insurance Regulation came into effect, pursuant to which banking financial institutions, such as commercial banks, established in China are required to purchase deposit insurance for deposits in RMB and in foreign currency placed with them. Such Deposit Insurance Regulation would not be effective in providing complete protection for the Company's accounts, as its aggregate deposits are much higher than the compensation limit of RMB500,000 (approximately $78,000). However, the Company believes that the risk of failure of any of these Chinese banks is remote. Bank failure is uncommon in China and the Company believes that the Chinese banks that hold the Company's cash and restricted cash are financially sound based on public available information. The Company has not experienced any losses in its bank accounts.

For the three months ended December 31, 2021 and 2020, the Company did not have any individual customer that accounted for more than 10% of the Company real estate sales revenue for the related periods.

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CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 3. REAL ESTATE PROPERTY DEVELOPMENT COMPLETED AND UNDER DEVELOPMENT

The following summarizes the components of real estate property development completed and under development as of December 31, 2021 and September 30, 2021:

Balance as of

    

December 31, 2021

    

September 30, 2021

(Unaudited)

Development completed:

 

 

Hanzhong City Mingzhu Garden Phase II

$

23,153,993

$

23,464,365

Hanzhong City Oriental Pearl Garden

 

19,494,416

 

19,435,711

Yang County Yangzhou Pearl Garden Phase II

 

2,275,390

 

2,250,388

Yang County Yangzhou Palace

42,741,497

42,995,377

Real estate property development completed

$

87,665,296

$

88,145,841

Under development:

 

 

Hanzhong City Liangzhou Road and related projects (a)

$

184,291,015

$

180,389,654

Hanzhong City Hanfeng Beiyuan East (b)

 

878,448

 

868,796

Hanzhong City Beidajie (b)

 

78,991,790

 

78,075,559

Yang County East 2nd Ring Road (c)

 

6,507,213

 

6,435,712

Real estate property under development

$

270,668,466

$

265,769,721

(a)In September 2013, the Company entered into an agreement (“Liangzhou Agreement”) with the Hanzhong local government on the Liangzhou 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 a 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. The Company launched the construction of the Liangzhou Road related projects in December 2020. As of December 31, 2021, the main Liangzhou road construction is substantially completed.

The Company’s development cost incurred for the Liangzhou Road Project is treated as the Company’s deposit on purchasing the related land use rights, as agreed by the local government. As of December 31, 2021, the actual costs incurred by the Company were approximately $184.3 million (September 30, 2021 - $180.4 million) and the incremental cost related to residence resettlements approved by the local government. The Company determined that the Company’s Investment in the Liangzhou Road Project in exchange for interests in future land use rights is a barter transaction with commercial substance.

(b)In September 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 ended June 30, 2014. As of December 31, 2021, the local government has not completed the budget for these projects therefore the delivery for these projects for the government’s acceptance and related settlement were extended to 2022.
(c)The Company was engaged by the Yang County local government to construct the East 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 by the China Construction Bank (December 31, 2021 and 2020 – 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 of December 31, 2021 and is in process of the government’s review and approval.

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CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 4. CONSTRUCTION LOANS

    

December 31,

    

September 30,

2021

2021

(Unaudited)

Loan A

$

102,334,191

$

101,209,744

Loan B

 

18,631,198

 

18,426,478

Total

$

120,965,389

$

119,636,222

(A)On June 26, 2015 and March 10, 2016, the Company signed phase I and Phase II agreements with Hanzhong Urban Construction Investment Development Co., Ltd, a state-owned Company, to borrow up to approximately $121.6 million (RMB775,000,000) for a long term loan with interest at 4.75% to develop the Liangzhou Road Project. As of December 31, 2021, the Company borrowed $102,334,191 under this credit line (September 30, 2021 - $101,209,744). Due to the local government’s delay in the relocation  of residences in the Liangzhou Road Project and related area, the Hanzhong Urban Construction Investment Development Co., Ltd has not released all the funds available to the Company and additional withdrawals will be based on the project’s development progress and the Company expects the loan will be extended upon maturity. The loan is guaranteed by Hanzhong City Hantai District Municipal Government and pledged by the Company’s Yang County Yangzhou Palace project with a carrying value of $42,741,497 as of December 31, 2021 (September 30, 2021- $42,995,377). For the three months ended December 31, 2021, the interest was $1,593,281 (December 31, 2020 - $1,632,889), which was capitalized into the development cost of the Liangzhou Road Project.

(B)In December 2016, the Company signed a loan agreement with Hantai District Urban Construction Investment Development Co., Ltd, a state-owned Company, to borrow up to approximately $18.7 million (RMB119,000,000) for the development of the Hanzhong City Liangzhou Road Project. The interest is 1.2% and due on June 20, 2031. The Company is required to repay the loan in equal annual principal repayments of approximately $3.3 million commencing from December 2027 through June 2031 with interest payable on an annual basis. The Company pledged the assets of the Liangzhou Road related projects with a carrying value of $184,291,015 as collateral for the loan. Total interest of $56,644 for the three months ended December 31, 2021 was capitalized into the development cost of the Hanzhong City Liangzhou Road Project (December 31, 2020- $55,321).

