4  PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment consist of the following:

		June 30, 2010				December 31, 2009
		(unaudited)
Buildings		$	2,812,390			$	2,564,638
Plant and machinery			15,264,317				11,762,449
Office equipment			77,243				76,639
Motor vehicles			262,328				148,020
			18,416,278				14,551,746
Less: Accumulated depreciation and amortization			(2,999,402)				(1,994,055	)
		$	15,416,876			$	12,557,691

Depreciation expense for the six months ended June 30, 2010 and 2009 was $989,410 and $693,729, respectively.

5. CONVERTIBLE NOTES

Convertible notes consist of the following at: 

 

		June 30,				December 31,
		2010				2009
			(unaudited)
10% convertible notes		$	--			$	10,217,000
Valuation discount			--				(8,601,975	)
Convertible notes, net			--				1,615,025
Less current portion			--				--
Long term portion		$	--			$	1,615,025

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In July 2009, the Company issued $11,592,000 of 10% senior secured convertible notes (the “Notes”) and issued warrants (the “Warrants”) to purchase up to 6,101,054 shares of common stock of the Company in a private placement.  The Notes bore interest at 10% per annum, were due in 2012, were unsecured, and were personally guaranteed by the Company’s Chief Executive Officer and certain shareholders.  The holders of the Notes had the right at any time to convert all or part of the outstanding principal amount of the Notes and any accrued and unpaid interest into common shares of the Company at the then effective conversion price, initially set at $1.90 per share.  In 2009, $1,375,000 of the convertible notes was converted at the stated conversion price of $1.90 per share into 723,684 shares of the Company’s common stock.  During the first quarter of 2010, the balance of the notes of $10,217,000 was converted at the stated conversion price of $1.90 per share into 5,377,368 shares of the Company’s common stock.  On March 5, 2010, the Company issued 266,387 shares of common stock to all holders of notes outstanding as of March 5, 2010, as consideration for their forfeiture of certain rights and interest payments.  The fair value of the additional 266,387 shares of common stock was $1,864,701 on the date the shares were issued, and is included in interest expense in the accompanying June 30, 2010 condensed consolidated financial statements.

 

At December 31, 2009, the Company had recorded a derivative liability of $28,404,181 related to the conversion feature of the convertible notes.   When the notes converted, the derivative liability was extinguished and a gain on extinguishment of the derivative was recorded.  Also upon conversion, the unamortized balance of the note discount of $8,601,975 was fully amortized and included in interest expense in the accompanying condensed consolidated financial statements.

6. DERIVATIVE LIABILITIY

At June 30, 2010 and December 31, 2009, derivative liabilities were made up of the following valued based on the Black-Scholes-Merton and bi-nominal valuation techniques with the following assumptions:

 

		June 30, 2010				December 31, 2009
		（Unaudited）
Conversion feature :
Risk-free interest rate			--				1.5	%
Expected volatility			.--				148.47	%
Expected life (in years)		--				2.75 years
Expected dividend yield			--				--
Warrants :
Risk-free interest rate			0.59	%			1.32	%
Expected volatility			123.79	%			148.47	%
Expected weighted average life (in years)		1.94 years				2.81 years
Expected dividend yield			0				0
Fair Value :
Conversion feature		$	--			$	28,404,181
Warrants			18,130,524				16,752,858
		$	18,130,524			$	45,157,039

The risk-free interest rate was based on rates established by the Federal Reserve Bank, the Company uses the historical volatility of its common stock, and the expected life of the instruments is determined by the expiration date of the instrument.  The expected dividend yield was based on the fact that the Company has not paid dividends to common shareholders in the past and does not expect to pay dividends to common shareholders in the future.

At December 31, 2009, the Company had recorded a derivative liability of $28,404,181 related to the conversion feature of the convertible notes.   When the notes converted, the derivative liability was extinguished and a gain on extinguishment of the derivative was recorded. For the three months ended June 30, 2010 and 2009, change in derivative liability was $2,862,263 and $(1,779,968), respectively. For the six months ended June 30, 2010 and 2009, change in derivative liability was $(1,377,666) and $(1,200,990), respectively.

