4  PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment consist of the following at March 31, 2010 and December 31, 2009:

		March 31, 2010				December 31, 2009
		(unaudited)
Buildings		$	2,565,351			$	2,564,638
Plant and machinery			15,185,157				11,762,449
Office equipment			76,842				76,639
Motor vehicles			260,967				148,020
			18,088,317				14,551,746
Less: Accumulated depreciation and amortization			(2,453,570	)			(1,994,055	)
		$	15,634,747			$	12,557,691

Depreciation expense on  the quarter ended March 31, 2010 and 2009 were $459,515 and $346,390, respectively.

5. CONVERTIBLE NOTES

Convertible notes consist of the following at:

 

		March 31,				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

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 in to 723,684 shares of the Company’s common stock.  During the quarter ended March 31, 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.  For some of the conversions made in 2010, note holders received an additional 266,387 shares of the Company’s stock representing additional interest consideration.  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 March 31, 2010 condensed consolidate financial statements.

 

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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 March 31, 2010 condensed consolidated financial statements.

At March 31, 2009, $1,335,650 of convertible debentures were outstanding that were paid off or converted into shares of the Company’s common stock in mid-2009. For the three month period ended March 31, 2009, $329,328 of discount amortization, $97,128 of amortization of loan fees, and $120,167 of expense for performance related compensatory escrow shares, was recorded related to the debentures.

 

6. DERIVATIVE LIABILITIY

At March 31, 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:

 

		March 31, 2010				December 31, 2009
		（Unaudited）
Conversion feature :
Risk-free interest rate			—				1.4	%
Expected volatility			—				139.96	%
Expected life (in years)		—				2.5 years
Expected dividend yield			—				—
Warrants :
Risk-free interest rate			0.67% to 1.32	%			0.93% to 1.43	%
Expected volatility			108.09% to 150.04	%			139.96% to 148.16	%
Expected life (in years)		0.46 to 2.6 years				0.71 to 2.8 years
Expected dividend yield			0				0
Fair Value :
Conversion feature		$	—			$	28,404,181
Warrants			20,992,787				16,752,858
		$	20,992,787			$	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 quarters ended March 31, 2010 and 2009, change in derivative liability was $(4,239,929) and $578,978, respectively.

7. COMMON STOCK

During the quarter ended March 31, 2010, the Company issued 5,643,755 shares of common stock upon conversion of $12,081,701 of convertibles notes and related interest.

 

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During the quarter ended March 31, 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

At March 31, 2010 and December 31, 2009, outstanding warrants and options were as follows:

 

		Number of Shares under Warrants and Options				Weighted Average Exercise Price
Warrants and options outstanding at January 1, 2010			4,413,744			$	2.51
Warrants and options granted			10,000			$	4.4
Warrants and options exercised			(62,632)			$	1.5
Warrants and options expired			(287,130)			$	1.5
Warrants and options outstanding at March 31, 2010			4,073,982			$	2.24

The following table summarizes information about warrants and options outstanding at March 31, 2010:

 

Outstanding Warrants and Options												Exercisable Warrants and Options
Exercise price				Number of shares under warrants and options				Weighted average remaining contractual life (years)				Number of shares under warrants and options exercisable				Weighted average exercise price
$	1.50				603,304				1.71				603,304			$	1.50
$	2.28				427,074				2.75				427,074			$	2.28
$	2.50				35,710				0.45				35,710			$	2.50
$	2.85				2,997,894				2.17				2,997,894			$	2.85
$	4.35				10,000				1.93				10,000			$	4.35
$	2.24				4,073,982								4,073,982			$	2.59

At March 31, 2010, the aggregate intrinsic value of the warrants and options outstanding and exercisable was $16,740,218.

9.  RELATED PARTY TRANSACTIONS

Amounts due to related parties at March 31, 2010 and December 31, 2009 consisted of the following:

 

		March 31, 2010				December 31, 2009
Due to director :		(unaudited)
Mr. Baowen Ren			73,466				73,466
		$	73,466			$	73,466

Amounts due to directors are non-interest bearing, unsecured, and due on demand.

Item 2.  Management’s Discussion and Analysis or Plan of Operation.

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.

 

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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, 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.