Additionally, in September 2017, the Urban Development Center Co., Ltd. approved a construction loan for the Company in the amount of approximately $27.5 million (RMB175,000,000) with an annual interest rate of 1.2% per year in connection with the Liangzhou Road and related Project. The Company is required to repay the loan in equal annual principal repayment of approximately $5 million commencing from December 2027 through May 2031 with the interest payable on an annual basis. The amount of this loan is available to be drawn down as soon as the land use rights of the Liangzhou Road Project are approved and the construction starts, which is expected to be completed before the end of 2022. Interest charges for the three months ended December 31, 2021 and 2020 were $83,299 and $81,354, respectively, which was included in the construction capitalized costs.

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CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 5. CUSTOMER DEPOSITS

Customer deposits consist of amounts received from customers for the pre-sale of residential units in the PRC. The detail of customer deposits is as follows:

    

December 31,

    

September 30,

2021

2021

(Unaudited)

Customer deposits by real estate projects:

 

 

Mingzhu Garden (Mingzhu Nanyuan and Mingzhu Beiyuan)

$

9,344,461

$

8,210,839

Oriental Pearl Garden

 

3,367,316

 

2,780,917

Liangzhou road and related projects

 

326,397

 

617,686

Yangzhou Pearl Garden

 

836,619

 

827,426

Yang County East 2nd Ring Road

2,353,828

2,327,964

Yangzhou Palace

 

5,572,900

 

5,039,085

Total

$

21,801,521

$

19,803,917

Customer deposits are typically 10% - 20% of the unit selling price for those customers who purchase properties in cash and 30%-50% of the unit selling price for those customers who purchase properties with mortgages.

NOTE 6. TAXES

(A) Business sales tax and VAT

The Company is subject to a 5% VAT for its existing real estate projects based on the local tax authority’s practice. As of December 31, 2021, the Company had business VAT tax payable of $5,471,564 (September 30, 2021 - $5,660,149), which is expected to be paid when the projects are completed and assessed by the local tax authority.

B) Corporate income taxes (“CIT”)

The Company’s PRC subsidiary and VIE are governed by the Income Tax Law of the People’s Republic of China for privately run enterprises, which are generally subject to income tax on income reported in the statutory financial statements after appropriate tax adjustments. The Company’s CIT rate is 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. As of December 31, 2021 and September 30, 2021, the Company’s total income tax payable amounted to $14,446,208 and $14,326,646, respectively, which included the income tax payable balances in the PRC of $10,881,208 and $10,761,646, respectively and the Company expects to pay this income tax payable balance when the related real estate projects are completely sold.

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CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 6. TAXES (continued)

The following table reconciles the statutory rates to the Company’s effective tax rate for the three months ended December 31, 2021 and 2020

For the three months ended

December 31, 

    

2021

    

2020

(Unaudited)

(Unaudited)

Chinese statutory tax rate

25.0

%

$

25.0

%

Other adjustments*

 

4.0

%

0.2

%

Effective tax rate

 

29.0

%

$

25.2

%

*other adjustment mainly represented non-deductible expenses for the three months ended December 31, 2021 and 2020.

Income tax expense for the three months ended December 31, 2021 and 2020 is summarized as follows:

For the three months ended

December 31, 

    

2021

    

2020

(Unaudited)

(Unaudited)

Current tax provision

$

148,875

$

98,193

Deferred tax provision

 

 

Income tax provision

$

148,875

$

98,193

Recent U.S. federal tax legislation, commonly referred to as the Tax Cuts and Jobs Act (the “U.S. Tax Reform”), was signed into law on December 22, 2017. The U.S. Tax Reform significantly modified the U.S. Internal Revenue Code by, among other things, reducing the statutory U.S. federal corporate income tax rate from 35% to 21% for taxable years beginning after December 31, 2017; limiting and/or eliminating many business deductions; migrating the U.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 eliminating U.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. The U.S. Tax Reform also includes provisions for a new tax on Global Intangible Low-Taxed Income (“GILTI”) effective for tax years of foreign corporations beginning after December 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. As of December 31, 2021 and September 30, 2021, the Company assessed that the related GILTI tax payable was Nil, which is subject to the reassessment upon the Company’s filling of GILTI information.

For the year ended September 30, 2018, the Company recognized a one-time transition toll tax of approximately $2.3 million that represented management’s estimate of the amount of U.S. corporate income tax based on the deemed repatriation to the United States of the Company’s share of previously deferred earnings of certain non-U.S. subsidiaries and VIE of the Company mandated by the U.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 of December 31, 2021 and September 30, 2021, the Company provided an additional $1.3 million provision due to delinquent U.S. tax return fillings.

