KINGOLD JEWELRY, INC. - Quarter Report: 2016 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended:

September 30, 2016

For the transition period from: _____________ to _____________

KINGOLD JEWELRY, INC.

(Exact name of registrant as specified in its charter)

15 Huangpu Science and Technology Park

Jiang’an District

Wuhan, Hubei Province, PRC 430023

(Address of principal executive offices) (Zip Code)

(011) 86 27 65694977

(Registrant’s telephone number, including area code)

 x  Yes  o  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

x  Yes  o  No

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of November 10, 2016, there were 66,018,867 shares of common stock outstanding, par value $0.001. 

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Statements in this report that are not historical facts or information are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “estimate,” “project,” “forecast,” “plan,” “believe,” “may,” “expect,” “anticipate,” “intend,” “planned,” “potential,” “can,” “expectation” and similar expressions, or the negative of those expressions, may identify forward-looking statements. Such forward-looking statements are based on management’s reasonable current assumptions and expectations. Such forward-looking statements involve risks, uncertainties and other factors, which may cause our actual results, levels of activity, performance or achievement to be materially different from any future results expressed or implied by such forward-looking statements, and there can be no assurance that actual results will not differ materially from management’s expectations. Such factors include, among others, the following:

We undertake no obligation to update any such forward looking statement, except as required by law.

PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements

KINGOLD JEWELRY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN US DOLLARS)

(UNAUDITED)

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

KINGOLD JEWELRY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(IN US DOLLARS)

(UNAUDITED)

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

KINGOLD JEWELRY, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(IN US DOLLARS)

(UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated Financial Statements

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1 — BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of Kingold Jewelry, Inc. (“Kingold” or the “Company”) have been prepared in accordance with generally accepted accounting principles (“U.S. GAAP”) for interim financial information pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to make the financial statements not misleading have been included. Operating results for the interim period ended September 30, 2016 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2016. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis, and the financial statements and notes thereto included in the Company’s Form 10-K for the fiscal year ended December 31, 2015, filed with the SEC on March 29, 2016.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

Wuhan Kingold Jewelry Co., Inc. (“Wuhan Kingold”) should be considered as a 100% contractually controlled affiliate. Kingold is empowered, through its wholly owned subsidiaries Dragon Lead Group Limited (“Dragon Lead”) and Wuhan Vogue-Show Jewelry Co., Inc. (“Wuhan Vogue-Show”), with the ability to control and substantially influence Wuhan Kingold’s daily operations and financial affairs, appoint its senior executives and approve all matters requiring shareholders’ approval. Kingold is also obligated to absorb a majority of expected losses of Wuhan Kingold, which enables Kingold to receive a majority of expected residual returns from Wuhan Kingold, and because Kingold has the power to direct the activities of Wuhan Kingold that most significantly impact Wuhan Kingold’s economic performance, Kingold, through its wholly-owned subsidiaries, accounts for Wuhan Kingold as its Variable Interest Entity under Accounting Standards Codification (“ASC”) 810-10-05-8A. Accordingly, Kingold consolidates Wuhan Kingold’s operating results, assets and liabilities. The Company makes an ongoing assessment to determine whether Wuhan Kingold is still a Variable Interest Entity.

The accompanying unaudited condensed consolidated financial statements include the financial statements of Kingold, Dragon Lead, Wuhan Vogue-Show, Wuhan Kingold and its 55% controlled subsidiaries Wuhan Kingold Internet Co., Ltd. (“Kingold Internet”) and Yuhuang Jewelry Design Co., Ltd (“Yuhuang”). All significant inter-company balances and transactions have been eliminated in consolidation.

Kingold, Dragon Lead, Wuhan Vogue-Show, Wuhan Kingold, Kingold Internet and Yuhuang are hereinafter collectively referred to as the “Company.”

Use of Estimates

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements as well as the reported amounts of revenues and expenses during the reporting period. Significant estimates required to be made by management include, but are not limited to, useful lives of property, plant and equipment, the recoverability of long-lived assets, allowance for doubtful accounts, deferred tax assets and liabilities and share based compensation. Actual results could differ from those estimates.

Restricted Cash

As of September 30, 2016 and December 31, 2015, the Company had restricted cash of $111,471,928 and $26,649,687, respectively. Approximately $5.3 million was related to the bank loan with various financial institutions. Approximately $106.2 million was related to the gold lease deposits with Shanghai Pudong Development Bank (“SPD Bank”), China Construction Bank (“CCB”) Commerce Bank of China (“ICBC”) and CITIC Bank – see Note 16 – Gold Lease Transactions.  

Accounts Receivable

The Company generally receives cash payment upon delivery of a product, but may extend unsecured credit to its customers in the ordinary course of business. The Company mitigates the associated risks by performing credit checks and actively pursuing past due accounts. An allowance for doubtful accounts is established and recorded based on management’s assessment of the credit history of the customers and current relationships with them. At September 30, 2016 and December 31, 2015, there was no allowance recorded as the Company considers all of the accounts receivable fully collectible. 

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Inventories

Inventories are stated at the lower of cost or market value, and cost is calculated on the weighted average basis. As of September 30, 2016 and December 31, 2015, there was no lower of cost or market adjustment because the carrying value of the Company’s inventories was lower than the current and expected market price of gold. The cost of inventories comprises all costs of purchases, costs of fixed and variable production overhead and other costs incurred in bringing the inventories to their present condition.

Property and Equipment

Property and equipment are stated at cost, less accumulated depreciation. Expenditures for additions, major renewals and betterments are capitalized, and expenditures for maintenance and repairs are charged to expense as incurred.

Depreciation is provided on a straight-line basis, less estimated residual value, over an asset’s estimated useful life. The estimated useful lives used in connection with the preparation of the financial statements are as follows:

Land Use Right

Under PRC law, all land in the PRC is owned by the government and cannot be sold to an individual or company. The government grants individuals and companies the right to use parcels of land for specified periods of time. These land use rights are sometimes referred to informally as “ownership.” Land use rights are stated at cost less accumulated amortization. Amortization is provided over the respective useful lives, using the straight-line method. Estimated useful life is 50 years, and is determined in connection with the term of the land use right. 

Long-Lived Assets

Certain assets such as property, plant and equipment and construction in progress, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Recoverability of assets that are held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount exceeds the fair value of the asset. There were no events or changes in circumstances that necessitated a review of impairment of long-lived assets as of September 30, 2016 and December 31, 2015.

Property Held for Sale

Property held for sale relates to the Company’s commitment to sell the real estate property of Kingold Jewelry Cultural Industry Park (the “Jewelry Park”), to third party. On June 27, 2016, the Company entered into a transfer contract with third party, Wuhan Lianfuda Investment Management Co., Ltd. (“Wuhan Lianfuda”), to sell all of its interest in the Jewelry Park to Wuhan Lianfuda (the “Transfer Transaction;” see Note 5). The Transfer Transaction has not been consummated as of September 30, 2016 therefore Jewelry Park real estate property was treated as property held for sale because all of the following criteria were met:

Upon designation the Jewelry Park as property held for sale, the Company records the carrying value of the Jewelry Park at the lower of its carrying value or its estimated fair value, less estimated costs to sell.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Fair Value of Financial Instruments

The Company follows the provisions of Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures.” ASC 820 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-Observable inputs such as unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.

Level 2-Inputs other than quoted prices that are observable for the asset or liability 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 management’s assumptions based on the best available information.

The carrying value of all current assets and liabilities approximate their fair values because of the short-term nature of these instruments. The Company determined that the carrying value of the long term loans approximated their fair value by comparing the stated loan interest rate to the rate charged by similar financial institutions

Revenue Recognition

Net sales (gross sales less valued added tax) are primarily composed of sales of branded products to wholesale and retail customers, as well as fees generated from customized production. In customized production, a customer supplies the Company with the raw materials and the Company creates products per that customer’s instructions, whereas in branded production the Company generally purchases gold directly and manufactures and markets the products on its own. The Company recognizes revenues under ASC 605 as follows:

Sαles of brαnded products

The Company recognizes revenue on sales of branded products when the goods are delivered and title to the goods passes to the customer provided that: (i) there are no uncertainties regarding customer acceptance; (ii) persuasive evidence of an arrangement exists; (iii) the sales price is fixed and determinable; and (iv) collectability is deemed probable.

Customized production fees

The Company recognizes services-based revenue (the processing fee) from such contracts for customized production when: (i) the contracted services have been performed and (ii) collectability is deemed probable.

Internet sales

The Company also engages in promoting the online sales of jewelry products through cooperation with Tmall.com, a large business-to-consumer online retail platform owned by Alibaba Group. Consistent with the criteria of ASC 605, Revenue Recognition, the Company recognizes revenues of internet sales when the following four revenue recognition criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the selling price is fixed or determinable, and (iv) collectability is reasonably assured.

In accordance with ASC 605, Revenue Recognition, the Company evaluates whether it is appropriate to record the gross amount of product sales and related costs or the net amount earned as commissions. When the Company is primarily obligated in a transaction, is subject to inventory risk, has latitude in establishing prices and selecting suppliers, or has several but not all of these indicators, revenues should be recorded on a gross basis. When the Company is not the primary obligor, doesn’t bear the inventory risk and doesn’t have the ability to establish the price, revenues are recorded on a net basis.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in net income in the period including the enactment date. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

The provisions of ASC 740-10-25, “Accounting for Uncertainty in Income Taxes,” prescribe a more-likely-than-not threshold for recognition and measurement of a tax position taken (or expected to be taken) in a tax return. This interpretation 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, and related disclosures. The Company does not believe that there was any uncertain tax position at September 30, 2016 and December 31, 2015.

To the extent applicable, the Company records interest and penalties as a general and administrative expense. The statute of limitations for the Company’s U.S. federal income tax returns and certain state income tax returns remains open for tax years 2010 and after. As of September 30, 2016, the tax years ended December 31, 2010 through December 31, 2015 for the Company’s PRC subsidiaries remain open for statutory examination by PRC tax authorities.

Foreign Currency Translation

Kingold, as well as its wholly owned subsidiary, Dragon Lead, maintain accounting records in United States Dollars (“US$”), whereas Wuhan Vogue-Show and Wuhan Kingold maintain their accounting records in Renminbi (“RMB”), which is the primary currency of the economic environment in which their operations are conducted. The Company’s principal country of operations is the PRC. The financial position and results of its operations are determined using RMB, the local currency, as the functional currency. The results of operations and the statement of cash flows denominated in foreign currency are translated at the average rate of exchange during the reporting period. Assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the applicable rates of exchange in effect at that date. The equity denominated in the functional currency is translated at the historical rate of exchange at the time of capital contribution and stock issuance. Because cash flows are translated based on the average translation rate, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet. Translation adjustments arising from the use of different exchange rates from period to period are included as a component of stockholders’ equity as “Accumulated Other Comprehensive Income (deficit)”.  

The value of RMB against US$ and other currencies may fluctuate and is affected by, among other things, changes in the PRC’s political and economic conditions. Any significant revaluation of RMB may materially affect the Company’s financial condition in terms of US$ reporting. The following table outlines the currency exchange rates that were used in creating the consolidated financial statements in this report:

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Comprehensive Income

Comprehensive income consists of two components, net income and other comprehensive income (loss). The foreign currency translation gain or loss resulting from translation of the financial statements expressed in RMB to US$ is reported in other comprehensive income in the consolidated statements of income and comprehensive income.