 

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7. COMMON STOCK

During the six months ended June 30, 2010, the Company issued 5,377,368 shares of common stock upon conversion of $10,217,000 of convertibles notes.  On March 5, 2010, the Company issued 266,387 shares of common stock to all holders of notes outstanding as of March 5, 2010, as consideration for their forfeiture of certain rights and interest payments.  The fair value of the additional 266,387 shares of common stock was $1,864,701 on the date the shares were issued, and is included in interest expense in the accompanying June 30, 2010 condensed consolidated financial statements.

.During the six months ended June 30, 2010, the Company issued 62,632 shares of common stock upon exercise of options and warrants for total proceeds of $173,980.

8.  WARRANTS AND OPTIONS

The following table summarizes stock warrants and option activity for the six months ended June 30, 2010:

 

		Number of Shares underlying Warrants and Options				Weighted Average Exercise Price
Warrants and options outstanding at January 1, 2010			4,413,744			$	2.51
Warrants and options granted			60,000			$	7.38
Warrants and options exercised			(62,632)			$	2.78
Warrants and options expired			(287,130)			$	1.50
Warrants and options outstanding at June 30, 2010			4,123,982			$	2.66

The following table summarizes information about warrants and options outstanding at June 30, 2010:

 

Outstanding Warrants and Options												Exercisable Warrants and Options
Exercise price				Number of shares underlying warrants and options				Weighted average remaining contractual life (years)				Number of shares underlying warrants and options exercisable				Weighted average exercise price
$	1.50				603,304				1.21				603,304			$	1.50
$	2.28				427,074				2.33				427,074			$	2.28
$	2.50				35,710				0.22				35,710			$	2.50
$	2.85				2,997,894				1.97				2,997,894			$	2.85
$	4.35				10,000				1.62				10,000			$	4.35
$	7.98				50,000				1.95				-			$	-
$	2.66				4,123,982								4,073,982			$	2.59

At June 30, 2010, the aggregate intrinsic value of the warrants and options outstanding and exercisable was $14,703,227.

The warrants have an initial exercise price ranging from $1.50 to $2.85 per share, and are subject to full ratchet anti-dilution adjustments in the event that the Company issues additional equity, equity linked securities or securities convertible into equity, at a purchase price less than the then applicable Conversion Price or the Exercise Price.

On February 12, 2010, the Company granted to its Chief Financial Officer an option to purchase 10,000 shares of common stock.  The options have an exercise price of $4.35 per share, an expiration date of 2 years from the date of grant, and vested immediately.  The Company determined the fair value of the options on the date of grant was $18,152 using the Black-Scholes option pricing model with the following assumptions: expected volatility, 114.35%; risk-free interest rate, 0.38%; expected weighted average life, 1 year; and expected dividend yield, 0%.  The Company has recorded $18,152 as fair value of the options granted during the six months ended June 30, 2010.

 

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On June 11, 2010, the Company granted to its Corporate Development consultant an option to purchase 50,000 shares of common stock. The options vest upon the completion of a public offering of the Company’s common stock, have an exercise price of $7.98 per share and an expiration date of 2 years from the grant date. During the six months ended June 30, 2010, the Company did not complete a public offering of its common stock and no expense was recognized related to these options.

9.  INCOME TAXES

        Companies in the PRC are generally subject to PRC Enterprise Income Tax at a uniform tax rate of 25% under the China's Unified Enterprise Income Tax Law ("New EIT Law"), which took effect from January 1, 2008.  The New EIT Law provides a five-year transition period from its effective date for those enterprises which were established before the promulgation date of the New EIT Law and which were entitled to a preferential EIT treatment. Accordingly, Shenyang Suo'ang New Energy is subject to the uniform tax rate of 25%. Shaanxi Suo'ang New Energy is entitled to two years tax holiday for 2007 and 2008 and 50% reduction on its EIT rate for the 2009, 2010 and 2011.

        The Company has not recorded a provision for U.S. federal income tax for the three and six month period ended June 30, 2010 and 2009 due to a net operating loss carry forward in the United States of America. At June 30, 2010 and 2009, the Company had net operating loss carryforwards in the United States of America of approximately $2,336,000 and $655,000, respectively, which begin to expire in 2028. The deferred tax asset created by the net operating loss has been offset by a 100% valuation allowance. At June 30, 2010 and 2009, there were no other significant deferred tax assets or deferred tax liabilities.