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CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 6. TAXES (continued)

(C) Land Appreciation Tax (“LAT”)

Since January 1, 1994, LAT has been applicable at progressive tax rates ranging from 30% to 60% on the appreciation of land values, with an exemption provided for the sales of ordinary residential properties if the appreciation values do not exceed certain thresholds specified in the relevant tax laws. However, the Company’s local tax authority in Hanzhong City has not imposed the regulation on real estate companies in its area of administration. Instead, the local tax authority has levied the LAT at the rate of 0.5% in Yang County and 1.0% in Hanzhong against total cash receipts from sales of real estate properties, rather than according to the progressive rates.

As at December 31, 2021 and September 30, 2021, the outstanding LAT payable balance was Nil with respect to completed real estate properties sold up to December 31,2021 and September 30, 2021, respectively.

(D) Taxes payable consisted of the following:

December 31,

September 30, 

    

2020

    

2020

(Unaudited)

(Unaudited)

CIT

$

14,595,522

$

14,326,646

Business tax

 

5,471,564

 

5,660,149

Other taxes and fees

3,011,981

 

2,967,216

Tax payable

$

23,079,067

$

22,954,011

18

Table of Contents

CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 7. COMMITMENTS AND CONTINGENCIES

From time to time, the Company is a party to various legal actions arising in the ordinary course of business. The Company accrues costs related to these matters when they become probable and as a result the amount of loss can be reasonably estimated. In determining whether a loss from a claim is probable, and if it is possible to estimate the loss, the Company reviews and evaluates its litigation and regulatory matters on at least a quarterly basis in light of potentially relevant factual and legal developments. If the Company determines a favorable outcome is probable, or that the amount of loss cannot be reasonably estimated, the Company does not accrue costs for a potential litigation loss.

As of December 31, 2021, the Company’s VIE, Guangsha, was subject to several civil disputes with a supplier (the “General Contractor”), a general contractor of the Company’s certain real estate projects. The total claim by the supplier is approximately $9.4 million, for which the Company estimated that it is more than likely to pay approximately $3.4 million which was included in the accounts payable and other payables in the accompanying consolidated balance sheets. The General Contractor and the Company are in the process of negotiating a settlement.  The Company believes it can reach a settlement with a favorable outcome.

In addition, certain subcontractor filed lawsuits against the Genernal Contractor with a total claim approximately of $3.4 million. The Company was added as a joint defendant in the lawsuits. The Company was not involved in the transactions between the General Contractor and the related subcontractor. The Company disputes the allegations in the lawsuit and intends to vigorously defend itself in the action. The Company is unable to estimate a range of loss, if any, were there to be an adverse final decision.

For the three months ended December 31, 2021, the Company paid approximately $648,000 of legal settlement costs previously accrued. On a quarterly basis, the Company assesses its liabilities and contingencies in connection with outstanding disputes and legal proceedings utilizing the latest information available. These legal accruals may be increased or decreased to reflect any relevant developments on a quarterly basis. Based on information currently available to the Company, the Company believes that its established accruals are adequate as of December 31, 2021.

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 buyer obtains 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 the six-to-twelve-month period, the mortgage banks require the Company to maintain, as restricted cash of at least 5% 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 the required reserves in its restricted cash account to cover any potential mortgage defaults as required by the mortgage lenders. Since inception through the release of this report, the Company has not experienced any delinquent mortgage loans and has not experienced any losses related to these guarantees. As of December 31, 2021 and September 30, 2021, our outstanding guarantees in respect of our customers’ mortgage loans amounted to approximately $66 million. As of December 31, 2021 and September 30, 2021, the amount of restricted cash reserved for these guarantees was approximately $3.3 million and the Company believes that such reserves are sufficient.

NOTE 8. SUBSEQUENT EVENTS

The Company has evaluated subsequent events through the date these financial statements were filed and determined that other than the following, there are no subsequent events that require disclosure.

On January 14, 2022, the Company closed a private placement with certain investors. In connection with the private placement, the Company issued an aggregate of 10,247,122 units (the “Units”), each Unit consisting of one share of common stock, par value $0.001 per share (“Common Stock”) and a warrant to purchase three shares of Common Stock (the “Warrant”) with an initial exercise price of $2.375 at a price of $2.375 per Unit, for gross proceeds of approximately $24.3 million.  As of December 31, 2021, the Company

19

Table of Contents

CHINA HGS REAL ESTATE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

received $2 million in advance from certain investors and these prepaid subscriptions were included other payables as of December 31, 2021.

20

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

The following discussion and analysis of financial condition and results of operations relates to the operations and financial condition reported in the unaudited condensed consolidated financial statements of China HGS Real Estate, Inc. for the three months ended December 31, 2021 and 2020 and should be read in conjunction with such financial statements and related notes included in this report.