Earnings per Share

Basic EPS is measured as net income 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 (i.e., 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.

Share or Stock-Based compensation

The Company follows the provisions of ASC 718, “Compensation — Stock Compensation,” which establishes the accounting for employee stock-based awards. For employee stock-based awards, share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense with graded vesting on a straight-line basis over the requisite service period for the entire award. For the non-employee stock-based awards, the fair value of the awards to non-employees are measured every reporting period based on the value of the Company’s common stock.

Debts Payable 

Debt issuance costs related to a recognized debt liability are presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts.

Deposit payables - Jewelry Park

Deposit payables consist of the following two components: (1) amounts received from customers relating to the pre-sale of the residential or commercial units in the Jewelry Park. The Company receives these funds and recognizes them as a liability until the revenue can be recognized; (2) amounts received from third party in connection with the Jewelry Park Transfer Transaction, to be offset against the Jewelry Park construction in process (“CIP”) in the near future when the Transfer transaction is consummated.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Risks and Uncertainties

The jewelry industry generally is affected by fluctuations in the price and supply of diamonds, gold, and, to a lesser extent, other precious and semi-precious metals and stones. The Company potentially has exposure to the fluctuation in gold commodity prices as part of its normal operations. In the past, the Company has not hedged its requirement for gold or other raw materials through the use of options, forward contracts or outright commodity purchasing. A significant increase in the price of gold could increase the Company’s production costs beyond the amount that it is able to pass on to its customers, which would adversely affect the Company’s sales and profitability. A significant disruption in the Company’s supply of gold, or other commodities, could decrease its production and shipping levels, materially increase its operating costs, and materially and adversely affect its profit margins. Shortages of gold, or other commodities, or interruptions in transportation systems, labor strikes, work stoppages, war, acts of terrorism, or other interruptions to or difficulties in the employment of labor or transportation in the markets in which the Company purchases its raw materials, may adversely affect its ability to maintain production of its products and sustain profitability. Although the Company generally attempts to pass on increased commodity prices to its customers, there may be circumstances in which it is not able to do so. In addition, if the Company were to experience a significant or prolonged shortage of gold, it would be unable to meet its production schedules and to ship products to its customers in a timely manner, which would adversely affect its sales, margins and customer relations.

Furthermore, the value of the Company’s inventory may be affected by commodity prices. The Company records the value of its inventory using the lower of cost or market value, cost calculated on the weighted average method. As a result, decreases in the market value of precious metals such as gold would result in a lower stated value of the Company’s inventory, which may require it to take a charge for the decrease in the value of its inventory.

The Company’s operations are located in the PRC. Accordingly, the Company’s business, financial condition, and results of operations may be influenced by the political, economic, and legal environments in the PRC, as well as by the general state of the PRC economy. The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment, and foreign currency exchange. The Company’s results may be adversely affected by changes in the political, regulatory and social conditions in the PRC, and by changes in governmental policies or interpretations with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things. In addition, the Company only controls Wuhan Kingold through a series of agreements. Although the Company believes the contractual relationships through which it controls Wuhan Kingold comply with current licensing, registration and regulatory requirements of the PRC, it cannot assure you that the PRC government would agree, or that new and burdensome regulations will not be adopted in the future. If the PRC government determines that the Company’s structure or operating arrangements do not comply with applicable law, it could revoke the Company’s business and operating licenses, require it to discontinue or restrict its operations, restrict its right to collect revenues, require it to restructure its operations, impose additional conditions or requirements with which the Company may not be able to comply, impose restrictions on its business operations or on its customers, or take other regulatory or enforcement actions against the Company that could be harmful to its business. If such agreements were cancelled, modified or otherwise not complied with, the Company would not be able to retain control of Wuhan Kingold and the impact could be material to the Company’s operations. Although the Company has not experienced losses from these situations and believes that it is in compliance with existing laws and regulations, including the organization and structure disclosed in Note 1, this may not be indicative of future results.

Reclassification

“Comprehensive income” in 2015 statements of income and comprehensive income has been changed to conform to the current period presentation. This reclassification has no effect on the accompanying unaudited condensed financial statements.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Recent Accounting Pronouncements

In January 2016, the FASB has issued Accounting Standards Update (ASU) No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance is intended to improve the recognition and measurement of financial instruments. The new guidance makes targeted improvements to existing U.S. GAAP by: (1) requiring equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. Requiring public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (2) Requiring separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; (3) Eliminating the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; and. (4) Requiring a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk (also referred to as “own credit”) when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. The new guidance is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is evaluating the effect, if any, that this update will have on the Company's unaudited condensed consolidated financial position, results of operations and cash flows.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which supersedes the existing guidance for lease accounting, Leases (Topic 840). ASU 2016-02 requires lessees to recognize leases on their balance sheets, and leaves lessor accounting largely unchanged. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early application is permitted for all entities. ASU 2016-02 requires a modified retrospective approach for all leases existing at, or entered into after, the date of initial application, with an option to elect to use certain transition relief. The Company is currently evaluating the impact of this new standard on its unaudited condensed consolidated financial statements.

In March 2016, the FASB issued Accounting Standards Update No. 2016-06, Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments. The amendments apply to all entities that are issuers of or investors in debt instruments (or hybrid financial instruments that are determined to have a debt host) with embedded call (put) options. The amendments clarify what steps are required when assessing whether the economic characteristics and risks of call (put) options are clearly and closely related to the economic characteristics and risks of their debt hosts, which is one of the criteria for bifurcating an embedded derivative. Consequently, when a call (put) option is contingently exercisable, an entity does not have to assess whether the event that triggers the ability to exercise a call (put) option is related to interest rates or credit risks. Public business entities must apply the new requirements for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. All other entities must apply the new requirements for fiscal years beginning after December 15, 2017 and interim periods within fiscal years beginning after December 15, 2018. All entities have the option of adopting the new requirements early, including adoption in an interim period. If an entity early adopts the new requirements in an interim period, it must reflect any adjustments as of the beginning of the fiscal year that includes that interim period. The Company does not expect any material impact of this new standard on its unaudited condensed consolidated financial statements.

In April 2016, the FASB released ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The ASU includes multiple provisions intended to simplify various aspects of the accounting for share-based payments. While aimed at reducing the cost and complexity of the accounting for share-based payments, the amendments are expected to significantly impact net income, EPS, and the statement of cash flows. Implementation and administration may present challenges for companies with significant share-based payment activities. The ASU is effective for public companies in annual periods beginning after December 15, 2016, and interim periods within those years. The Company is currently evaluating the impact of this new standard on its unaudited condensed consolidated financial statements.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Recent Accounting Pronouncements – continued

In May 2016, the FASB issued ASU No. 2016-11 Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815); Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting, which is rescinding certain SEC Staff Observer comments that are codified in Topic 605, Revenue Recognition, and Topic 932, Extractive Activities—Oil and Gas, effective upon adoption of Topic 606. The Company is assessing the impact of the adoption of the ASU on its unaudited condensed consolidated financial statements, disclosure requirements and methods of adoption.

In May 2016, FASB issued ASU No. 2016-12—Revenue from Contracts with Customers (Topic 606); Narrow-Scope Improvements and Practical Expedients, which is intended to not change the core principle of the guidance in Topic 606, but rather affect only the narrow aspects of Topic 606 by reducing the potential for diversity in practice at initial application and by reducing the cost and complexity of applying Topic 606 both at transition and on an ongoing basis.  The Company is assessing the impact of the adoption of the ASU on its unaudited condensed consolidated financial statements, disclosure requirements and methods of adoption.

In August 2016, the FASB issued ASU No. 2016 15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, to provide guidance on the presentation and classification of certain cash receipts and cash payments on the statement of cash flows. The guidance specifically addresses cash flow issues with the objective of reducing the diversity in practice. The guidance will be effective for the Company in fiscal year 2018, but early adoption is permitted. The Company is currently evaluating the impact of this new standard on its unaudited condensed consolidated financial statements and related disclosures.

In October 2016, the FASB issued ASU No. 2016-17, Consolidation (Topic 810): Interest Held through Related Parties That Are under Common Control, to provide guidance on the evaluation of whether a reporting entity is the primary beneficiary of a VIE by amending how a reporting entity, that is a single decision maker of a VIE, treats indirect interests in that entity held through related parties that are under common control. The amendments are effective for public business entities for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the impact of this new standard on its unaudited condensed consolidated financial statements and related disclosures.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 3 - INVENTORIES, NET

Inventories as of September 30, 2016 and December 31, 2015 consisted of the following:

As of September 30, 2016, 28,106,750 grams of Au9999 gold with carrying value of approximately $983.6 million were pledged for certain bank loans (see Note 6). No inventory was pledged on the debts payable because it has been fully repaid upon maturity and accordingly previously pledged inventory has been released (see Note 7).

As of December 31, 2015, 3,977,490 grams of Au9999 gold with carrying value of approximately $115.1 million were pledged for certain bank loans and another 2,456,000 grams of Au9999 gold with carrying value of approximately $71 million were pledged for the Company’s debts payable.

For the three and nine months ended September 30, 2016, the Company recorded $Nil lower cost or market adjustment. For the three and nine months ended September 30, 2015, the Company recorded $Nil lower of cost or market adjustment. 

NOTE 4 - PROPERTY AND EQUIPMENT, NET

The following is a summary of property and equipment as of September 30, 2016 and December 31, 2015:

Depreciation expense for the three and nine months ended September 30, 2016 was $311,812 and $941,164, respectively. Depreciation expense for the three and nine months ended September 30, 2015 was $329,624 and $1,000,162, respectively.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 5 – PROPERTY HELD FOR SALE, JEWELRY PARK

On October 23, 2013, the Company, through its wholly-owned subsidiary, Wuhan Kingold, entered into an acquisition agreement (the “Acquisition Agreement”) with third-parties Wuhan Wansheng House Purchasing Limited (“Wuhan Wansheng”) and Wuhan Huayuan Science and Technology Development Limited Company (“Wuhan Huayuan”). The Acquisition Agreement provides for the build out of the planned “Shanghai Creative Industry Park,” which is proposed to be renamed to “Kingold Jewelry Cultural Industry Park” (the “Jewelry Park”). Pursuant to the Acquisition Agreement, Wuhan Kingold acquired the land use rights for a parcel of land (the “Land”) in Wuhan for a total of 66,667 square meters (approximately 717,598 square feet, or 16.5 acres) (the “Land Use Right”), which had been approved for real estate development use. Wuhan Kingold committed to provide a total sum of RMB 1.0 billion (approximately $149.9 million) for the acquisition of this Land Use Right and to finance the entire development and construction of a total of 192,149 square meters (approximately 2,068,000 square feet) of commercial properties, which were proposed to include a commercial wholesale center for various jewelry manufacturers, two commercial office buildings, a commercial residence of condominiums as well as a hotel.

