10-Q 1 v201166_10q.htm Unassociated Document
 
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
 
FORM 10-Q
 
þ
  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2010.
 
or
 
q
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from to __________.
 
Commission File Number 000-25413
 
CHINA INTEGRATED ENERGY, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
65-0854589
     
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
Dongxin Century Square, 7th Floor
Hi-Tech Development District
Xi’an, Shaanxi Province, People’s Republic of China, 710043
(Address of Principal Executive Offices including zip code)
 
+86 29 8268 3920
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No q
 
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). *Yes q  No q* The registrant has not yet been phased into the interactive data requirements.
 
Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company

Large Accelerated Filer o
Accelerated Filer o
Non-Accelerated Filer o
Smaller reporting company þ
   
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act).  
Yes o No þ
 
As of November 5, 2010, 33,830,091 shares of the issuer’s common stock, par value $0.0001, were outstanding.


 
TABLE OF CONTENTS
 
Part I FINANCIAL INFORMATION
 
 
ITEM 1
CONSOLIDATED FINANCIAL STATEMENTS
1
 
ITEM 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
23
 
ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
33
 
ITEM 4T.
CONTROLS AND PROCEDURES.
33
Part II OTHER INFORMATION
 
 
ITEM 1
LEGAL PROCEEDINGS
34
 
ITEM 1A.
RISK FACTORS
34
 
ITEM 2
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
34
 
ITEM 3
DEFAULTS UPON SENIOR SECURITIES
34
 
ITEM 4
OTHER INFORMATION
34
 
ITEM 5
EXHIBITS
36

 
Part I
FINANCIAL INFORMATION
 
ITEM 1  
CONSOLIDATED FINANCIAL STATEMENTS
 
CHINA INTEGRATED ENERGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
September30, 2010
   
December31, 2010
 
   
(Unaudited)
   
(Audited)
 
ASSETS
           
             
CURRENT ASSETS
           
Cash and cash equivalents
  $ 79,653,492     $ 62,415,443  
Accounts receivable
    7,853,650       3,099,587  
Other receivables and deposits
    4,729,002       7,231,586  
Prepaid expenses
    3,115,795       3,145,502  
Advance to suppliers
    33,065,887       34,544,100  
Inventories, net
    23,132,881       20,954,851  
                 
Total current assets
    151,550,707       131,391,069  
                 
Prepaid rents
    30,355,870       24,620,685  
                 
Property, plant and equipment, at cost
    10,328,600       10,017,987  
Construction in progress
    12,800,346       -  
Less accumulated depreciation
    (2,826,408 )     (2,456,080 )
Property, plant and equipment , net
    20,302,538       7,561,907  
                 
Intangible asset, net
    14,289,470       -  
                 
Total noncurrent assets
    64,947,878       32,182,592  
TOTAL ASSETS
  $ 216,498,585     $ 163,573,661  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
CURRENT LIABILITIES
               
Advance from customers
  $ 12,104,710     $ 1,903,124  
Taxes payable
    856,851       1,242,931  
Other payables and accruals
    1,046,248       2,700,988  
Loans payable
    4,483,970       4,395,025  
Total current liabilities
    18,491,779       10,242,068  
                 
STOCKHOLDERS' EQUITY
               
Series A Convertible Preferred stock,  $.001 par value;  authorized shares 3,000,000; issued and outstanding 989,000 and 1,000,000 shares at September 30, 2010 and December 31, 2009, respectively
    989       1,000  
Series B Convertible Preferred stock,  $.001 par value;  authorized shares 7,000,000; issued and outstanding 1,605,753 and 2,115,753 shares at September 30, 2010 and December 31, 2009, respectively
    1,605       2,115  
Common stock,  $.0001 par value;  authorized shares 79,000,000;  issued and outstanding 33,830,091 and 33,269,091 shares at September 30, 2010 and December 31, 2009, respectively
    3,382       3,326  
Additional paid in capital
    79,240,858       75,858,994  
Statutory reserve
    4,920,114       4,920,114  
Accumulated other comprehensive income
    8,264,637       5,473,420  
Retained earnings
    105,575,221       67,072,624  
                 