As used in this report, the terms “Company,” “we,” “our,” “us” and “HGS” refer to China HGS Real Estate, Inc. and its subsidiaries.

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 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 the U.S. Securities and Exchange Commission (the “SEC”). 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.

Business Overview

We conduct substantially all of our business through Shaanxi Guangsha Investment and Development 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 in China.

For the three months ended December 31, 2021, our sales and gross profit were $2.9 million and $1.4 million, respectively, representing an approximate 4.5% and 55.3% increase in sales and gross profit as compared to three months ended December 31, 2020, respectively.   The increase in sales and gross profit was mainly the result of more commercial units sold with higher prices during the current quarter.

For the three months ended December 31, 2021, the average selling price (“ASP”) for our real estate projects located in Yang County was approximately $513 per square meter, decreased from the ASP of $611 per square meter for the three months ended December 31, 2020, which was mainly due to the fact that we lowered our selling prices on certain commercial units to promote their sales. The ASP of our Hanzhong real estate projects was approximately $1,382 per square meter, significantly increased from the ASP of $564 per square meter for the three months ended December 31, 2020. The increase in ASP in Hanzhong real estate projects was mainly due to the fact that the all the units sold in the Oriental Garden real estate property were commercial units for the three months ended December 31,2021 with higher ASP of approximately $2,953 per square meters.

21

Market Outlook

The Chinese government is expected to continue implementing measures to cool down the real estate market. These measures may include restrictions on home purchase, increase the down-payment requirement against speculative buying, encourage the development of low-cost rental housing property to help low-income groups while reducing the demand in the commercial housing market, increase the real estate property tax to discourage speculation, and control of the land supply and slowdown the construction land auction process. The pressure on home sales and prices will be especially obvious in third and fourth-tier cities, while the property market in the first and second-tier cities is expected to be resilient.

The Company intends 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.

The Company started the construction of the Liangzhou Road related projects after the approval by the local government of the road. These projects comprise residential for end-users and upgraders, shopping malls as well as serviced apartments and offices to satisfy different market demands.

In December 2019, a novel strain of coronavirus (COVID-19) surfaced. COVID-19 has spread rapidly to many parts of the PRC and other parts of the world in the first quarter of 2020, which has caused significant volatility in the PRC and international markets. There is significant uncertainty around the breadth and duration of business disruptions related to COVID-19, as well as its impact on the PRC and international economies. For the three months ended December 31, 2021, the COVID-19 pandemic did not have a material net impact on the Company’s financial position and operating results. The extent of the impact on the Company’s future financial results will be dependent on future developments such as the length and severity of the crisis, the potential resurgence of the pandemic, future government actions in response to the pandemic and the overall impact of the COVID-19 pandemic on the local economy and real estate markets, among many other factors, all of which remain highly uncertain and unpredictable. Given this uncertainty, the Company is currently unable to quantify the future impact of the COVID-19 pandemic on its future operations, financial condition, liquidity and results of operations if the current situation continues.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect our reported assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis and base them on historical experience and various other assumptions that are believed to be reasonable under the circumstances as the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates because of different and changing assumptions or conditions.

We believe the following critical accounting policies affect our significant estimates and judgments used in the preparation of our condensed consolidated financial statements. These policies should be read in conjunction with Note 2 of the notes to the unaudited condensed consolidated financial statements.

Revenue recognition

The Company follows FASB ASC Topic 606 “Revenue from Contracts with Customers” (“ASC 606”). Under ASC 606, Revenue from Contracts with Customers, revenue is recognized in accordance with the transfer of goods and services to customers at an amount that reflects the consideration that the Company expects to be entitled to for those goods and services. The Company determines revenue recognition through the following steps:

identification of the contract, or contracts, with a customer;
identification of the performance obligations in the contract;
determination of the transaction price, including the constraint on variable consideration;

22

allocation of the transaction price to the performance obligations in the contract; and
recognition of revenue when (or as) the Company satisfies a performance obligation.

Most of the Company’s revenue is derived from real estate sales of condominiums and commercial properties in the PRC. The majority of the Company’s contracts contain a single performance obligation involving significant real estate development activities that are performed together to deliver a real estate property to its 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 (“percentage completion method”). Otherwise, revenue is recognized at a point in time when the customer obtains control of the asset. For the three months ended December 31, 2021 and 2020, the Company did not have any construction in progress meet the revenue recognition under percentage completion method.

Disaggregation of Revenues

Disaggregated revenues was as follows:

    

For the three months ended December 31,

2021

    

2020

(Unaudited)

(Unaudited)

Revenue recognized for completed condominium real estate projects, net of sales taxes

$

2,818,994

$

2,731,724

Revenue recognized for condominium real estate projects under development, net of sales taxes

 

 

Total revenue, net of sales taxes

$

2,818,994

$

2,731,724

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 the passage of time. Contract liabilities include cash collected in advance and in excess of revenue recognized. Customer deposits are excluded from contract liabilities.