        Income tax expense consists of the following for the:

		Three months ended June 30								Six months ended June 30
		2010				2009				2010				2009
Current-PRC Enterprise Income Tax		$	1,540,627			$	303,382			$	3,291,132			$	592,668
Deferred tax			-				-				-				-
Total income tax expense			1,540,627				303,382				3,291,132				592,668

The following table reconciles the U.S. statutory rates to the Company's effective tax rate for the:

 

		Three months ended June 30,								Six months  ended June 30,
		2010				2009				2010				2009
U.S. statutory rate			34	%			34	%			34	%			34	%
Permanent differences			(9	)%			14	%			(17	)%			8	%
Tax holiday			(3	)%			(9	)%			(2	)%			(16	)%
Effect of statutory rate differential			(7	)%			(3	) %			(5	)%			(4	)%
Effective tax rate			15	%			36	%			10	%			22	%

 

Permanent differences are related to gain (loss) on change in the value of derivatives and the extinguishment of the derivatives liabilities.

 

     Effective January 1, 2007, the Company adopted authoritative guidance issued by the FASB for uncertainty in income taxes. The Interpretation addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC 740-10, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. ASC 740-10 also provides guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. At the date of adoption, and as of June 30, 2010, the Company does not have a liability for unrecognized tax uncertainties except as described below. The Company and its Chinese subsidiaries have never been subject to a tax examination and all years are open to examination by the tax authorities.

 

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        The Company was delinquent in filing its U.S. federal income tax returns for its taxable years ended September 30, 2007 and 2008 and information reports for its bank accounts located in the PRC for 2006, 2007, and 2008. There is no U.S taxable income for the applicable years and the Company believes that its failure to file the information reports was not willful.  Accordingly, no provision has been made for U.S. income taxes and the Company has recorded its estimate of total penalties that may be assessed for the delinquent U.S. tax returns and reports in the accompanying condensed consolidated financial statements.

        The Company enjoys certain tax holidays under the New EIT Law. For the three and six months ended June 30, 2010, the tax holidays decreased income tax expense by approximately $364,154 and $739,906, respectively, and the benefit of the tax holiday on net income per share (basic) was approximately $0.02 and $0.05, respectively.  For the three and six months ended June 30, 2009, the tax holidays decreased income tax expense by approximately $242,256 and $437,873, respectively, and the benefit of the tax holiday on net income per share (basic) was approximately $0.05 and $0.05, respectively.

10.  RELATED PARTY TRANSACTIONS

Amounts due to related parties consisted of the following at:

 

		June 30, 2010 (unaudited)				December 31, 2009
Due to executive officer and director :
Mr. Baowen Ren		$	73,466			$	73,466

Amounts due to executive officer and director are non-interest bearing, unsecured, and due on demand.

 

11. COMMITMENTS

 

Tongchuan facility

We have entered into an agreement with Tongchuan City Investment and Development Co., Ltd. ("TCID") to develop a new heat supply company for the purpose of providing heating for the new district in Tongchuan. TCID has stated that 15 new heat supply plants will need to be built to supply an area of 16.4 million square meters. The first three plants are expected to be built and operational by the end of 2010, with the remaining plants expected to be completed over the following five to seven years. The newly formed heat supply company will require an investment of $12.5 million by TCID, for which it will receive an 85% stake in the new company, and $2.2 million by Suo'ang New Energy, for which it will receive a 15% stake in the new company. As of August 10, 2010, we have not made any investment in the heat supply company.

Nanning facility

In November 2009, through our subsidiary, Suoke Clean Energy, we entered into a memorandum of understanding with the local government of Nanning, Guangxi Province, pursuant to which we plan to establish a 500,000 metric ton per annum CWSF production facility in the city of Nanning. We expect to commence construction on the facility in third quarter 2010, with a view to commencing commercial production by 2011. As of August 10, 2010, we have not entered into any contracts or commitments related to the Nanning facility construction.