On June 27, 2016, Wuhan Kingold entered into a transfer contract with Wuhan Lianfuda Investment Management Co., Ltd. (“Wuhan Lianfuda”), an unrelated party, to sell all of its interest in the Jewelry Park to Wuhan Lianfuda (“Transfer Transaction”). Pursuant to the transfer contract, Wuhan Lianfuda is obligated to pay Wuhan Kingold RMB 1.14 billion (approximately US $170.9 million) (“Selling Price”). This amount includes (1) RMB 640 million (approximately US $96 million) for the share acquisition fees and the construction fees that Wuhan Kingold has paid to Wuhan Wansheng; and (2) transfer fees of RMB 500 million (approximately US $75 million). In addition, Wuhan Kingold transfers and Wuhan Lianfuda receives all the rights and obligations in the Transfer Transaction Agreement, including 60% stock rights of Wuhan Huayuan. Wuhan Lianfuda will undertake Wuhan Kingold’s remaining payment obligation of RMB 360 million (approximately US $54 million) stipulated in the Acquisition Agreement.

As of September 30, 2016, the carrying value of Jewelry Park was approximately $161.9 million (RMB 1.08 billion), included the following components (1) Land use right of approximately $9 million (RMB 60.4 million), which represents the total cost of the Land Use Right and (2) the construction progress of approximately $152.9 million (RMB 1.02 billion), consisting of the Company’s cash payment of approximately $86.9 million (RMB 579.6 million) towards the construction of Jewelry Park project, capitalized interest of approximately $12 million (RMB 80 million) and construction payable of approximately $54.0 million (RMB 360.0 million) which has been accrued based on the billing request by the construction company Wuhan Wansheng as of September 30, 2016. As of September 30, 2016 and December 31, 2015, the construction payable of approximately $54.0 million and $23.9 million has been accrued based on the billing request of the construction company, respectively. The Company determines the selling price to Wuhan Lianfuda represents the fair value of the property and no material estimated costs to sell, therefore the Company did not recognize any impairment loss for the three and nine months ended September 30, 2016.

As of September 30, 2016, the project has passed all inspections and completed acceptance procedures. The Company is waiting for the certificate of occupancy to be issued by local government, and is in the process of transferring the ownership title to Wuhan Lianfuda.

Based on the total budget of $149.9 million (RMB 1.0 billion) on the Jewelry Park, Wuhan Kingold was still obligated to pay the remaining $54.0 million (RMB 360 million) to Wuhan Wansheng as of September 30, 2016 after deducting all the progress payments made by Wuhan Kingold. In connection with the Jewelry Park Transfer Transaction, Wuhan Lianfuda will undertake Wuhan Kingold’s remaining payment obligation of $54.0 million (RMB 360 million), when the Transfer Transaction is consummated in the near future.

The following table presents the components of the property held for sale- Jewelry Park at September 30, 2016 and December 31, 2015:

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 6 - LOANS

Short term loans consist of the following:

Short term loans

a) Loans payable to CITIC Bank Wuhan Branch have been fully repaid on March 1, 2016.

b) Loan payable to Bank of Hubei, Wuhan Jiang’an Branch has been fully repaid by September 30, 2016.

c) Loan payable to Minsheng Trust has been fully repaid by September 30, 2016.

d) The current portion of loans payable to Yantai Huangshan Road Branch of Evergrowing Bank (see note (i) below).

e) On April 26, 2016, the Company entered into a trust loan agreement and an amendment to the trust loan agreement with the National Trust Ltd. (“National Trust”) to borrow a maximum of approximately $75 million (RMB 500 million) as working capital loan. The loan is comprised of two installments, with the first installment of approximately $15 million (RMB 100 million) and the second installment of approximately $60 million (RMB 400 million). Each installment has a one-year term starting from the installment release date. For each installment, the Company is required to make the first interest payment equal to 4.1% of the principal received, then the rest of interest payments are calculated based on a fixed interest rate of 8% and due on semi-annual basis. The Company is required to pledge 2,600 kilogram of Au9995 gold with carrying value of approximately $100 million (RMB 666.7 million) as collateral to secure this loan. The loan is jointly guaranteed by Mr. Zhihong Jia, the CEO and Chairman of the Company, and Wuhan Vogue-Show. The Company received full proceeds in May 2016. The Company also made a restricted deposit of approximately $0.7 million (RMB 5 million) to secure these loans. The deposit will be refunded when the loan is repaid upon maturity.

On July 11, 2016, the Company entered into a Trust Loan Agreement with the National Trust Ltd. (“National Trust”) to borrow a maximum of approximately $75 million (RMB 500 million) as a working capital loan. The Company is required to make first interest payment equal to 4.1% of the loan principal amount within 3 days after the loan proceeds are received. Subsequently, the Company is subject to 8% interest which will be paid on a semiannual basis. The term of the loan is one year from the payment release date and could be extended for one additional year. The Company is required to pledge 2,660 kilogram of Au9995 gold with carrying value of approximately $107.1 million (RMB 714.4 million) as collateral. The loan is guaranteed by Mr. Zhihong Jia, the CEO and Chairman of the Company, and Wuhan Vogue-Show. The Company also made a restricted deposit of approximately $0.7 million (RMB 5 million) to secure these loans. The deposit will be refunded when the loan is repaid upon maturity.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 6 – LOANS - continued

f) On April 28, 2016, Wuhan Kingold and Shanghai AJ Trust Co., Ltd. (“AJ Trust”) entered into a gold income right transfer and repurchase agreement. According to the agreement, AJ Trust acquired the income rights from Wuhan Kingold for Wuhan Kingold’s Au9999 gold worth at least RMB 412.5 million based on the closing price of gold on the most recent trading day at the Shanghai Gold Exchange (the “Gold Income Right”). AJ Trust’s acquisition price for the Gold Income Right was approximately $45 million (RMB 300 million) (the “Acquisition Price”). Wuhan Kingold is required to repurchase the Gold Income Right back from AJ Trust with installments and the last installment shall be within the 24 months after establishment of the trust plan. The repurchase price is equal to the Acquisition Price with annual return of 10% for the period from the agreement date and the last repayment date. The repurchase obligation may be accelerated under certain conditions, including upon breach of representations or warranties, certain cross-defaults, upon the occurrence of certain material events affecting the financial viability of Wuhan Kingold, and other customary conditions. Wuhan Kingold pledged the 1,542 kilograms of related Au9999 gold under the Gold Income Right to AJ Trust. The agreement is also personally guaranteed by Mr. Zhihong Jia, the CEO and Chairman. As of September 30, 2016, the carrying value of the pledged gold was approximately $61.8 million (RMB 412.5 million). The Company also made a restricted deposit of $0.4 million (RMB 3 million) to secure this loan. The deposit will be refunded when the loan is repaid upon maturity. Management believes the substance of this agreement is a debt arrangement with AJ Trust, therefore AJ Trust’s acquisition price was recorded as loan payable. Since Wuhan Kingold has a right to repurchase the Gold Income Right in 12 months, the loan is treated as a short term loan.

Interest expense for all of the short term loans mentioned above amounted approximately to $5.0 million and $11.7 million for the three and nine months ended September 30, 2016, respectively. Interest expense for all of the short term loans mentioned above amounted approximately to $299,713 and $681,866 for the three and nine months ended September 30, 2015, respectively.

Long term loans consist of the following:

(h) Loans payable to Evergrowing Bank – Qixia Branch

On December 18, 2015, Wuhan Kingold signed a loan agreement with the Qixia Branch of Evergrowing Bank in the amount of approximately $30 million (RMB 200 million). This loan was used to partially fund the construction of the Jewelry Park and as working capital. The loan period was from December 18, 2015 to December 15, 2017 with the annual interest of 7.5%. The loan is secured by 1,300,000 grams of Au9999 gold with carrying value of approximately $45.5 million (RMB 303.4 million). In addition, the Company’s CEO and Chairman, Mr. Zhihong Jia signed a guarantee agreement with the bank, to provide a guarantee for the loan.

In January 2016, Wuhan Kingold further signed two Loan Agreements of Circulating Funds with the Qixia Branch of Evergrowing Bank for loans of approximately $119.9 million (RMB 800 million) in aggregate. The purpose of the loans is for purchasing gold. The terms of loans are two years and bear fixed interest of 7.5% per year. The loans are secured by 5,000,000 grams of Au9999 gold in aggregate with carrying value of approximately $175 million (RMB 1.2 billion) and are guaranteed by Mr. Zhihong Jia, the CEO and Chairman of the Company. Both loans are due in January 2018. The repayment of the loans may be accelerated under certain conditions, including upon a default of principal or interest payment when due, breach of representations or warranties, certain cross-defaults, upon the occurrence of certain material events affecting the financial viability of Wuhan Kingold, and other customary conditions. There are no financial covenant requirements for the loans.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 6 – LOANS - continued

(i) Loans payable to Evergrowing Bank- Yantai Huangshan Road Branch

From February 24, 2016 to March 24, 2016, Wuhan Kingold signed ten Loan Agreements with the Yantai Huangshan Road Branch of Evergrowing Bank for loans of approximately $149.9 million (RMB 1 billion) in aggregate. The purpose of the loans is for purchasing gold. The terms of loans are two years and bear fixed interest of 7% per year. The loans are secured by 5,828,750 gram of Au9999 gold in aggregate with carrying value of approximately $204 million (RMB 1.4 billion) and are guaranteed by Mr. Zhihong Jia, the CEO and Chairman of the Company. Based on the loan repayment plan as specified in the loan agreements, approximately $149,920 (RMB 1 million) was repaid in August 2016. Approximately $149,920 (RMB 1 million) should be repaid on February 23, 2017 and another $149,920 (RMB 1 million) should be repaid in August 23, 2017. Accordingly, these amounts have been reclassified as the current portion of the long-term loans. The remaining loans are due in February to March 2018. The repayment of the loans may be accelerated under certain conditions, including upon a default of principal or interest payment when due, breach of representations or warranties, certain cross-defaults, upon the occurrence of certain material events affecting the financial viability of Wuhan Kingold, and other customary conditions. There are no financial covenant requirements for the loans. The repayment requirement is listed below:

(j) Loans payable to Anxin Trust Co., Ltd

In January 2016, Wuhan Kingold signed a Collective Trust Loan Agreement with Anxin Trust Co., Ltd. (“Anxin Trust”). The agreement allows the Company to access of approximately $449.8 million (RMB 3 billion) within 60 months. Each individual loan will bear a fixed annual interest of 14.8% with a term of 36 months or less. The loan is subject to certain covenants required by the agreement. The purpose of this trust loan is to provide working capital for the Company to purchase gold. The loan is secured by 1,700,000 gram of Au9999 gold in aggregate with carrying value of approximately $59.5 million (RMB 396.8 million). There is no financial covenant requirement for this loan. The loan is also guaranteed by Mr. Zhihong Jia, the CEO and Chairman of the Company. As of September 30, 2016, the Company received an aggregate of approximately $374.8 million (RMB 2.5 billion) from the loan. The Company also made a restricted deposit of approximately $1.5 million (RMB 10 million) to secure these loans. The deposit will be refunded when the loan is repaid upon maturity. On October 11, 2016, the Company subsequently obtained additional loan of approximately $75 million (RMB 500 million) from Anxin Trust under the same loan agreement. 