The Company immediately expenses sales commissions (included under selling expenses) because sales commission is not expected to be recovered.

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 Ownership 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.

23

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.

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 asset is not recoverable and exceeds its fair value. The carrying amount is not recoverable if it exceeds the sum of the undiscounted cash flows expected to be generated by the asset. The Company reviews 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 three months ended December 31, 2021 and 2020, the Company did not recognize any impairment loss for its real estate properties.

RESULTS OF OPERATIONS

Three Months Ended December 31, 2021 compared to Three Months Ended December 31, 2020

Revenues

The following is a breakdown of revenue:

 

For the three months ended December 31,

 

2021

 

2020

 

(Unaudited)

 

(Unaudited)

Revenue recognized for completed condominium real estate projects, net of sales taxes

    

$

2,818,994

    

$

2,731,724

Revenue recognized for condominium real estate projects under development, net of sales taxes

 

 

Total revenue, net of sales taxes

$

2,818,994

$

2,731,724

24

Revenue recognized for completed condominium real estate projects

The following table summarizes our revenue generated by different projects:

    

For Three Months Ended December 31,

    

    

    

    

 

2021

2020

Variance

 

    

Revenue

    

%

Revenue

    

%

  

Amount

    

%

 

(Unaudited)

(Unaudited)

Mingzhu Garden (Mingzhu Nanyuan & Mingzhu Beiyuan) Phase I and II

$

815,863

 

28.3

%  

$

119,625

 

4.3

%  

$

696,238

 

(582.0)

%

Oriental Pearl Garden

 

770,452

 

26.8

%  

 

 

 

770,452

 

100

%

Yangzhou Palace

 

1,292,900

 

44.9

%  

 

2,635,637

 

95.7

%  

 

(1,342,737)

 

(50.9)

%

Gross Real Estate Sales

2,879,215

 

100

%  

 

2,755,262

 

100

%  

 

123,953

 

4.5

%

Less: Sales Tax

 

(60,221)

 

 

(23,538)

 

 

36,683

 

155.8

%  

Revenue, net of sales tax

$

2,818,994

$

2,731,724

 

$

87,270

 

3.2

%  

Our revenues are derived from the sale of residential buildings, commercial store-fronts and parking spaces in projects that we have developed. Comparing to the same period of last year, revenues before sales tax increased by approximately $0.1 million to approximately $2.9 million for the three months ended December 31, 2021 from approximately $2.8 million in the same period of last year. The total GFA sold during three months ended December 31, 2021 was 3,670 square meters, decreased from the 4,525 square meters completed and sold during the same period of last year. However, since we sold more commercial units in this quarter with higher ASP, our total revenue before sales tax increased 4.5% from the same period of last year. The sales tax for the three months ended December 31, 2021 was approximately $0.06 million, increased from three months ended December 31, 2020 due to more surtax charged for the completed real estate properties during the three months ended December 31, 2021.

Cost of Sales

The following table sets forth a breakdown of our cost of sales:

    

For Three Months Ended December 31,

 

2021

2020

Variance

 

Cost

    

%  

Cost

    

%  

Amount

    

%

(Unaudited)

(Unaudited)

Land use rights

$

138,278

 

9.5

%  

$

166,828

 

9.0

%  

$

(28,550)

 

(17.1)

%

Construction cost

 

1,317,278

 

90.5

%  

 

1,686,814

 

91.0

%  

 

(369,536)

 

(21.9)

%

Total cost

$

1,455,556

 

100.0

%  

$

1,853,642

 

100.0

%  

$

(398,086)

 

(21.5)

%

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 $1.5 million for the three months ended December 31, 2021 compared to $1.9 million for the same period of last year. The decrease in cost of sales was mainly attributable to less GFA sold during the three months ended December 31, 2021.

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 three months ended December 31,2021 and 2020 were approximately$0.1 and $0.2 million, respectively.

25

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. Our construction costs consist primarily of the payments to our third-party contractors, 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 three months ending December 31, 2021 were approximately $1.3 million as compared to approximately $1.7 million for the three months ended December 31, 2020, representing a decrease of approximately $0.4 million. The decrease in construction cost was due to less units sold during the quarter ended December 31, 2021.