  

Until November 12, 2009, all of our business operations were conducted through Shaanxi Suo’ang Biological Science & Technology Co., Ltd., a PRC company (“Suo’ang BST”), which we controlled through contractual arrangements designed to comply with the law of The People’s Republic of China (“PRC” or “China”) and Suo’ang BST’s PRC subsidiary, Shaanxi Suo’ang New Energy Enterprise Co., Ltd. (“Suo’ang New Energy”).  Beginning in June 2009, we effected a reorganization of our corporate structure in order to make Suo’ang New Energy wholly owned.  Pursuant to such reorganization, our business is now operated by Suo’ang New Energy through our indirect wholly-owned subsidiary Tongchuan Suoke Clean Energy Co., Ltd., a PRC limited liability company (“Suoke Clean Energy”), which is incorporated under PRC law and wholly owned by Wiscon Holdings Limited, a Hong Kong company (“Wiscon”), our directly owned Hong Kong subsidiary/holding company, which was incorporated in 2006 and acquired by us in June 2009.  On September 27, 2009, we received approval from the Tongchuan Bureau of Commerce for the transfer of all of Suo’ang New Energy’s equity interests to Suoke Clean Energy.  With the approval, Suo’ang New Energy has become a “domestic PRC enterprise wholly-owned by a wholly-foreign owned enterprise.”  Registration of the approval with the Tongchuan Administration of Industry and Commerce, the final step in completing this reorganization, was completed on November 12, 2009.  On October 12, 2009, Suo’ang New Energy established Shenyang Sou’ang Energy Co., Ltd., a wholly-owned PRC subsidiary(“Shenyang Energy”), to conduct the CWSF business in Shenyang, Liaoning province.

Reverse Stock Split

On May 7, 2010, we effected a reverse stock split pursuant to which every ten shares of Company's common stock then issued and outstanding was automatically converted into one share of the Company’s common stock.  All share and per share amounts in the accompanying condensed consolidated financial statements have been adjusted to reflect the reverse stock split as if it had occurred at the beginning of the earliest period presented.

Corporate Organization and History

 

We were originally incorporated in Texas as “Discount Mortgage Services, Inc.” on July 11, 2000. In September 2001, we purchased Endo Networks, Inc., a Canadian software developer, and changed our name to “Endo Networks, Inc.” on November 5, 2001. We re-domiciled to the State of Nevada on December 13, 2001.

 

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On October 20, 2006 we consummated a share exchange transaction with Hangson, a British Virgin Islands company, the stockholders of Hangson and a majority of our stockholders.  We issued a total of 260,000 shares of our common stock (reflects 10-for-one reverse split) to the Hangson Stockholders and a consultant in the transaction, in exchange for 100% of the common stock of Hangson.  As a result of the transaction we became engaged in the CWSF business, through the operations of Suo’ang BST and Suo’ang New Energy.  On January 4, 2007, we changed our name from “Endo Networks, Inc.” to “China West Coal Energy Inc.”, and then on August 15, 2007, we changed our name again to our present name, “Sino Clean Energy Inc.” to better reflect the direction and business of the Company Hangson did not conduct any substantive business operations of its own, but from August 2006 to June 30, 2009, controlled Suo’ang BST, a PRC company and Suo’ang BST’s 80%-owned subsidiary Suo’ang New Energy.  From June 30, 2008 to November 12, 2009 Hangson owned 20% of Suo’ang New Energy.  Hangson controlled Suo’ang BST through a series of contractual arrangement.

 

Beginning in June 2009, we effected a reorganization of our corporate structure in order to make Suo’ang New Energy a wholly-owned subsidiary (the “2009 Reorganization”).  On June 30, 2009, we were a party to a series of agreements (collectively the “Transfer Agreements”) transferring the contractual arrangements, through which Hangson controlled Suo’ang BST, to Suoke Clean Energy.

  

On September 15, 2009, Suo’ang BST and Hangson entered into a share transfer agreement with Suoke Clean Energy pursuant to which Suo’ang BST and Hangson transferred 100% of the equity interests in Suo’ang New Energy to Suoke Clean Energy.  On September 27, 2009, the Tongchuan Bureau of Commerce approved the transfer of all of Suo’ang New Energy’s equity interests to Suoke Clean Energy.  Registration of the approval of the equity transfer with the Tongchuan Administration of Industry and Commerce, which was a condition to the closing of the Share Transfer, was completed on November 12, 2009.  As a result of receiving the required approval and registration the share transfer transaction was closed and we were able, through Suoke Clean Energy to own 100%of the equity interests of  Suo’ang New Energy.  On October 12, 2009, Suo’ang New Energy established a wholly-owned subsidiary to conduct the CWSF business in Shenyang, Liaoning province. 

 

On December 31, 2009, we entered into a series of termination agreements to terminate the contractual arrangements by and among Suoke Clean Energy, Suo’ang BST and certain stockholders of Suo’ang BST.  We no longer needed to keep such contractual arrangements in place due to the fact that Suo’ang BST was no longer engaged in any substantial business operations. In connection with the termination agreements, certain assets held by Suo’ang BST, such as, office equipment, vehicles, bank deposits, accounts receivable, were transferred to Suoke Clean Energy. Employees of Suo’ang BST signed new employment contracts with Suoke Clean Energy. All rights and obligations under certain business operation agreements and research and development contracts between Suo’ang BST and third parties were assigned to Suo’ang New Energy.

 

On December 31, 2009, Hangson transferred all of its equity interests in Wiscon to us.  Since Hangson had no substantive operations of its own after the transfer and termination of the contractual arrangements, we decided to dissolve Hangson on December 31, 2009.