(k) On June 24, 2016, Wuhan Kingold entered into a loan agreement with Minsheng Trust, with an aggregate amount of approximately $30 million (RMB 200 million), with a maturity date of June 22, 2018. The annual interest rate was 10.85%. The loan is to be used for the working capital. Wuhan Kingold pledged 1,090,000 grams of gold with carrying value of approximately $42.9 million (RMB 285.9 million) as of September 30, 2016 to secure this loan. The Company was also required to pledge approximately $0.3 million (RMB 2 million) restricted cash with Minsheng Trust as collateral. In addition, the Company’s CEO, Mr. Zhihong Jia and his wife, Ms. Lili Huang, jointly signed a guarantee agreement with the Minsheng Trust, to provide a guarantee for the loan.

(l) On March 9, 2016, Wuhan Kingold entered into a Trust Loan Contract with Chang’An International Trust Co., Ltd. (“Chang’An Trust”). The agreement allows the Company to access a total of approximately $45 million (RMB 300 million) for the purpose of working capital needs. The loan has a 24-month term starting from the date of releasing the loan, and bears interest at a fixed rate of 13% per annum. The loan is secured by 1,121 kilograms of Au9995 gold, which approximately $42.9 million (RMB 285.9 million) is pledged by Wuhan Kingold. The loan is guaranteed by Mr. Zhihong Jia, the CEO and Chairman of the Company and shall be repaid upon maturity. As of September 30, 2016, the Company received an aggregate of approximately $29.8 million (RMB 199 million) from the loan. The Company also made a restricted deposit of approximately $0.3 million (RMB 1.99 million) to secure these loans. The deposit will be refunded when the loan is repaid upon maturity.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 6 – LOANS - continued

(m) On September 7, 2016, the Company entered into a trust loan agreement with the Sichuan Trust Ltd. (“Sichuan Trust”) to borrow a maximum of approximately $149.9 million (RMB 1 billion) as working capital loan. The loan period is 24 months from September 7, 2016 to September 7, 2018. For the loan obtained the Company is required to make interest payments are calculated based on a fixed annual interest rate of 8.46% (the Company is required to make the first interest payment equal to 1.21% of the principal received, then the rest of interest payments are calculated based on a fixed interest rate of 7.25%). The Company is required to pledge 2,345 kilogram of Au9999 gold with carrying value of approximately $100 million (RMB 667.3 million) as collateral to secure this loan. The loan is guaranteed by Mr. Zhihong Jia, the CEO and Chairman of the Company. The Company also made a restricted deposit of approximately $0.7 million (RMB 5 million) to secure these loans. The deposit will be refunded when the loan is repaid upon maturity. As of September 30, 2016, the Company received an aggregate of approximately $75 million (RMB 500 million) from the loan. On October 13, 2016, the Company subsequently obtained additional loan of approximately $75 million (RMB 500 million) from Sichuan Trust under the same loan agreement.

(n) On September 7, 2016, the Company entered into a loan agreement with China Aviation Capital Investment Management (Shenzhen) ("China Aviation Capital") to borrow a maximum of approximately $90 million (RMB 600 million) as working capital loan. The first installment of the loan is approximately $43.5 million (approximately RMB 290 million) with a period of 24 months from September 7, 2016 to September 7, 2018. For the loan obtained, the Company is required to make interest payments calculated based on a fixed annual interest rate of 7.5% and a one-time consulting fee of 3% based on the principal amount received. The Company is required to pledge 1,473 kilogram of Au9999 gold with carrying value of approximately $62.1 million (RMB 414.5 million) as collateral to secure this loan. The loan is guaranteed by Mr. Zhihong Jia, the CEO and Chairman of the Company. As of September 30, 2016, the Company received an aggregate of approximately $43.5 million (approximately RMB 290 million) from the loan.

(o) On August 29, 2016, the Company entered into a trust loan agreement with China Construction Investment Trust to borrow a maximum of approximately $45 million (RMB 300 million) as working capital loan for the purpose of purchasing of gold solely with a period of 24 months from August 29, 2016 to August 29, 2018. For the loan obtained, the Company is required to make interest payments calculated based on a fixed annual interest rate. The interest payment is divided into two parts: (1) 1% of the principal amount received is required to be paid before December 25, 2016; (2) the remaining interest payments are calculated based on a fixed interest rate of 7.5% and due on quarterly basis. The Company is required to pledge 1,447 kilogram of Au9999 gold with carrying value of approximately $60.7 million (RMB 405 million) as collateral to secure this loan. The loan is guaranteed by Mr. Zhihong Jia, the CEO and Chairman of the Company. As of September 30, 2016, approximately $44.5 million (RMB 297 million) of the loan was received by the Company. On October 9, 2016, the Company subsequently received the rest of $0.4 million (RMB 3 million) of the loan.

Interest expense for all of the long term loans mentioned above amounted approximately to $21.5 million and $33.5 million for the three and nine months ended September 30, 2016, respectively. There were no interest expense for the three and nine months ended September 30, 2015.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 7 - DEBTS PAYABLE

Amounts owed by the Company to Shanghai Pudong Development Bank (“SPD Bank”) under a Credit Agent Agreement were full repaid upon maturity on March 24, 2016 and approximately $5.3 million (RMB 35 million) security deposit was returned to the Company. The remaining deferred financing cost of $144,134 was fully amortized in the nine months ended September 30, 2016. Interest expense incurred on the debt financing instruments amounted to approximately $3.3 million for the year ended December 31, 2015 and was capitalized into construction in progress of Jewelry Park project. For the nine months period ended September 30, 2016, approximately $1 million interest expenses were capitalized into construction in progress of Jewelry Park project,

Pursuant to a Private Placement Agreement dated on August 12, 2014, the RMB 750 million debt financing instruments can be issued within two years. Since the Company obtained alternative financing through several bank borrowings, management does not expect this approved debt issuance will be materialized in the near future.

NOTE 8 - DEPOSIT PAYABLES - JEWELRY PARK

As of December 31, 2015, the Company received the advance payment from potential customers approximately $22 million (RMB 144 million) to acquire certain real estate property in the Jewelry Park. As of September 30, 2016, in connection with the Transfer Transaction, the Company received the advance payments from Wuhan Lianfuda approximately $170.9 million (RMB 1,140 million) (see Note 5) and included in Deposit payable, while the Company refunded $22 million of customer deposits to Wuhan Lianfuda because Wuhan Kingold transferred all its interest in Jewelry Park to Wuhan Lianfuda in accordance with the Transfer Transaction.

NOTE 9 – RELATED PARTY TRANSACTIONS

For the nine months ended September 30, 2016, the Company borrowed total of $1,041,634 from Mr. Zhihong Jia, the CEO and Chairman of the Company, to pay certain expense to various service providers on behalf of the Company. Such amount is unsecured and repayable on demand with free of interest. As of September 30, 2016 and December 31, 2015, the balance of due to related party amounted to $1,041,634 and $200,059, respectively.

For the nine months end September 30, 2016 and 2015, Mr. Zhihong Jia, the CEO and Chairman of the Company, together with his wife provided their personal guarantees to various financial institutions to support the Company (see Notes 6 and 7).

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 10 - INCOME TAXES

The Company is subject to income taxes on an entity basis on income arising in or derived from the tax jurisdiction in which each entity is domiciled.

Kingold is incorporated in the United States and has incurred net operating loss for income tax purposes through 2015 resulting in loss carry forwards of approximately $16.5 million available for offsetting against future taxable U.S. income, expiring in 2036. Management believes that the realization of the benefits from these losses is uncertain due to its history of continuing losses in the United States. Accordingly, a full deferred tax asset valuation allowance has been provided and no deferred tax asset benefit has been recorded. The valuation allowance as of September 30, 2016 and December 31, 2015 was approximately $5.6 million and $5.4 million, respectively.

Dragon Lead is incorporated in the British Virgin Islands (the “BVI”), and under current laws of the BVI, income earned is not subject to income tax.

Wuhan Vogue-Show, Wuhan Kingold, Kingold Internet, and Yuhuang are incorporated in the PRC and are subject to PRC income tax, which is computed according to the relevant laws and regulations in the PRC. The applicable tax rate is 25% for the periods ended September 30, 2016 and 2015. The Company recorded $17,660,837 deferred income tax assets and $1,774,993 deferred tax liability as of September 30, 2016 and December 31, 2015, respectively.

The Company intends to reinvest its foreign profits indefinitely in order to avoid a tax liability upon repatriation to the United States.

Income (loss) from continuing operations before income taxes was allocated between the U.S. and foreign components for the three and nine months ended September 30, 2016 and 2015:

Significant components of the income tax provision were as follows for the three and nine months ended September 30, 2016 and 2015:

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 10 - INCOME TAXES - continued

The components of deferred tax assets and deferred tax liability as of September 30, 2016 and December 31, 2015 consist of the following:

NOTE 11 - EARNINGS PER SHARE

For three and nine months ended September 30, 2016 and 2015, the basic average shares outstanding and diluted average shares outstanding were the same because the effect of potential shares of common stock was anti-dilutive since the exercise prices for the warrant and options were greater than the average market price for the related periods. As a result, for the three and nine months ended September 30, 2016, total of 721,218 and 308,942 unexercised warrants and options are dilutive, respectively, and were included in the computation of diluted EPS. For the three and nine months ended September 30, 2015, no unexercised warrants and options were dilutive.

The following table presents a reconciliation of basic and diluted net income per share:

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 12 - OPTIONS

On March 24, 2011, the Board of Directors voted to adopt the 2011 Stock Incentive Plan (the “Plan”), which was later ratified by the Company’s stockholders on October 31, 2011, at the 2011 annual meeting.

The Plan permits the granting of stock options (including incentive stock options as well as nonstatutory stock options), stock appreciation rights, restricted and unrestricted stock awards, restricted stock units, performance awards, other stock-based awards or any combination of the foregoing. Under the terms of the Plan, up to 5,000,000 shares of the Company’s common stock may be granted. Prior to January 1, 2012, the Company granted 1,620,000 options under the plan. In accordance with the vesting periods, $Nil was recorded as part of operating expense-stock compensation for the three and nine months ended September 30, 2016, respectively. The Company recorded $Nil and $110,439 as part of operating expense-stock compensation for the three and nine months ended September 30, 2015, respectively

On January 9, 2012, the Company granted 1,300,000 options with an exercise price of $1.22 to certain members of management and directors. These options can be exercised within ten years from the grant date once they become exercisable. The options become exercisable in accordance with the schedule below: (a) 25% of the options become exercisable on the first anniversary of the grant date (such date is the initial vesting date), and (b) 6.25% of the options become exercisable on the date three and six months after the initial vesting date and on such date every third month thereafter, through the fourth anniversary of the grant date. The fair value of the options was calculated using the Black-Scholes options pricing model using the following assumptions: volatility of 124.81%, risk free interest rate of 1.98 %, and expected term of 10 years. The fair value of the options was $1,516,435. In accordance with the vesting periods, $Nil was recorded as part of operating expense-stock compensation for the 1,300,000 options above for the three and nine months ended September 30, 2016, respectively. The Company recorded $91,200 and $277,178 as part of operating expense-stock compensation for the three and nine months ended September 30, 2015, respectively

On April 1, 2012, the Company granted 120,000 options with an exercise price of $1.49 to its Chief Financial Officer (“CFO”) per his employment agreement. These options can be exercised within ten years from the grant date once they become exercisable. The options become exercisable every three months starting from grant date for the one year service period from April 1, 2012. The fair value of the options was calculated using the Black-Scholes options pricing model using the following assumptions: volatility of 124.50%, risk free interest rate of 2.23%, and expected term of 10 years. The fair value of the options was $170,967. These options have fully vested by December 31, 2013.