Total stockholders' equity
    198,006,806       153,331,593  
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 216,498,585     $ 163,573,661  
 
The accompanying notes are an integral part of these condensed consolidated financial statements
 
1

 
CHINA INTEGRATED ENERGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
 
 
For The Three Months
Ended September 30,
   
For The Nine Months
Ended September 30,
 
(Unaudited)
 
2010
   
2009
   
2010
   
2009
 
Sales
  $ 106,794,714     $ 72,401,010     $ 320,634,654     $ 196,303,917  
                                 
Cost of goods sold
    90,790,112       61,544,988       275,795,810       168,295,024  
                                 
Gross profit
    16,004,602       10,856,022       44,838,844       28,008,893  
                                 
Selling, general and administrative expenses
    1,988,110       996,604       5,859,828       2,163,179  
                                 
Income from operations
    14,016,492       9,859,418       38,979,016       25,845,714  
                                 
Non-operating income (expenses)
                               
Interest expense
    (40,931 )     (22,048 )     (138,649 )     (91,228 )
Subsidy income
    21,870       38,210       21,870       155,174  
Other expense
    (253,778 )     (2,132 )     (359,640 )     (8,226 )
                                 
Total non-operating expenses
    (272,839 )     14,030       (476,419 )     55,720  
                                 
Net income
    13,743,653       9,873,448       38,502,597       25,901,434  
                                 
Other comprehensive item
                               
Foreign currency translation gain (Loss)
    1,758,939       69,861       2,791,217       55,787  
                                 
Comprehensive Income
  $ 15,502,592     $ 9,943,309     $ 41,293,814     $ 25,957,221  
                                 
Basic and diluted weighted average shares outstanding
                               
Basic
    33,829,656       27,287,040       33,621,516       27,287,040  
Diluted
    43,328,716       35,757,432       43,117,860       35,017,932  
 
                               
Basic and diluted net earnings per share available to common stockholders
                               
Basic
  $ 0.41     $ 0.36     $ 1.15     $ 0.95  
Diluted
  $ 0.32     $ 0.28     $ 0.89     $ 0.74  
 
The accompanying notes are an integral part of these condensed consolidated financial statements

2

 
CHINA INTEGRATED ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EQUITY
 
   
Preferred stock
   
Common stock
   
Additional
paid-in
   
Statutory
   
Other comprehen-sive
   
Retained
   
Total stockholders’
 
   
Shares
   
Amount
   
Shares
   
Amount
   
capital
   
reserves
   
income
   
earnings
   
equity
 
Balance at December 31, 2008
    3,465,753     $ 3,465       27,169,091     $ 2,716       44,434,250     $ 4,920,114     $ 5,337,003     $ 29,201,661     $ 83,899,209  
                                                                         
Preferred B conversion
    (350,000 )     (350 )     350,000       35       315                          
                                                                         
Shares issued to employees
                            30,056                         30,056  
                                                                         
Stock purchase option - directors
                            155,104                         155,104  
                                                                         
Stock-based compensation
                            555,710                         555,710  
                                                                         
Net income for the year
                                              37,870,963       37,870,963  
                                                                         
Issuance of common stock
                5,750,000       575       30,683,559                         30,684,134  
                                                                         
Foreign currency translation gain
                                        136,417             136,417  
                                                                         
Balance at December 31, 2009
    3,115,753       3,115       33,269,091       3,326       75,858,994       4,920,114       5,473,420       67,072,624       153,331,593  
                                                                         
Preferred A conversion
    (11,000 )     (11 )     50,000       5       6                          
 
                                                                       
Preferred B conversion
    (510,000 )     (510 )     510,000       51       459                          
 
                                                                       
Stock purchase option - directors
                            182,106                         182,106  
 
                                                                       
Stock-based compensation - consultants
                            1,065,097                         1,065,097  
 
                                                                       
Employee stock option compensation
                            2,127,156                         2,127,156  
 
                                                                       
Exercise Employee stock option
                1,000             7,040                         7,040  
 
                                                                       
Net income for the period
                                              38,502,597       38,502,597  
 
                                                                       
Foreign currency translation gain
                                        2,791,217             2,791,217  
 