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

The following management’s discussion and analysis should be read in conjunction with our consolidated financial statements and the notes thereto and the other financial information appearing elsewhere in this item. In addition to historical information, the following discussion contains certain forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These statements relate to our future plans, objectives, expectations and intentions. These statements may be identified by the use of words such as “may”, “will”, “could”, “expect”, “anticipate”, “intend”, “believe”, “estimate”, “plan”, “predict”, and similar terms or terminology, or the negative of such terms or other comparable terminology. Although we believe the expectations expressed in these forward-looking statements are based on reasonable assumptions within the bound of our knowledge of our business, our actual results could differ materially from those discussed in these statements. Factors that could contribute to such differences include, but are not limited to, those discussed in the “Risk Factors” section of the Company's Annual Report on Form 10-K filed with the SEC on April 9, 2010.  We undertake no obligation to update publicly any forward-looking statements for any reason even if new information becomes available or other events occur in the future.

 

Our financial statements are prepared in U.S. Dollars and in accordance with accounting principles generally accepted in the United States. See “Exchange Rates” below for information concerning the exchanges rates at which Renminbi were translated into U.S. Dollars at various pertinent dates and for pertinent periods.

In this Quarterly Report on Form 10-Q, references to “we”, “our”, “us”, the “Company” or the “Registrant” refer to Sino Clean Energy Inc., a Nevada corporation, and its subsidiaries and affiliated companies.

 

Overview

 

Sino Clean Energy Inc. (sometimes referred to in this annual report as “Company”, “we” or “our”) is a holding company that, through its subsidiaries, based upon total third party sales revenue in China, is a leading commercial producer and distributor of coal-water slurry fuel (“CWSF”) in China. CWSF is a clean fuel that consists of fine coal particles suspended in water.  Our CWSF products are mainly used to fuel boilers and furnaces to generate steam and heat for residential and industrial applications.  We sell our products in China and our customers include industrial, commercial, residential and government organizations. Our strong reputation in the CWSF industry in China, together with our established track record for consistently delivering products in large quantities, has enabled us to expand our customer base.  We primarily use washed coal to produce CWSF. We acquire the raw materials for each of our production facilities primarily from three nearby coal mines.  We have established strong relationships with our suppliers and our ability to purchase large quantities of raw materials has allowed us to achieve favorable pricing and delivery terms.

  

Critical Accounting Policies and Estimates

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates.

 

Revenue Recognition

Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectibility is reasonably assured.  Revenues are presented net of value added tax (“VAT”). In our revenue arrangements, physical delivery is the point in time when customer acceptance occurs since title and risk of loss are transferred to the customer.  No return allowance is made as products are normally not returnable upon acceptance by the customers.

 

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Accounts receivable

Accounts receivables are recognized and carried at original invoiced amount less an allowance for any uncollectible accounts. The Company uses the aging method to estimate the valuation allowance for anticipated uncollectible receivable balances.  Under the aging method, bad debts determined by management are based on historical experience as well as the current economic climate and are applied to customers' balances categorized by the number of months the underlying invoices have remained outstanding.  The valuation allowance balance is adjusted to the amount computed as a result of the aging method.  When facts subsequently become available to indicate that an adjustment to the allowance should be made, this is recorded as a change in estimate in the current year. As of June 30, 2010 and December 31, 2009, accounts receivable were net of allowances of zero and zero, respectively.

Derivative Financial Instruments

The Company evaluates all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the condensed consolidated statements of operations. For stock-based derivative financial instruments, the Company uses both the Black-Scholes-Merton and Binomial option pricing models to value the derivative instruments at inception and on subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period.  Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

 

Stock based Compensation

The Company periodically issues stock options and warrants to employees and non-employees in capital raising transactions, for services and for financing costs. Stock-based compensation is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period. Options vest and expire according to terms established at the grant date.

We estimate the fair value of stock options and warrants using the Black-Scholes option-pricing model, which was developed for use in estimating the fair value of options that have no vesting restrictions and are fully transferable. This model requires the input of subjective assumptions, including the expected price volatility of the underlying stock and the expected life of stock options. Projected data related to the expected volatility of stock options is based on the average volatility of the trading prices of comparable companies and the expected life of stock options is based upon the average term and vesting schedules of the options. Changes in these subjective assumptions can materially affect the fair value of the estimate, and therefore the existing valuation models do not provide a precise measure of the fair value of our employee stock options.

 

We estimate the fair value of shares of common stock issued for services based on the closing price of our common stock on the date shares are granted.  