On July 16, 2013, the Company granted 90,000 options with an exercise price of $1.18 to its non-employee directors, which options expire ten years from the grant date under the Plan. These options became exercisable in accordance with the following schedule: (a) 25% of the options became exercisable on the first anniversary of the grant date (the “Initial Vesting Date”), and (b) 6.25% of the options became exercisable on the date three months after the Initial Vesting Date and on such date every third month thereafter, through the fourth anniversary of the grant date. The fair value of the options was calculated using the Black-Scholes options pricing model using the following assumptions: volatility of 118.01%, risk free interest rate of 2.55%, and expected term of 6.25 years. The fair value of the options was $92,458. In accordance with the vesting periods, $5,779 and $17,337 were recorded as part of operating expense-stock compensation for the three and nine months ended September 30, 2016, respectively. The Company recorded $5,779 and $17,337 as part of operating expense-stock compensation for the three and nine months ended September 30, 2015, respectively.

On February 25, 2015, the Company granted 90,000 options with an exercise price of $1.11 to its non-employee directors, which options expire ten years from the grant date under the Plan. These options became exercisable in accordance with the following schedule: (a) 25% of the options became exercisable on the first anniversary of the grant date, and (b) 6.25% of the options became exercisable on the date three and six months after the initial vesting date and on such date every third month thereafter, through the fourth anniversary of the grant date. The fair value of the options was calculated using the Black-Scholes options pricing model under the following assumptions: volatility of 115.20%, risk free interest rate of 1.96%, and expected term of 6.25 years. The aggregate fair value of the options was $85,822. In accordance with the vesting periods, $5,364 and $16,091 were recorded as part of operating expense-stock compensation for the 90,000 options above for the three and nine months ended September 30, 2016, respectively. The Company recorded $5,364 and $12,516 as part of operating expense-stock compensation for the three and nine months ended September 30, 2015, respectively.

The Company recorded $11,143 and $33,428 stock-based compensation expense for the three and nine months ended September 30, 2016, respectively. The Company recorded $102,343 and $417,470 stock-based compensation expense for the three and nine months ended September 30, 2015, respectively.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 12 – OPTIONS - continued

The following table summarized the Company’s stock option activity:

NOTE 13 - WARRANTS

Following is a summary of the status of warrant activities as of September 30, 2016 and December 31, 2015

On August 12, 2015, the Company signed a consulting agreement to engage Bespoke Independent Partners (“BIP”), a wholly owned subsidiary of FPIA Partners LLC to operate as a strategic advisor to Kingold in matters relating to investor relations, capital markets and shareholder value creation strategy. As the part of the agreement with BIP, an aggregate of 900,000 shares of warrants with exercise price ranging from $1.20 to $1.80 will be directly issued at no cost to BIP if certain stock performance targets are met within a three-year period. Through September 30, 2016, no warrants were issued to BIP because the performance target has not been met.

On March 29, 2016, pursuant to the consulting agreement, the Company’s obligation to issue BIP warrants to purchase 150,000 shares of the Company’s common stock for $1.20 per share (the “First Tranche Warrants”) was triggered as a result of certain milestone accomplishments. The warrants will expire on June 29, 2017. Accordingly, the Company recorded $64,204 consulting expense and included in the general administrative expense. The fair value of the warrants was calculated using the Black-Scholes options pricing model using the following assumptions: volatility of 81%, risk free interest rate of 0.84%, and expected term of 1.25 years. The fair value of the warrants was $64,204.

On April 18, 2016, pursuant to the consulting agreement, the Company’s obligation to issue BIP warrants to purchase 150,000 shares of the Company’s common stock for $1.50 per share (the “Second Tranche Warrants”) was triggered as a result of certain milestone accomplishments. The warrants will expire on July 17, 2017. Accordingly, the Company recorded $65,091 consulting expense and included in the general administrative expense. The fair value of the warrants was calculated using the Black-Scholes options pricing model using the following assumptions: volatility of 79.7%, risk free interest rate of 0.63%, and expected term of 1.25 years. The fair value of the warrants was $65,091.

On May 10, 2016, the Company terminated the consulting agreement. On June 27, 2016, the Company and BIP signed a settlement agreement (the “Settlement Agreement”). In connection with the Settlement Agreement, the Company and BIP agreed that (1) the First Tranche Warrants and the Second Tranche Warrants would remain vested and outstanding, (2) the third, fourth and fifth tranches of success fee warrants would be cancelled; and (3) crediting of $66,439 in outstanding but unpaid fees against the exercise price of the First Tranche Warrants would be the only payment made or required under the Service Agreement. As a result, BIP will receive (a) 55,365 shares, (b) warrants to purchase 94,635 shares for $1.2 per share, expiring June 28, 2017, and (c) warrants to purchase 150,000 shares for $1.50 per share, which may be exercised from July 18, 2016 until July 17, 2017. As a result of the Settlement Agreement, the Company does not have any liability for future warrants issuance to BIP. As of September 30, 2016, the remaining 244,635 outstanding warrants may be exercised in the future by BIP upon delivery of cash and an exercise notice to the Company.

A total of 294,000 warrants consisting of 150,000 warrants issued to Wallington Investment Holdings Ltd with exercise price of $3.25 per share on January 13, 2011 and 144,000 warrants issued to Rodman & Renshaw, LLC with exercise price of $3.99 per share on January 13, 2011 were expired on January 13, 2016.

During the three and nine months ended September 30, 2016, the Company included $65,091 and $129,295 warrants cost in the general administrative expenses, respectively.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 14- NONCONTROLLING INTEREST

Non-controlling interest represents the minority stockholders’ 45% proportionate share of the results of the newly established subsidiary Kingold Internet and Yuhuang.  A reconciliation of non-controlling interest as of September 30, 2016 and December 31, 2015 are as follows:

NOTE 15 - CONCENTRATIONS AND RISKS

The Company maintains certain bank accounts in the PRC and BVI, which are not insured by Federal Deposit Insurance Corporation (“FDIC”) insurance or other insurance. The cash and restricted cash balance held in the PRC bank accounts was $240,857,521 and $29,544,475 as of September 30, 2016 and December 31, 2015, respectively. The cash balance held in the BVI bank accounts was $35,163 and $13,277 as of September 30, 2016 and December 31, 2015, respectively. As of September 30, 2016 and December 31, 2015, the Company held $155,897 and $144,465 of cash balances within the United States, no balance was in excess of FDIC insurance limits of $250,000 as of September 30, 2016 and December 31, 2015, respectively.

For the periods ended September 30, 2016 and 2015, almost 100% of the Company's assets were located in the PRC and 100% of the Company's revenues were derived from its subsidiaries located in the PRC.

The Company’s principal raw material used during the year was gold, which accounted for almost 100% of its total purchases for the periods ended September 30, 2016 and 2015. The Company purchased gold directly, and solely, from the Shanghai Gold Exchange, the largest gold trading platform in the PRC.

No customer accounted for more than 10% of annual sales for the periods ended September 30, 2016 or 2015.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 16 - GOLD LEASE TRANSACTIONS

The Company leased gold as a way to finance its growth and will return the same amount of gold to China Construction Bank (“CCB”), Shanghai Pudong Development Bank (“SPD Bank”), CITIC Bank and Industrial & Commercial Bank of China (“ICBC”) at the end of the respective lease agreements. Under these gold lease arrangements, each of CCB, SPD Bank, CITIC Bank and ICBC retains beneficial ownership of the gold leased to the Company and treats it as if the gold is placed on consignment to the Company. All three banks have their own representatives on the Company’s premises to monitor on a daily basis the use and security of the gold leased to the Company. Accordingly, the Company records these gold lease transactions as operating leases because the Company does not have ownership nor has it assumed the risk of loss for the leased gold.

During 2015, the Company renewed gold lease agreements with CCB and leased an aggregate of 2,330 kilograms of gold, which amounted to approximately $54.8 million (RMB 365 million). The leases have initial terms of one year and provide an interest rate of 6% per annum. The leased gold shall be returned to the Bank upon lease maturity in 2016.

During nine months ended September 30, 2016, the Company entered into gold lease agreements with CCB and leased an aggregated of 975 kilograms of gold, which amounted to approximately $35.2 million (RMB 235 million). The leases have initial terms of one year and provide an interest rate of 5.7% per annum. The leased gold shall be returned to the Bank upon lease maturity in 2017. During the nine months ended September 30, 2016, the Company returned 1,415 kilograms of gold, which amounted to approximately $51.4 million (RMB 342.8 million) back to CCB upon lease maturity.

As of September 30, 2016 and December 31, 2015, 1,075 kilograms and 1,515 kilograms of leased gold were outstanding and not yet returned to the Bank, respectively, which amounted to approximately $38.6 million (RMB 257.5 million) and $56.3 million (RMB 365.3 million), respectively due in various months through out of 2016 and 2017. As of September 30, 2016 and December 31, 2015, the Company pledged restricted cash of approximately $37.5 million and Nil as collateral to safeguard the gold lease from CCB, respectively.

On April 10, 2015, Wuhan Kingold entered into a gold lease agreement with SPD Bank to lease additional 197 kilograms of gold (valued at approximately RMB 47 million or approximately $7.2 million). The lease has initial term of one year and provides an interest rate of 3.2% per annum.

In the third quarter of 2015, Wuhan Kingold entered into several gold lease agreements with SPD Bank to lease an aggregate of 720 kilograms of gold, valued approximately $25.9 million (RMB 168.2 million). The leases have initial terms of one year and provide an interest rate of 2.8% to 6% per annum. The Company is required to deposit cash into an account at SPD Bank equal to approximately $15.9 million (RMB 103 million).

During nine months ended September 30, 2016, the Company entered into gold lease agreements with SPD bank and leased an aggregated of 345 kilograms of gold, which amounted to approximately $14 million (RMB 93.3 million). The leases have initial terms of six months to one year and provide an interest rate of 6.0% per annum. During nine month ended September 30, 2016, the Company returned 917 kilograms of gold, which amounted to approximately $32.3 million (RMB 215.2 million) back to SPD bank upon lease maturity. The remaining leased gold shall be returned to the Bank upon lease maturity in December 2016 and June 2017.

As of September 30, 2016 and December 31, 2015, about 345 kilograms and 917 kilograms of leased gold were outstanding and not yet returned to SPD Bank, respectively, which amounted to approximately $14 million (RMB 93.3 million) and $33.2 million (RMB 215.2 million), respectively. Such gold leases will be due in various months in 2016 and 2017. As of September 30, 2016 and December 31, 2015, the Company pledged restricted cash of approximately $68.7 million and $16.3 million as collateral to safeguard the gold lease from SPD Bank, respectively.

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 16 - GOLD LEASE TRANSACTIONS – continued

During the nine months ended September 30, 2016, the Company entered into additional gold lease agreements with ICBC and leased an aggregated amount of 527 kilograms of gold, which amounted to approximately $20.9 million (RMB 139.7 million). The leases have initial terms of half year and provide an interest rate of 2.75% per annum. The leased gold shall be returned to the Bank upon lease maturity in September 2016. As of September 30, 2016, 527 kilograms of leased gold were all returned to ICBC. As of September 30, 2016 and December 31, 2015, no restricted cash was pledged by the Company as collateral to safeguard the gold lease from ICBC, respectively.