Gross Profit

Gross profit was approximately $1.4 million for the three months ended December 31, 2021 as compared to approximately $0.9 million for the three months ended December 31, 2020, representing an increase of $0.5 million, which was mainly attributable to more commercial units sold in the three months ended December 31, 2021 with higher ASP.  For the three months ended December 31, 2021, the ASP of our Hanzhong real estate projects was approximately $1,382 per square meter, significantly increased from the ASP of $564 per square meter for the three months ended December 31, 2020. The increase in ASP in Hanzhong real estate projects was mainly due to the fact that the all the units sold in the Oriental Garden real estate property were commercial units for the three months ended December 31,2021 with higher ASP of approximately $2,953 per square meters.  As a result, our gross margin increased to 47.4% in the first quarter of fiscal 2021 from31.9% in the first quarter of fiscal 2020.

    

For three months ended December 31,

 

2021

2020

 

Gross Profit

    

Gross Margin

    

Gross Profit

    

Gross Margin

 

(Unaudited)

(Unaudited)

Mingzhu Garden (Mingzhu Nanyuan & Mingzhu Beiyuan) Phase I and II

$

246,481

 

30.2

%

$

26,337

 

22.0

%

Oriental Garden

 

613,688

 

79.7

%

 

 

%

Yangzhou Pearl Garden Phase I and II

 

 

 

 

%

Yangzhou Palace

 

563,490

 

43.6

%  

 

875,283

 

33.2

%

Sales Tax

 

(60,221)

 

 

(23,538)

 

Total Gross Profit

$

1,363,438

 

47.4

%  

$

878,082

 

31.9

%

Total Real Estate Sales before Sales Tax

$

2,879,215

$

2,755,262

 

  

Operating Expenses

Total operating expenses increased by 121.1% to approximately $0.9 million for the three months ended December 31, 2021 from $0.4 million for the three months ended December 31, 2020, primarily as a result of an increase of $0.1 million in selling expense related to more promotional activities during the first quarter of fiscal 2021 and an increase of $0.3 million in general administrative expenses. Our general and administrative expense was approximately $0.6 million for the three months ended December 31, 2021, increased by $0.3 million from the three months ended December 31, 2020 due to more professional and consulting fees incurred. Our total operating expenses accounted for 29.6% and 14.0% of our real estate sales before sales taxes for the three months ended December 31, 2021 and 2020, respectively.

    

For three months ended

 

December 31,

2021

2020

 

(Unaudited)

(Unaudited)

Selling expenses

$

219,787

$

79,345

General and administrative expenses

 

631,927

 

305,925

Total operating expenses

$

851,714

$

385,270

Percentage of Real Estate Sales before Sales Tax

 

29.6

%  

 

14.0

%

26

Income Taxes

PRC Taxes

The Company’s PRC subsidiary and VIE are governed by the Income Tax Law of the People’s Republic of China concerning the privately run enterprises, which are generally subject to income tax on income reported in the statutory financial statements after appropriate tax adjustments. The Company’s CIT rate is 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. For the three months ended December 31, 2021 and 2020, the Company’s effective income tax rate was 29.0 and 25.2%. The increase in the effective income tax rate for the three months ended December 31, 2021 was due to nondeductible expenses including professional fees, and penalties and interest expense related to our U.S. delinquent tax filings.

Net Income

We reported net income of approximately $0.4 million for the three months ended December 31, 2021, as compared to net income of approximately $0.3 for the three months ended December 31, 2020. The increase in net income was primarily due to higher revenue, offset by more operating expenses for the three months ended December 31, 2021 as discussed above.

Other Comprehensive Income

We operate primarily in the PRC and the functional currency of our operating subsidiary and VIE is the Chinese Renminbi (“RMB”).  RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that RMB amounts could have been, or could be, converted into USD at the rates used in translation.

Translation adjustments resulting from this process amounted to $2.2 million and $7.0 million for the three months ended December 31, 2021 and 2020, respectively. The balance sheet amounts with the exception of equity at December 31, 2021 were translated at 6.3726 RMB to 1.00 USD as compared to 6.4434 RMB to 1.00 USD at September 30, 2021. The equity accounts were stated at their historical rate. The average translation rates applied to the income statements accounts for the periods ended December 31, 2021 and 2020 were 6.3914 RMB and 6.6235 RMB, respectively.

Liquidity and Capital Resources

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.