 

Wiscon Holdings Limited

 

Wiscon is a limited liability company incorporated in Hong Kong under the Companies Ordinance on September 4, 2006 and Hangson acquired all of its issued and outstanding equity interests on June 30, 2009. On December 31, 2009, Hangson transferred all of its equity interests in Wiscon to Sino Clean Energy Inc. As a result, Wiscon became a direct wholly-owned subsidiary of Sino Clean Energy Inc.

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 in 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 March 31, 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.  For periods prior to the consummation of the Merger Transaction, there was no readily available market quotations for our shares of common stock and, as such, we used alternative methods to value shares of our common stock including valuations based upon the conversion price per share of common stock of our convertible notes and the sale price of units consisting of one share of our common stock and warrants to purchase one share of common stock, which management believes were the best indicators of the fair value of our common stock.

Recent accounting pronouncements

In October 2009, the FASB issued authoritative guidance on revenue recognition that will become effective in fiscal years beginning on or after June 15, 2010, with earlier adoption permitted. Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued authoritative guidance on revenue arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance. Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition.   We believe the adoption of this new guidance will not have a material impact on our financial statements.

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In January 2010, the FASB issued guidance on improving disclosures about fair value measurements to add new disclosure requirements for significant transfers in and out of Level 1 and 2 measurements and to provide a gross presentation of the activities within the Level 3 rollforward.   The guidance also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value.  The disclosure requirements are effective for interim and annual reporting periods beginning after December 15, 2009, except for the requirement to present the Level 3 rollforward on a gross basis, which is effective for fiscal years beginning after December 15, 2010.  The adoption of this guidance was limited to the form and content of disclosures, and will not have a material impact on our consolidated results of operations and financial condition.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and 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 March 31, 2010 as compared to three month period ended March 31, 2009

Revenue. During the three-month period ended March 31, 2010, we had revenues from sales of our coal-water slurry fuel of $24,509,004 as compared to revenues of $7,778,277 during the three-month period ended March 31, 2009, an increase of 215%. 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 March 31, 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 Tongcuan , as compared to 350,000 tones as at March 31 2009 . At March 31 , 2010 we had 30 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 March 31 , 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.

  

Cost of Goods Sold. Cost of goods sold, consisting of raw materials, direct labor and manufacturing overhead, depreciation of plant and machinery, was $14,400,177 for the three-month period ended March 31, 2010, as compared to $5,348,107 for the same period of 2009, an increase of 169%. The increase in cost of goods sold is in line with our increase in sales. However, gross profit margin improved from 31% in 2009 to 41% in 2010 mainly as a result of better pricing of CWSF in Shenyang

Selling Expenses. Selling expenses totaled $911,079 for the three-month period ended March 31, 2010, as compared to $3,559 for the three-month period ended March 31, 2009, an increase of 25,499%. 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 $719,182 for the three-month period ended March 31, 2010, as compared to $548,899 for the three-month period ended March 31, 2009, an increase of 31%. This increase was primarily caused by our expansion in operation and the increased expenses related to our company being a public company.

Other Income. Other income totaled $13,732,560 for the three-month period ended March 31, 2010, as compared to other expense of $22,950 for the three-month period ended March 31, 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 $10,444,563 in 2010 which included $8,601,975 relating to the amortization of discount on our notes payable and $1,864,701 related to value of shares of our stock issued as additional interest.

Net Income. We had net income of $20,460,621 for the three-month period ended March 31, 2010, as compared to net income of $1,565,476 for the same period in 2009.  The increase in net income is primarily attributable to the increase in sales in the first three months of 2010 and the gain on extinguishment of derivative liability as mentioned above.

Liquidity and Capital Resources

For the three-month period ended March 31, 2010, we generated $11,307,822 from operating activities, as compared to $1,590,687 that we generated from operating activities for the three-month period ended March 31, 2009.  This increase is primarily due to the increase in sales proceeds.

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For the three-month period ended March 31, 2010, we used $4,031,585 in investing activities, of which $3,532,523 was used in the purchase of property, plant and equipment , as compared to $ nil for the three-month period ended March 31, 2009.

For the three-month period ended March 31, 2010, we provided $173,980 from financing activities, primarily cash received from exercise of warrants and options.

As of March 31, 2010, we had cash and cash equivalents of $25,760,626.  Our total current assets were $33,694,618 and our total current liabilities were $26,803,693 which resulted in a net working capital of $6,890,925.

We had no capital expenditure commitments outstanding as of March 31, 2010 in relation to the purchase of machinery.

During the quarter ended March 31, 2010, convertible notes aggregating $10,217,000 were converted at the stated conversion price of $1.90 per share into 5,377,368 shares of the Company’s common stock.  For some of the conversions, note holders received an additional 266,387 restricted shares of the Company’s stock representing additional interest consideration.  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 for the quarter ended March 31, 2010.

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.

Inflation

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