As of September 30, 2016 and December 31, 2015, a total amount of 1,420 kilograms and 2,782 kilograms of leased gold were outstanding, at the approximated amounts of $52.6 million and $101.8 million, respectively. Interest expense for the leased gold for the nine month period ended September 30, 2016 and 2015 were approximately $3.3 million and $5.6 million, respectively, which was included in the cost of sales. Interest expense for the leased gold for the three month period ended September 30, 2016 and 2015 were approximately $0.9 million and $1.9 million, respectively, which was included in the cost of sales.

NOTE 17 – COMMITMENTS AND CONTINGENCIES

Operating Lease

On June 27, 2016, Wuhan Kingold signed certain 5 years lease agreements to rent office and store space at the Jewelry Park commencing in July 2016 and October 2016, respectively, with aggregated annual rent with aggregated annual rent of approximately $0.09 million and $0.17 million, respectively. For the three and nine months ended September 30, 2016, the Company recorded $21,884 rent expense. As of September 30, 2016, the Company was obligated under non-cancellable operating leases for minimum rentals as follows:

KINGOLD JEWELRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 18 – CONVERTIBLE NOTE PURCHASE AGREEMENT

On April 2, 2015, the Company entered into a Convertible Note Purchase Agreement (the “Purchase Agreement”) with Fidelidade – Companhia de Seguros, S.A., a company duly incorporated and existing under the laws of Portugal and a majority-owned subsidiary of Fosun International Limited (the “Holder”). Pursuant to the Purchase Agreement, the Company agreed to issue and sell to the Holder $15 million aggregate principal amount 6.0% Senior Secured Convertible Note due 2018 (the “Note”), subject to customary closing conditions. The Company was to sell the Note in reliance on the exemption from registration provided by Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”). The Note and the underlying shares of the Company’s common stock issuable upon conversion of the Note have not been registered under the Securities Act and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.

The Note was to bear interest at a rate of 6.0% per year payable annually and mature on the third anniversary of the issuance date of the Note, unless earlier converted. The Note constituted a general, senior, secured obligation of the Company. The Company was required to grant the Holder a security interest in certain collateral as identified in the Purchase Agreement, to secure the payment, discharge and performance of all the Company’s obligations under the Note. Mr. Zhihong Jia, Chairman and Chief Executive Officer of the Company, was to execute a guarantee in favor of the Holder, pursuant to which Mr. Jia will be jointly liable for the Company’s obligations under the Note. 

Subject to and upon compliance with the provisions of the Purchase Agreement, the Holder has the right, at its option, to convert the principal amount of the Note or any portion of such principal amount which is $1,000 or an integral multiple of $1,000 in excess thereof, into shares of common stock at the applicable conversion rate. The conversion rate is initially 869.57 shares of common stock per $1,000 principal amount of Note (equivalent to an initial conversion price of approximately $1.15 per share), subject to adjustment in certain events described in the Purchase Agreement. Upon conversion, the Company will deliver shares of common stock as set forth in the Purchase Agreement. No fractional shares will be issued upon any conversion.

In connection with the entry into the Purchase Agreement, the Company will enter into a registration rights agreement (the “Registration Rights Agreement”) with the Holder as a condition to closing the sale of the Note, which sets forth the rights of the Holder to have the shares of common stock issuable upon conversion of the Note registered with the SEC for public resale under the Securities Act. Pursuant to the Registration Rights Agreement, the Company is required to file a registration statement with the SEC (the “Initial Registration Statement”) within 60 days following the date of the issuance of the Note, registering the shares of common stock issuable upon conversion of the Note. The Company is required to use its reasonable best efforts to have the Initial Registration Statement declared effective as promptly as possible following the filing thereof and, in any event, by no later than 90 days after the date of the issuance of the Note. In addition, the agreement gives the Holder the ability to exercise certain piggyback registration rights in connection with registered offerings by the Company.

The Purchase Agreement was set to terminate automatically on May 31, 2015 in the absence of a closing or extension at the discretion of the Holder. Closing did not occur prior to such time because the Company had not secured a $15 million letter of credit required under the agreement. The Holder has not provided written notice to the Company of its intention either to terminate or to extend the Purchase Agreement, and the Company continues to pursue the $15 million letter of credit. While there can be no guarantee that the Company will locate a letter of credit on terms acceptable to the Holder, the Company remains willing to proceed under the Purchase Agreement.

NOTE 19 – SUBSEQUENT EVENTS

On September 30, 2016, the Company entered into an Entrust Loan Agreement with the Hubei Asset Management Co., Ltd. to borrow from ICBC Wuhan Jiang'an Branch of a maximum of approximately $45 million (RMB 300 million) as a working capital loan in the later period. The Company is subject to 9.5% fixed annual interest rate. The term of the loan is two years from the date of receiving the principal amount. The Company is required to pledge 1,497 kilograms of Au9999 gold with carrying value of approximately $61.6 million (RMB 410.9 million) as collateral. The loan is jointly guaranteed by Mr. Zhihong Jia, the CEO and Chairman of the Company. The full amount of this entrust loan was subsequently received by the Company on October 28, 2016.

On October 13, 2016, the SEC declared effective a registration statement filed by the Company on Form S-3 that registered the sale, from time to time, of up to $80 million of the securities.

On October 14, 2016, the Company entered into a Trust Loan Agreement with the Minsheng Trust to borrow a maximum of 70% of amount of pledged gold as a working capital loan. The Company is subject to 7.6% fixed annual interest rate. The term of the loan is one year from receiving of the principal amount. The Company is required to pledge 1,877.49 kilograms of Au9995 gold with carrying value of approximately $76.9 million (RMB 512.9 million) as collateral. The total amount received by the Company was approximately $53.8 million (RMB 359 million) as 70% of carrying value of the gold pledged.

The Company is expected to receive the certificate of occupancy for Jewelry Park project and the ownership title will be transferred to Wuhan Lianfuda to complete the Transfer Transaction before the end of the fiscal year 2016.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read together with the financial statements and related notes included in this Report and in our Annual Report on Form 10-K for the year ended December 31, 2015. This discussion contains forward-looking statements that involve risks and uncertainties. See also the “Cautionary Statement for Purposes of the “Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995” appearing elsewhere in this Report. Our actual results may differ materially from those anticipated in those forward-looking statements as a result of certain factors, including, but not limited to, those contained in the “Risk Factors” section of this Report and in our Annual Report on Form 10-K for the year ended December 31, 2015.

Our Business

Through a variable interest entity, or VIE, relationship with Wuhan Kingold Jewelry Company Limited (“Wuhan Kingold”), a company incorporated in the People’s Republic of China, or PRC, we believe that we are one of the leading professional designers and manufacturers of high quality 24 Karat gold jewelry and PRC ornaments developing, promoting, and selling a broad range of products to the rapidly expanding jewelry market across the PRC. We offer a wide range of in-house designed products including, but not limited to, gold necklaces, rings, earrings, bracelets, and pendants.

We have historically sold our products directly to distributors, retailers and other wholesalers, who then sell our products to consumers through retail counters located in both department stores and other traditional stand-alone jewelry stores. We sell our products to our customers at a price that reflects the market price of the base material, plus a mark-up reflecting our design fees and processing fees. This mark-up typically ranges from 3% – 6% of the price of the base material. During 2015, we established a new subsidiary Wuhan Kingold Internet Co., Ltd. and started the online sales of our jewelry products to customers. However, the online sales were immaterial as of September 30, 2016.

We aim to become an increasingly important participant in the PRC’s gold jewelry design and manufacturing sector. In addition to expanding our design and manufacturing capabilities, our goal is to provide a large variety of gold products in unique styles and superior quality under our brand, Kingold.

To broaden our business lines and strengthen our processing capacity, in October 2013, we entered into an agreement (“the Acquisition Agreement”) to acquire the operating rights for 66,667 square meters (approximately 717,598 square feet, or 16.5 acres) of land in Wuhan for an aggregate purchase price of RMB 1 billion (approximately US $149.9 million at the spot rate). The $149.9 million includes the land use right costs and the construction costs of the Jewelry Park. We financed the installment payments paid to date through bank loans. The land use rights are held in the Shanghai Creative Industry Park, which we intended to rename as the Kingold Jewelry Cultural Industry Park (the “Jewelry Park”). The acquisition was structured as an equity purchase of the company holding the land use rights, with Wuhan Wansheng House Purchasing Limited (“Wuhan Wansheng”) (i) initially granting us a portion of ownership of Wuhan Huayuan Science and Technology Development Limited Company (“Wuhan Huayuan”), (ii) granting us the right to appoint the chief financial officer for the project to supervise and manage the use of funds, and (iii) naming Wuhan Wansheng as agent for the completion of the construction. Accordingly, we own 60% of the Jewelry Park as of September 30, 2016. However, because no other assets or liabilities have been transferred with the acquisition of Wuhan Huayuan, we treated the Jewelry Park acquisition as an asset purchase for accounting purposes.

We originally intend to develop the land and to utilize the completed Jewelry Park as our new operation center and show center and rent spaces within the Jewelry Park to other jewelry manufacturers and retailers in China, and sell developed commercial and residential properties to individual and corporate buyers. To move away from the real estate industry and to solely focus on its jewelry business, on June 27, 2016, we entered into a transfer contract with Wuhan Lianfuda Investment Management Co., Ltd. (“Wuhan Lianfuda”), an unrelated party, to sell all of its interest in the Jewelry Park to Wuhan Lianfuda (“Transfer Transaction”). Pursuant to the transfer contract, Wuhan Lianfuda is obligated to pay Wuhan Kingold RMB 1.14 billion (approximately US $170.9 million). This amount includes (1) RMB 640 million (approximately US $96 million) for the share acquisition fees and the construction fees that Wuhan Kingold has paid to Wuhan Wansheng; and (2) transfer fees of RMB 500 million (approximately US $75 million). In addition, Wuhan Kingold transfers and Wuhan Lianfuda receives, all the rights and obligations in the Transfer Transaction Agreement, including 60% stock rights of Wuhan Huayuan. Wuhan Lianfuda will undertake Wuhan Kingold’s remaining payment obligation of RMB 360 million (approximately US $54 million) stipulated in the Acquisition Agreement. According to an evaluation report issued by an independent evaluation agency, the evaluated value of the Jewelry Park on June 26, 2016 was approximately RMB 1.48 billion (approximately US $222.8 million). As of September 30, 2016, the project has passed all inspections and completed acceptance procedures. The Company is waiting for the certificate of occupancy to be issued by local government, and is in the process of transferring the ownership title to Wuhan Lianfuda.

Results of Operations

The following table sets forth our statements of income (unaudited) for the three and nine months ended September 30, 2016 and 2015 in U.S. dollars:

KINGOLD JEWELRY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(IN US DOLLARS)

(UNAUDITED)

Three Month Period Ended September 30, 2016 Compared to the Three Month Period Ended September 30, 2015

Net Sales

Net sales for the three months ended September 30, 2016 amounted to $390.5 million, an increase of $126.7 million, or 48.1%, from net sales of $263.8 million for the three months ended September 30, 2015. For the three months ended September 30, 2016, our branded production sales accounted for 98.2% of the total sales and customized production sales accounted for 1.8% of the total sales. When comparing with three months ended September 30, 2015, our branded production sales increased by $123.8 million or 47.6%, our customized production sales increased by $2.9 million or 74.4%.