Recent accounting pronouncements

In April 2010, the Financial Accounting Standards Board (FASB) issued new accounting guidance in applying the milestone method of revenue recognition to research or development arrangements. Under this guidance management may recognize revenue contingent upon the achievement of a milestone in its entirety, in the period in which the milestone is achieved, only if the milestone meets all the criteria within the guidance to be considered substantive. This standard is effective on a prospective basis for research and development milestones achieved in fiscal years, beginning on or after June 15, 2010. Early adoption is permitted; however, adoption of this guidance as of a date other than January 1, 2011 will require the Company to apply this guidance retrospectively effective as of January 1, 2010 and will require disclosure of the effect of this guidance as applied to all previously reported interim periods in the fiscal year of adoption. As the Company plans to implement this standard prospectively, the effect of this guidance will be limited to future transactions. The Company does not expect adoption of this standard to have a material impact on its financial position or results of operations as it has no material research and development arrangements which will be accounted for under the milestone method.

 

In April 2010, the FASB issued new accounting guidance to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity.  The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  The Company does not expect adoption of this standard will have an effect on our consolidated results of operation or our financial position.

 

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In January 2010, the FASB issued new accounting guidance which requires new disclosures regarding transfers in and out of Level 1 and Level 2 fair value measurements, as well as requiring presentation on a gross basis of information about purchases, sales, issuances and settlements in Level 3 fair value measurements. The guidance also clarifies existing disclosures regarding level of disaggregation, inputs and valuation techniques. The new guidance is effective for interim and annual reporting periods beginning after December 15, 2009.  Disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements are effective for fiscal years beginning after December 15, 2010.  As this guidance requires only additional disclosure, there should be no impact on the consolidated financial statements of the Company upon adoption.

 

In April 2010, the FASB issued new accounting guidance to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity.  The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  The Company does not expect adoption of this standard will have a material impact on its consolidated financial statements.

 

In October 2009, a new accounting consensus was issued for multiple-deliverable revenue arrangements. This consensus amends existing revenue recognition accounting standards. This consensus provides accounting principles and application guidance on whether multiple deliverables exist, how the arrangement should be separated and the consideration allocated. This guidance eliminates the requirement to establish the fair value of undelivered products and services and instead provides for separate revenue recognition based upon management’s estimate of the selling price for an undelivered item when there is no other means to determine the fair value of that undelivered item. Previously the existing accounting consensus required that the fair value of the undelivered item be the price of the item either sold in a separate transaction between unrelated third parties or the price charged for each item when the item is sold separately by the vendor. Under the existing accounting consensus, if the fair value of all of the elements in the arrangement was not determinable, then revenue was deferred until all of the items were delivered or fair value was determined. This new approach is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The Company is in the process of evaluating whether the adoption of this standard will have a material effect on its financial position, results of operations or cash flows.

In June 2009, the FASB issued authoritative guidance on consolidation of variable interest entities.  The new guidance is intended to improve financial reporting by requiring additional disclosures about a company’s involvement in variable interest entities.  This new guidance is effective for fiscal years and interim periods beginning after November 15, 2009.  The Company adopted this guidance effective January 1, 2010, and it had no impact on the consolidated financial statements of the Company.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the Securities Exchange Commission (the "SEC") did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statements.

Results of Operations

Three month period ended June 30, 2010 compared to three month period ended June 30, 2009

 

The following tables set forth key components of our results of operations for the periods indicated.

 

		Three months ended June 30,
		(Unaudited)
		2010				2009
Revenue		$	24,149,761			$	8,314,500
Cost of goods sold			(14,779,016	)			(5,534,929	)
Gross profit			9,370,745				2,779,571
Selling expenses			1,136,019				2,261
General and administrative expenses			626,053				432,412
Income from operations			7,608,673				2,344,898
Other income (expenses)
Interest and finance costs			(13,591	)			(596,098	)
Expense related to escrow shares			-				(120,166	)
Interest income			19,353				7,285
Change in fair value of derivative liabilities			2,862,263				(1,779,968	)
Gain on extinguishment of derivative liability			-				989,260
Sundry income			4,688				-
Total other income (expenses)			2,872,713				(1,499,687	)
Income before provision for income taxes			10,481,386				845,211
Provision for income taxes			1,540,627				303,382
Net income			8,940,759				541,829
Other comprehensive income
Foreign currency translation adjustment			269,266				12,010
Comprehensive income		$	9,210,025			$	553,839