27

In recent years, the Chinese government has implemented measures to control overheating residential and commercial property prices including but not limited to restrictions on home purchase, increasing the down-payment requirement against speculative buying, development of low-cost rental housing properties to help low-income groups while reducing the demand in the commercial housing market, increasing real estate property taxes to discourage speculation, control of the land supply and slowdown the construction land auction process, etc. In addition, in December 2019, a novel strain of coronavirus (COVID-19) surfaced. COVID-19 has spread rapidly throughout China and worldwide, which has caused significant volatility in the PRC and international markets. There is significant uncertainty around the breadth and duration of business disruptions related to COVID-19, as well as its impact on the PRC and international economies. To reduce the spread of COVID-19, the Chinese government has employed measures including city lockdowns, quarantines, travel restrictions, suspension of business activities and school closures. Due to difficulties resulting from the COVID-19 pandemic, including, but not limited to, the temporary closure of the Company’s facilities and operations beginning in early February through early March 2020, limited support from the Company’s employees, delayed access to construction raw material supplies, reduced customer visits to the Company’s sales office, and inability to promote real estate property sales to customers on a timely basis, The Company experienced recovery of its real estate business in fiscal 2021 and the following period.  The Company had real estate sales of approximately $2.9 million for the three months ended December 31, 2021, increased from $2.8 million in the same period of last year. Based on the assessment of the current economic environment, customer demand and sales trends, we believe that consumer spending has been restored in the local real estate market and real estate sales are expected to grow in the coming periods. On the other side, due to the negative impact from the COVID-19 pandemic and its variants, the development period of real estate properties and our operating cycle has been extended and we may not be able to liquidate our large balance of completed real estate properties within the short term as we originally expected. In addition, as of December 31, 2021, we had large construction loans payable of approximately $121.0 million and accounts payable of approximately $13.9 million to be paid to subcontractors. The extent of the impact of COVID-19 on the Company’s future financial results will be dependent on future developments such as the length and severity of the crisis, the potential resurgence of the crisis, future government actions in response to the crisis and the overall impact of the COVID-19 pandemic on the local economy and real estate markets, among many other factors, all of which remain highly uncertain and unpredictable. Given this uncertainty, the Company is currently unable to quantify the expected impact of the COVID-19 pandemic on its future operations, financial condition, liquidity and results of operations if the current situation continues. The above mentioned facts raise substantial doubt about the Company’s ability to continue as a going concern for at least one year from the date of this filing.

In assessing its liquidity, management monitors and analyzes the Company’s cash on-hand, its ability to generate sufficient revenue sources in the future, and its operating and capital expenditure commitments. As of December 31, 2021, our total cash and restricted cash balance was approximately $5.7 million, increased from approximately $3.5 million as of September 30, 2021. With respect to capital funding requirements, the Company budgeted its capital spending based on ongoing assessments of needs to maintain adequate cash.  On January 14, 2022, the Company closed a private placement with net proceeds of approximately $ $24.3 million of which $2.0 million was received as of December 31, 2021. As of December 31, 2021, we had approximately $87.7 million of completed residential apartments and commercial units available for sale to potential buyers. Although we reported approximately $13.9 million of accounts payable as of December 31, 2021, due to the long-term relationship with our construction suppliers and subcontractors, we were able to effectively manage cash spending on construction and negotiate with them to adjust the payment schedule based on our cash on hand. In addition, most of our existing real estate development projects relate to the old town renovation which is supported by the local government. As of December 31, 2021, we reported approximately $121.0 million of construction loans borrowed from financial institutions controlled by the local government and such loans can only be used on the old town renovation related project development. We expect that we will be able to renew all of the existing construction loans upon their maturity and borrow additional new loans from local financial institutions, when necessary, based on our past experience and the Company’s good credit history. Also, the Company’s cash flows from pre-sales and current sales should provide financial support for our current development projects and operations. For the three months ended December 31, 2021, we had six large ongoing construction projects (see Note 3, real estate properties under development) which were in the preliminary development stage due to delayed inspection and acceptance of the development plans by the local government. In June 2020, we completed the residence relocation surrounding the Liangzhou Road related projects and launched the construction of these projects in December 2020. For the other four projects, we expect we will be able to obtain the government’s approval of the development plans on these projects in the coming fiscal year and start the pre-sale of the real estate properties to generate cash when certain property development milestones have been achieved.

28

Cash Flow

Comparison of cash flows results is summarized as follows:

Three months ended

December 31,

    

2021

    

2020

(Unaudited)

(Unaudited)

Net cash provided by operating activities

$

602,095

$

643,115

Net cash provided by financing activities

 

2,000,000

 

Effect of change of foreign exchange rate on cash and restricted cash

 

(358,596)

 

166,542

Net increase in cash and restricted cash

 

2,243,499

 

806,657

Cash and restricted cash, beginning of period

 

3,465,189

 

3,867,536

Cash and restricted cash, end of period

$

5,708,688

$

4,677,193

Operating Activities

Net cash provided by operating activities during the three months ended December 31, 2021 was approximately $0.6 million, consisting of net income of approximately $0.4 million and net changes in our operating assets and liabilities, which mainly included a decrease of other assets of approximately $2.9 million due to the reduction of receivables from housing buyers, a decrease in real estate property completed of approximately $1.5 million due to sales of our Yangzhou Palace and other projects and an increase in customer deposits received of $1.8 million, offset by payments of other payables of approximately of $4.5 million and additional spending in real estate under development of $1.9 million.