The overall increase in our revenue in three months ended September 30, 2016 as compared to three months ended September 30, 2015 was due to the following factors: (1) Total sales volume (in terms of quantity sold) increased from 13.48 metric tons in three months ended September 30, 2015 to 20.55 metric tons in three months ended September 30, 2016, causing 7.1 metric tons or 52.4% increase. As a result, approximately $84.7 million increase in our revenue was attributable to the increase in our sales volume.  (2) The average unit selling price for our brand production sales increased from RMB 206.74 per gram in three months ended September 30, 2015 to RMB 257.06 per gram in three months ended September 30, 2016, causing 24.3% increase. As a result, approximately $63.2 million increase in brand production revenue was affected by the increase in our selling price. (3) Foreign currency adjustment effect was approximately a $17.1 million foreign currency translation loss converting RMB into USD when the average exchange rate of USD: RMB increased from 1 USD=6.2214 RMB in three months ended September 30, 2015 to 1 USD=6.6515 RMB in three months ended September 30, 2016. 

In the third quarter of 2016, we processed a total of 20.6 metric tons of gold, of which branded production accounted for 10 metric tons (48.3%) and customized production accounted for 10.6 metric tons (51.7%). In the third quarter of 2015, we processed a total of 13.5 metric tons of gold, of which branded production accounted for 7.8 metric tons (58.0%) and customized production accounted for 5.7 metric tons (42.0%).  

Cost of Sales

Cost of sales for the three months ended September 30, 2016 amounted to $340.1 million, an increase of $91.9 million, or 37.0%, from $248.2 million for the same period in 2015. The increase was primarily due to higher volume of products sold. The sale quantity increased 52.4% to approximately 20.6 metric tons in three months ended September 30, 2016 from 13.5 metric tons in three months ended September 30, 2015.

Gross Profit and Margin

Gross profit for the three months ended September 30, 2016 was $50.4 million, an increase of $34.9 million from $15.6 million for the same period in 2015. Accordingly, gross margin for the three months ended September 30, 2016 was 12.9%, compared to 5.9% for the same period in 2015. The primary reason for the substantial increase in gross margin was due to the unit price of branded production sales was RMB 257.1 per gram for the three months ended September 30, 2016, while the unit price of branded production sales was RMB 206.7 per gram for the three months ended September 30, 2015, the unit price increased by 24.3%. On the other hand, the unit cost of branded production was RMB 227.6 per gram for the three months ended September 30, 2016, while the unit cost of branded production was RMB 197.2 per gram for the three months ended September 30, 2015. Although there was an increase in unit cost for branded production, the percentage increase of the unit cost is smaller than the increase in the sales due to the fact that the Company purchased significant quantity of gold in prior period at relatively low price and reserved for the subsequent productions. As a result, the unit margin of branded production was RMB 29.5 per gram for the three months ended September 30, 2016 compared to RMB 9.5 per gram for the three months ended September 30, 2015.

Expenses

Total operating expenses for the three months ended September 30, 2016 were $4.0 million compared with $3.4 million for the same period in 2015. The increase was mainly due to increased Selling, General and Administrative expenses for broader marketing efforts, such as increased employee salary and annual bonus expense during the Chinese Spring Festival, increased legal, accounting for special projects, additional stock-based compensation expenses to settle our consulting agreement with a consultant, increased asset insurance expenses as a result of increased gold inventory, as well as the increased consulting expenses in relation to obtaining loans from banks and various other financial institutions.

Interest expenses for the three months ended September 30, 2016 were $26.6 million compared with $0.3 million for the same period in 2015. The increase of interest expenses was mainly due to the significant loan borrowings for the three months ended September 30, 2016.

The current provision for income tax expense was approximately $25.2 million for three months ended September 30, 2016, an increase of $25.1 million from $0.07 million for the same period in 2015. The increase was primarily due to the increase in our taxable income, arising from increased sales and higher gross margin and recorded investment income per book. The deferred income tax benefit was approximately $19.9 million, which was mainly due to the temporary differences from the gain from the sale of the Jewelry Park for three months ended September 30, 2016, comparing to a deferred income tax provision of approximately $3.1 million for three months ended September 30, 2015.

Net Income Attributable to Common Stockholders

For the forgoing reasons, net income was $15.7 million for the three months ended September 30, 2016 compared to $8.8 million for the same period in 2015, an increase of $6.9 million.

Nine Month Period Ended September 30, 2016 Compared to the Nine Month Period Ended September 30, 2015

Net Sales

Net sales for the nine months ended September 30, 2016 amounted to $1,063 million, an increase of $343.6 million, or 47.8%, from net sales of $719.4 million for the nine months ended September 30, 2015. For the the nine months ended September 30, 2016, our branded production sales accounted for 98.3% of the total sales and customized production sales accounted for 1.7% of the total sales. When comparing with nine months ended September 30, 2015, our branded production sales increased by $345.4 million or 49.4%, our customized production sales decreased by $1.7 million or 9.0%.

The overall increase in our revenue in nine months ended September 30, 2016 as compared to nine months ended September 30, 2015 was due to the following combined factors: (1) Total sales volume (in terms of quantity sold) increased from 40.26 metric tons in nine months ended September 30, 2015 to 55.73 metric tons in nine months ended September 30, 2016, causing 15.5 metric tons or 38.4% increase. As a result, approximately $308.9 million increase in our revenue was attributable to the increase in our sales volume. (2) The average unit selling price for our brand production sales increased from RMB 212.5 per gram in nine months ended September 30, 2015 to RMB 240.3 per gram in nine months ended September 30, 2016, causing 13.1% increase. As a result, approximately $91.5 million increase in brand production revenue was affected by the increase in our selling price, partially offset against the decrease in customized production revenue to certain extent. (3) Foreign currency adjustment effect was approximately a $45.9 million foreign currency translation loss converting RMB into USD when the average exchange rate of USD: RMB increased from 1 USD=6.1606 RMB in nine months ended September 30, 2015 to 1 USD=6.5802 RMB in nine months ended September 30, 2016. 

In nine months ended September 30, 2016, we processed a total of 55.7 metric tons of gold, of which branded production accounted for 28.6 metric tons (51.4%) and customized production accounted for 27.1 metric tons (48.6%). In nine months ended September 30, 2015, we processed a total of 40.3 metric tons of gold, of which branded production accounted for 20.3 metric tons (50.4%) and customized production accounted for 20.0 metric tons (49.6%).  

Cost of Sales

Cost of sales for the nine months ended September 30, 2016 amounted to $938.0 million, an increase of $247.4 million, or 35.8%, from $690.6 million for the same period in 2015. The increase was primarily due to higher volume of products sold. The sale quantity increased 38.4% to approximately 55.7 metric tons in nine months ended September 30, 2016 from 40.3 metric tons in nine months ended September 30, 2015.

Gross Profit and Margin

Gross profit for the nine months ended September 30, 2016 was $125.0 million, an increase of $96.2 million from $28.8 million for the same period in 2015. Accordingly, gross margin for the nine months ended September 30, 2016 was 11.8%, compared to 4.0% for the same period in 2015. The primary reason for the substantial increase in gross margin was due to the unit price of branded production sales was RMB 240.3 per gram for the nine months ended September 30, 2016, while the unit price of branded production sales was RMB 212.5 per gram for the nine months ended September 30, 2015, the unit price increased by 13.1%. On the other hand, the unit cost of branded production was RMB 215.3 per gram for the nine months ended September 30, 2016, while the unit cost of brand production was RMB 209.2 per gram for the nine months ended September 30, 2015. Although there was an increase in unit cost for branded production, the percentage increase of the unit price is smaller than the increase in the sales due to the fact that the Company purchased significant quantity of gold in prior period at relatively low price and reserved for the subsequent productions. As a result, the unit margin of branded production was RMB 25.0 per gram for the nine months ended September 30, 2016 compared to RMB 3.3 per gram for the nine months ended September 30, 2015.

Expenses

Total operating expenses for the nine months ended September 30, 2016 were $13.8 million compared with $7.6 million for the same period in 2015. The increase was mainly due to increased Selling, General and Administrative expenses for broader marketing efforts, such as increased employee salary and annual bonus expense during the Chinese Spring Festival, increased legal, accounting for special projects, and additional stock-based compensation expenses to settle the investor relationship agreement with a consultant, increased asset insurance expenses as a result of increased gold inventory, as well as the increased consulting expenses in relation to obtaining loans from banks and various of other financial institutions.

Interest expenses for the nine months ended September 30, 2016 were $45.1 million compared with $0.7 million for the same period in 2015. The increase of interest expenses was mainly due to the significant loan borrowings of $1,062.3 million for the nine months ended September 30, 2016.

The current provision for income tax expense was approximately $36.9 million for nine months ended September 30, 2016, an increase of $33.5 million from $3.4 million for the same period in 2015. The increase was primarily due to the increase in our taxable income, arising from increased sales and higher gross margin and recorded investment income per book. The deferred income tax benefit was approximately $19.7 million, which was mainly due to the temporary differences from the gain on sale of Jewelry Park for nine months ended September 30, 2016, comparing to a deferred income tax provision of approximately $1.3 million for three months ended September 30, 2015.

Net Income Attributable to Common Stockholders

For the forgoing reasons, net income was $50.7 million for the nine months ended September 30, 2016 compared to $15.9 million for the same period in 2015, an increase of $34.8 million.

Cash Flows

Net cash used in operating activities.

Net cash used in operating activities was $726.3 million for the nine months ended September 30, 2016, compared with net cash used in operating activities of $34.0 million for the same period in 2015.

The significant increase in net cash used in operating activities was mainly due to our spending on purchase of inventory of $817.8 million in anticipation of the increased production and sales demand when the Jewelry Park is completed which may stimulate our sales starting from the second half 2016. In addition, in connection with our significant bank borrowings during the nine months ended September 30, 2016, we are required to pledge 28,106,750 grams of gold with the banks as collateral, which also led us to increase the inventory purchases and stockpile. On the other hand, in connection with the Jewelry Park Transfer Transaction, we received net proceeds of $151.4 cash payment from Wuhan Lianfuda for the Jewelry Park transfer, and such amount will be adjusted when we deliver the Jewelry Park to Wuhan Lianfuda in the near future. The overall increase in cash used in operating activities for the nine months ended September 30, 2016 is reflected in the above mentioned factors.

Analysis and Expectations: Our net cash from operating activities can fluctuate significantly due to changes in our inventories. Factors that may vary significantly include our purchases of gold and value added tax. Looking forward, we expect the net cash that we generate from operating activities to continue to fluctuate as our inventories, receivables, accounts payables and other factors described above change with increased production, and the purchase of larger quantities of raw materials. These fluctuations could cause net cash from operating activities to fall, even if, as we expect, our net income grows as we expand. Although we expect net cash from operating activities will rise over the long term, we cannot predict how these fluctuations will affect our cash flow in any particular quarter.

Net cash used in investing activities.

Net cash used in investing activities was $20.7 million for the nine months ended September 30, 2016, compared with net cash used in investing activities of $26.2 million for the nine months ended September 30, 2015.  The decrease in the net cash used in the investing activities was mainly because there was $5.7 million less cash paid to finance the construction of the Jewelry Park during the current period.