 

Revenue. During the three-month period ended June 30, 2010, we had revenues from sales of our coal-water slurry fuel of $24,149,761 as compared to revenues of $8,314,500 during the three-month period ended June 30, 2009, an increase of 190%. This significant increase is primarily attributable to the increased production from the production line added in late 2009, which led to an increase in sales to existing customers.  The annual production capacity as at June 30, 2010 was 850,000 tonnes after the commencement of our new CWSF production plant in Shenyang with annual output capacity of 300,000 tonnes and 200,000 production line added in Tongchuan , as compared to 350,000 tones as at June 30 2009 . At June 30 , 2010 we had 43 customers under CWSF supply agreements totaling approximately 600,000 tonnes per year , as compared to 27 customers totaling approximately 400,000 tonnes of CWSF per year as at June 30 , 2009. We believe that our sales and number of customers in 2010 as compared to 2009 are indicative of the growing market acceptance of CWSF.

 

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Cost of Goods Sold. Cost of goods sold, consisting of raw materials, direct labor and manufacturing overhead, depreciation of plant and machinery, was $14,779,016 for the three-month period ended June 30, 2010, as compared to $5,534,929 for the same period of 2009, an increase of 167%. The increase in cost of goods sold is in line with our increase in sales. However, gross profit margin improved from 33% in 2009 to 39% in 2010 mainly as a result of better pricing of CWSF in Shenyang.

Selling Expenses. Selling expenses totaled $1,136,019 for the three-month period ended June 30, 2010, as compared to $2,261 for the three-month period ended June 30, 2009. This increase is mainly in transportation cost as a result of the growth of our business in 2010.

General and Administrative Expenses. General and administrative expenses totaled $626,053 for the three-month period ended June 30, 2010, as compared to $432,412 for the three-month period ended June 30, 2009, an increase of 45%. This increase was primarily caused by our expansion in operation and the increased expenses related to being a public company.

Income from Operations. Our income from operations for the three months ended June 30, 2010 was $7,608,673, an increase of 224% as compared to $2,344,898 for the same period in 2009, in line with the increase in sales over period.

Other Income. Other income totaled $2,872,713 for the three-month period ended June 30, 2010, mainly as the result of the change in fair value of the derivative liabilities of $2,862,263 as compared to other expense of $1,499,687 for the three-month period ended June 30, 2009, primarily caused by the loss on change in fair value of derivative liabilities of $1,779,968 which was partially set off by the gain on extinguishment of derivative liability of $989,260 in 2009.

Provision for income taxes.    For the three month period ended June 30, 2010 and 2009, our provision for income taxes was $1,540,627 and $303,382, respectively. The increase in income taxes reflects the increase in taxable income from our operations in China. For the three months ended June 30, 2010 and 2009, our effective tax rate was 15% and 36%, respectively, of income before provision for income taxes. In 2010 and 2009, our effective tax rate was reduced by 16% and increased by 11%, respectively, due to expenses related to financings and derivatives that are classified as permanent differences. Additionally, in 2010 and 2009, our effective tax rate was reduced by 3% and 9%, respectively, for certain tax holidays we enjoy in the PRC.

Net Income. We had net income of $8,940,759 for the three-month period ended June 30, 2010, as compared to net income of $541,829 for the same period in 2009.  The increase in net income is primarily attributable to the increase in sales in 2010.

Six month period ended June 30, 2010 compared to six month period ended June 30, 2009

 

The following tables set forth key components of our results of operations for the periods indicated.

 

		Six months ended June 30,
		(Unaudited)
		2010				2009
Revenue		$	48,658,765			$	16,092,777
Cost of goods sold			(29,179,193	)			(10,883,036	)
Gross profit			19,479,572				5,209,741
Selling expenses			2,047,098				5,820
General and administrative expenses			1,345,235				981,311
Income from operations			16,087,239				4,222,610
Other income (expenses)
Interest and finance costs			(10,458,154	)			(1,081,845	)
Expense related to escrow shares			-				(240,333	)
Interest income			32,224				11,271
Change in fair value of derivative liabilities			(1,377,666	)			(1,200,990	)
Gain on extinguishment of derivative liability			28,404,181				989,260
Sundry income			4,688				-
Total other income (expenses)			16,605,273				(1,522,637	)
Income before provision for income taxes			32,692,512				2,699,973
Provision for income taxes			3,291,132				592,668
Net income			29,401,380				2,107,305
Other comprehensive income
Foreign currency translation adjustment			281,472				8,694
Comprehensive income		$	29,682,852			$	2,115,999