Net cash provided by operating activities during the three months ended December 31, 2020 was approximately $0.6 million, consisting of net income of approximately $0.3 million and net changes in our operating assets and liabilities, which mainly included a decrease in real estate property completed by approximately $1.9 million due to sales of our Yangzhou Palace project and an increase in customer deposit received of $1.7 million, offset by additional spending in real estate under development of $1.3 million and payments of taxes payable of approximately $0.9 million.

Financing Activities

Net cash flows provided by financing activities was approximately $2.0 million for three months ended December 31, 2021, which was advance proceeds from investors for the private placement sale of Units, which was completed on January 14, 2022.

There was no net cash provided by or (used in) financing activities during the three months ended December 31, 2020.

29

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 buyer obtains 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 the six-to-twelve-month period, the mortgage banks require the Company to maintain, as restricted cash of at least 5% 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 the required reserves in its restricted cash account to cover any potential mortgage defaults as required by the mortgage lenders. Since inception through the release of this report, the Company has not experienced any delinquent mortgage loans and has not experienced any losses related to these guarantees. As of December 31, 2021 and September 30, 2021, our outstanding guarantees in respect of our customers’ mortgage loans amounted to approximately $66 million. As of December 31, 2021 and September 30, 2021, the amount of restricted cash reserved for these guarantees was approximately $3.3 million and the Company believes that such reserves are sufficient.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Inflation

Inflationary factors, such as increases in the cost of our products and overhead costs, could impair our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of sales revenue if the selling prices of our products do not increase with these increased costs.

We Conduct Substantially All Our Business in Foreign Country

Substantially all of our operations are conducted in China and are subject to various political, economic, and other risks and uncertainties inherent in conducting business in China. Among other risks, our Company and our subsidiaries’ operations are subject to the risks of restrictions on transfer of funds; export duties, quotas, and embargoes; domestic and international customs and tariffs; changing taxation policies; foreign exchange restrictions; and political conditions and governmental regulations.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”). The evaluation of our disclosure controls and procedures included a review of our processes and the effect on the information generated for use in this Quarterly Report on Form 10-Q. In the course of this evaluation, we sought to identify any material weaknesses in our disclosure controls and procedures and to confirm that any necessary corrective action, including process improvements, was taken. The purpose of this evaluation is to determine if, as of the Evaluation Date, our disclosure controls and procedures were operating effectively such that the information, required to be disclosed in our SEC reports (i) was recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) was accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

30

Management conducted its evaluation of disclosure controls and procedures under the supervision of our chief executive officer and our chief financial officer. Based upon this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were not effective as of December 31, 2021. Management is committed to improving the internal controls over financial reporting and will undertake the consistent improvements or enhancements on an ongoing basis. To remediate the material weakness and significant deficiencies and to prevent similar deficiencies in the future, we are currently evaluating additional controls and procedures, which may include:

Provide more U.S. GAAP knowledge and SEC reporting requirements training for the accounting department and establish formal policies and procedures.

The remedial measures being undertaken may not be fully effectuated or may be insufficient to address the significant deficiencies we identified, and there can be no assurance that significant deficiencies or material weaknesses in our internal control over financial reporting will not be identified or occur in the future. If additional significant deficiencies (or if material weaknesses) in our internal controls are discovered or occur in the future, among other similar or related effects: (i) the Company may fail to meet future reporting obligations on a timely basis, (ii) the Company’s consolidated financial statements may contain material misstatements, and (iii) the Company’s business and operating results may be harmed.

Changes in Internal Control over Financial Reporting

Except for the matters described above to improve our internal controls over financial reporting, there were no changes in our internal control over financial reporting for the three months ended December 31, 2021 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, however, the Company is in the process of designing and planning to change as described above.

31

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We may be subject to, from time to time, various legal proceedings relating to claims arising out of our operations in the ordinary course of our business. We are not currently a party to any legal proceedings, the adverse outcome of which, individually or in the aggregate, would have a material adverse effect on the business, financial condition, or results of operations of the Company.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

None.

32

ITEM 6. EXHIBITS

(a)Exhibits

Exhibit Number

    

Description of Exhibit

 

 

 

31.1*

 

Rule 13a-14(a) Certification of Chief Executive Officer

 

 

 

31.2*

 

Rule 13a-14(a) Certification of Chief Financial Officer

 

 

 

32.1*

 

Section 1350 Certification of Chief Executive Officer and Chief Financial Officer

 

 

 

101.INS*

 

XBRL Instance

 

101.SCH*

 

XBRL Taxonomy Extension Schema

 

101.CAL*

 

XBRL Taxonomy Extension Calculation

 

101.DEF*

 

XBRL Taxonomy Extension Definition

 

101.LAB*

 

XBRL Taxonomy Extension Labels

 

101.PRE*

 

XBRL Taxonomy Extension Presentation

*

Furnished electronically herewith

33

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

China HGS Real Estate, Inc.

February 22, 2022

By:

/s/ Neng Chen

Neng Chen

Chief Executive Officer

34

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