Analysis and Expectations: Since we committed to sell the Jewelry Park to Wuhan Lianfuda, we do not expect a significant fluctuation in our investing activities in the near future.

Net cash provided by financing activities.

Net cash provided by financing activities was $875.4 million for the nine months ended September 30, 2016, compared with net cash provided by financing activities of $89.1 for the nine months ended September 30, 2015. The increase net cash provided by the financing activities was mainly due to the fact that the Company borrowed additional $1,077 million bank loans during the nine months ended September 30, 2016 and we also repaid $54.9 million bank loans and $60.8 million debts payable upon maturity.

Analysis and Expectations:  We expect that cash generated from financing activities may increase significantly as a result of additional financing being obtained to meet the needs of expanded production. 

Off-Balance Sheet Arrangements

We originally guaranteed payment to a non-related third-party of approximately $10.2 million (RMB 68 million) in bank loans. The guarantee terminated in May 2015.

As of September 30, 2016 and December 31, 2015, an aggregate of 1,420 kilograms and 2,782 kilograms of leased gold were outstanding, at the approximated amounts of $52.6 million and $101.8 million, respectively.

Liquidity and Capital Resources

As of September 30, 2016, we had approximately $129.6 million in cash and cash equivalents. We have financed our operations with cash flow generated from operations and through borrowing of bank loans as well as through private and public borrowing and offerings in the U.S. and Chinese capital markets, such as our recent placement under our commercial paper program with Shanghai Pudong Development Bank (“SPD Bank”).

At September 30, 2016, we had total outstanding loans of $1,092.2 million (including $195.2 million short-term loans and $897 million long term loans). The amounts outstanding under these bank loans are presented in our financial statements as “loans.” For additional information regarding our loans, please see Note 6 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report.

We have maintained a close relationship with the banks from where we leased gold. Therefore we expect that we are able to renew current gold leases upon maturity and obtain additional gold leases from the banks, if necessary. We are expecting to generate additional cash flows in the coming period of time from developing new customers, expanding our sales through our online sales platform and an increase in our revenue during the upcoming sales season.

As of September 30, 2016, the Company had positive working capital of $1,018 million. We believe that our current cash and cash flow from operations will be sufficient to meet our anticipated cash needs, including our cash needs for working capital for the next 12 months.. We may, however, require additional cash resources due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. Our ability to maintain sufficient liquidity depends partially on our ability to achieve anticipated levels of revenue, while continuing to control costs. We continue to seek favorable additional financing to meet our capital requirements to fund our operations and growth plans in the ordinary course of business.

The ability of Wuhan Vogue-Show to pay dividends may be restricted due to the PRC’s foreign exchange control policies and our availability of cash. A majority of our revenue being earned and currency received is denominated in RMB. We may be unable to distribute any dividends outside of China due to PRC exchange control regulations that restrict our ability to convert RMB into U.S. Dollars. Accordingly, Vogue-Show’s funds may not be readily available to us to satisfy obligations incurred outside the PRC, which could adversely affect our business and prospects or our ability to meet our cash obligations.

On June 27, 2016, Wuhan Kingold signed certain 5 years lease agreements to rent office and store space at the Jewelry Park commencing in July 2016 and October 2016, respectively, with aggregated annual rent of approximately $0.09 million and $0.17 million, respectively. For the three and nine months ended September 30, 2016, the Company recorded $21,884 rent expense. As of September 30, 2016, the Company was obligated under non-cancellable operating leases for minimum rentals as follows:

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures in the financial statements. Critical accounting policies are those accounting policies that may be material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and that have a material impact on financial condition or operating performance. While we base our estimates and judgments on our experience and on various other factors that we believe to be reasonable under the circumstances, actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies used in the preparation of our financial statements require significant judgments and estimates. For additional information relating to these and other accounting policies, see Note 2 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report.

Inventories

Inventory is stated at the lower of cost or market value. Cost is determined using the weighted average method. We continually evaluate the composition of our inventory, turnover of our products, the price of gold, and the ability of our customers to pay for their products. We write down slow-moving and obsolete inventory based on an assessment of these factors, but principally customer demand. Such assessments require the exercise of significant judgment by management. Additionally, the value of our inventory may be affected by commodity prices. Decreases in the market value of gold would result in a lower stated value of our inventory, which may require us to take a charge for the decrease in the value. In addition, if the price of gold changes substantially in a very short period, it might trigger customer defaults, which could result in inventory obsolescence. If any of these factors were to become less favorable than those projected, inventory write-downs could be required, which would have a negative effect on our earnings and working capital.

Revenue Recognition

Our revenue is derived from the sales price of goods sold and fees for services provided. We recognize revenue for goods sold when they are delivered to the customer. We recognize revenue for services provided when the services have been performed and collectability is deemed probable. Management has not made an allowance for estimated sales returns because they are considered immaterial when viewed in light of our overall revenue and historical experience.

Item 3. Quantitative and Qualitative Disclosure about Market Risk

Foreign Currency Exchange Rate Risk

Given that all of our revenues are generated in RMB, yet our results are reported in U.S. dollars, devaluation of the RMB could negatively impact our results of operations. The value of RMB is subject to changes in the PRC’s governmental policies and to international economic and political developments. In January 1994, the PRC government implemented a unitary managed floating rate system. Under this system, the People’s Bank of China, or PBOC, began publishing a daily base exchange rate with reference primarily to the supply and demand of RMB against the U.S. dollar and other foreign currencies in the market during the previous day. Authorized banks and financial institutions are allowed to quote buy and sell rates for RMB within a specified band around the central bank’s daily exchange rate. On July 21, 2005, the PBOC announced an adjustment of the exchange rate of the U.S. dollar to RMB from 1:8.27 to 1:8.11 and modified the system by which the exchange rates are determined. Over the past four years, RMB has appreciated 8.6% against the U.S. dollar (from USD1 = RMB 7.2946 on January 1, 2008 to USD1 = RMB 6.6702 on September 30, 2016). While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in further fluctuations of the exchange rate of RMB against the U.S. dollar, including possible devaluations. As all of our net revenues are recorded in RMB, any future devaluation of RMB against the U.S. dollar could negatively impact our results of operations.

Along these lines, the income statements of our operations are translated into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currencies denominated transactions results in reduced revenue, operating expenses and net income for our international operations. Similarly, to the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency denominated transactions results in increased revenue, operating expenses and net income for our international operations. We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign subsidiaries into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign subsidiaries’ financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income. In addition, we have certain assets and liabilities that are denominated in currencies other than the relevant entity’s functional currency. Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss. We have not entered into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future. The availability and effectiveness of any hedging transaction may be limited and we may not be able to successfully hedge our exchange rate risks.

Interest Rate Risk

Our bank borrowings as of September 30, 2016, were approximately $1,092.2 million, and interest expense paid was $45.1 million for the nine months ended September 30, 2016.

At the end of September 30, 2016, our weighted average interest rate was 10.3%. We do not expect the interest expense will be changed dramatically as we have secured the gold lease for a period of 12 months. We currently have no interest rate hedging positions in place to reduce our exposure to interest rates.

Commodity Price Risk

Most of our sales are of products that include gold, precious metals and other commodities, and fluctuations in the availability and pricing of commodities would adversely impact our ability to obtain and make products at favorable prices. The jewelry industry generally is affected by fluctuations in the price and supply of diamonds, gold, and, to a lesser extent, other precious and semi-precious metals and stones. In the past, we have not hedged our requirement for gold or other raw materials through the use of options, forward contracts or outright commodity purchasing, although we may do so in the future. A significant increase in the price of gold could increase our production costs beyond the amount that we are able to pass on to our customers, which would adversely affect our sales and profitability. A significant disruption in our supply of gold or other commodities could decrease our production and shipping levels, materially increase our operating costs, and materially and adversely affect our profit margins. Shortages of gold, or other commodities, or interruptions in transportation systems, labor strikes, work stoppages, war, acts of terrorism, or other interruptions to or difficulties in the employment of labor or transportation in the markets in which we purchase our raw materials, may adversely affect our ability to maintain production of our products and sustain profitability. If we were to experience a significant or prolonged shortage of gold, we would be unable to meet our production schedules and to ship products to our customers in a timely manner, which would adversely affect our sales, margins and customer relations.

A dramatic increase in the price of gold could increase our production costs beyond the amount that we may be able to pass on to our customers, which could adversely affect our gross profit margin and profitability. Furthermore, the carrying value of our inventory may be affected. Slight decreases in the market price of gold following the end of a reporting period could impact the carrying amount of the inventory at the balance sheet date and/or the following reporting period’s gross profit margin and profitability.

If the market value dropped by just RMB 5 per gram below our weighted purchase price, we would need to write down our inventory by approximately RMB 157,000,000 (approximately $23,000,000) based on our holdings of approximately 31,388,000 grams of gold at September 30, 2016. We maintain significant inventory of gold. As of September 30, 2016, our inventory was valued at RMB 233.42 per gram, which represents the lower of actual purchase price or market value. Our inventory purchase price is calculated using the weighted value on a first in, first out basis. As of September 30, 2016, our weighted purchase price was RMB 233.42 per gram, while the market price was RMB 238.01 per gram.

Because the market price was higher than our weighted purchase price, we were not required to write down the value of our gold, but we cannot guarantee that this will continue to be the case. If the market price drops in the future, such write downs could be significant. For example, over the last 12 months the market value of gold has fluctuated between RMB 217.91 per gram and RMB 251.97 per gram a variance of RMB 34.06 per gram. If the market value dropped by just RMB 5 per gram below our weighted purchase price, we would need to write down our inventory by approximately RMB 157,000,000 (approximately $23,000,000), based on our holdings of approximately 31,388,000 grams of gold at September 30, 2016. By contrast, if the market value increased by RMB 5 per gram above the current price, it would not benefit our inventory carrying value.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to provide reasonable assurance that material information required to be disclosed by us in the reports filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that the information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on our review, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were not effective at the reasonable assurance level as of the end of the period covered by this Quarterly Report due to the continued existence of material weaknesses in our internal control over financial reporting.

In connection with the preparation of this Quarterly Report, management determined that, as of September 30, 2016, we did not maintain effective internal control over financial reporting due to the existence of the following material weaknesses:

In order to remedy the material weakness of inadequate controls over cash management, our Board adopted resolutions requiring management to seek Board approval prior to entering into any transactions including gold leases and loans with a value in excess of $250,000. Further, we intend to explore implementing additional policies and procedures, which may include:

Changes in Internal Controls

There have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during our nine months ended September 30, 2016. Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. Further, because of changes in conditions, effectiveness of internal controls over financial reporting may vary over time. Our system contains self-monitoring mechanisms, and actions are taken to correct deficiencies as they are identified.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we may be subject to legal proceedings and claims in the ordinary course of business. We are not currently a party to any litigation the outcome of which, if determined adversely to us, would individually or in the aggregate be reasonably expected to have a material adverse effect on our business, operating results, cash flows or financial condition. Our business may also be adversely affected by risks and uncertainties not presently known to us or that we currently believe to be immaterial. If any of the events contemplated by the following discussion of risks should occur, our business, prospects, financial condition and results of operations may suffer.

Item 1A.  Risk Factors

As a smaller reporting company, we are not required to provide the information otherwise required by this Item.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.