 

Revenue. During the six-month period ended June 30, 2010, we had revenues from sales of our coal water mixture of $48,658,765 as compared to revenues of $16,092,777 during the six-month period ended June 30, 2009, an increase of 202%.   This increase is mainly attributable to increase in the revenue and number of customers, from 27 for the six months ended June 30, 2009, to 43 for the same period in 2010.  

Cost of Goods Sold. Cost of goods sold, consisting of raw materials, direct labor and manufacturing overhead, depreciation of plant and machinery, was $29,179,193 for the six-month period ended June 30, 2010, as compared to $10,883,036 for the same period of 2009, an increase of 168%. The increase in cost of sales sold is in line with the increase in sales. However, gross profit margin improved from 32% in 2009 to 40% in 2010 mainly as a result of better pricing of CWSF in Shenyang.

 

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Selling Expenses. Selling expenses totaled $2,047,098 for the six-month period ended June 30, 2010, as compared to $5,820 for the six-month period ended June 30, 2009.  This increase in selling expenses is mainly due to increase in transportation cost as a result of the growth of our business in 2010 ..

General and Administrative Expenses. General and administrative expenses totaled $1,345,235 for the six-month period ended June 30, 2010, as compared to $981,311 for the six-month period ended June 30, 2009, an increase of 37%. This increase was primarily caused by our expansion in operations and the expenses related to being a public company.

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Income from Operations. Our income from operations for the six months ended June 30, 2010 was $16,087,239, an increase of 281% as compared to $4,222,610 for the same period in 2009, in line with the increase in sales.

 

Other Income (Expense). Other income totaled $16,605,273  for the six-month period ended June 30, 2010, as compared to other expense of $1,522,637 for the six-month period ended June 30, 2009, primarily caused by the gain on extinguishment of derivative liability of $28,404,181 which was partially set off by the interest expense of $10,458,154 in 2010.

Provision for income taxes.    For the six month period ended June 30, 2010 and 2009, our provision for income taxes was $3,291,132 and $592,668, respectively. The increase in income taxes reflects the increase in taxable income from our operations in China. For the six months ended June 30, 2010 and 2009, our effective tax rate was 10% and 22%, respectively, of income before provision for income taxes. In 2010 and 2009, our effective tax rate was reduced by 22% and increased by 4%, respectively, due to expenses related to financings and derivatives that are classified as permanent differences. Additionally, in 2010 and 2009, our effective tax rate was reduced by 2% and 16%, respectively, for certain tax holidays we enjoy in the PRC. 

Net Income. We had net income of $29,401,380 for the six-month period ended June 30, 2010, as compared to net income of $2,107,305 for the same period in 2009.  The increase in net income is primarily attributable to the increase in sales in the first six months of 2010 and gain on extinguishment of derivative liability.

Liquidity and Capital Resources

For the six-month period ended June 30, 2010, we generated $10,247,134 from operating activities, as compared to $5,754,000 that we generated from operating activities for the six-month period ended June 30, 2009.  This increase is primarily due to the increase in sales proceeds.

For the six-month period ended June 30, 2010, we used $2,703,876 in investing activities, of which $2,606,556 was used in the purchase of property, plant and equipment, as compared to the net cash provided by investing activities of $ 47,880 for the six-month period ended June 30, 2009.

For the six-month period ended June 30, 2010, we used $478,073 in financing activities, primarily in prepayment and deposits.

As of June 30, 2010, we had cash and cash equivalents of $25,575,339.  Our total current assets were $41,048,152 and our total current liabilities were $24,979,084 which resulted in a net working capital of $16,069,068.

We had no capital expenditure commitments outstanding as of June 30, 2010 in relation to the purchase of machinery.

We believe that we have sufficient cash flow to meet our obligations on a timely basis in the foreseeable future.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to our investors.

 

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Inflation

We believe that inflation has not had a material effect on our operations to date.