                                                                       
Balance at September 30, 2010
    2,594,753     $ 2,594       33,830,091     $ 3,382     $ 79,240,858     $ 4,920,114     $ 8,264,637     $ 105,575,221     $ 198,006,806  
 
The accompanying notes are an integral part of these condensed consolidated financial statements

3

 
CHINA INTEGRATED ENERGRY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
 
 
For the Nine Months Ended September 30
 
Unaudited
 
2010
   
2009
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 38,502,597     $ 25,901,434  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Loss on disposal of property and equipment
    238,975        
Depreciation and amortization
    1,015,039       883,778  
Stock based compensation
    3,374,359       256,679  
(Increase) decrease in current assets:
               
Accounts receivable
    (4,597,028 )     2,733,209  
Other receivables, deposits and prepaid expenses
    (2,710,890 )     3,638,603  
Advance to suppliers
    2,147,630       (7,495,285 )
Inventories
    (1,702,813 )     1,322,620  
Prepaid expenses - Rents, non-current
    (8,162,645 )     (10,043,265 )
Increase (decrease) in current liabilities:
               
Accounts payable
          889,211  
Advance from customers
    10,058,995       2,024,552  
Taxes payable
    (405,670 )     91,211  
Other payables and accrued expenses
    (2,172,560 )     (939,882 )
Net cash provided by operating activities
    35,585,989       19,262,865  
 
               
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Acquisition of property and equipment
    (91,990 )     (204,646 )
Acquisition of gas stations
    (6,845,104 )        
Construction in progress
    (12,744,538 )      
 
               
Net cash used in investing activities
    (19,681,632 )     (204,646 )
 
               
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Restricted cash released
          919,367  
Repayment of auto loans and notes payable
          (2,243,366 )
Net cash used in financing activities
          (1,323,999 )
 
               
EFFECT OF EXCHANGE RATE CHANGE ON CASH AND CASH EQUIVALENTS
    1,333,692       46,805  
 
               
NET INCREASE IN CASH AND CASH EQUIVALENTS
    17,238,049       17,781,025  
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    62,415,443       23,119,028  
CASH AND CASH EQUIVALENTS, END OF PERIOD
  $ 79,653,492     $ 40,900,053  
 
               
Supplemental Cash flow data:
               
Income tax paid
  $     $  
Interest paid
  $ 178,726     $ 105,966  
Non-cash activities:
               
Financing activities
               
Conversion of preferred stock to common stock
  $ 61     $  
Transferring:
               
Transferring from other receivables and prepaid rents to intangible assets
  $ 7,994,143     $  
 
The accompanying notes are an integral part of these condensed consolidated financial statements
 
4

 
CHINA INTEGRATED ENERGY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements of the Company and its subsidiaries have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission including the instructions to Form 10-Q and Regulation S-X. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted from these statements pursuant to such rules and regulation and, accordingly, they do not include all the information and notes necessary for comprehensive consolidated financial statements and should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2009, included in our Annual Report on Form 10-K for the year ended December 31, 2009.
 
In the opinion of the management of the Company, all adjustments, which are of a normal recurring nature, necessary for a fair statement of the results for three-month period have been made. Results for the interim periods presented are not necessarily indicative of the results that might be expected for the entire fiscal year. When used in these notes, the terms “Company,” “we,” “us” or “our” means China Integrated Energy Inc. and all entities included in our consolidated financial statements.
 
The unaudited condensed consolidated financial statements include the financial statements of the Company, and its wholly owned or controlled subsidiaries and all other entities that it has a controlling financial interest in or is considered to be the primary beneficiary, pursuant to the rules of the Accounting Standards Codification. All significant inter-company transactions and balances between the Company, its subsidiaries and VIEs are eliminated upon consolidation. The Company has included the results of operations of its subsidiaries from the dates of acquisition.
 
The Company, its subsidiaries and VIEs referenced above are hereinafter collectively referred to as the (“Company”).
 
Principle of Consolidation
 
The accompanying consolidated financial statements include our accounts and the accounts of our wholly owned subsidiaries, Baorun Group and Redsky Industrial, and our consolidated subsidiary, Xi’an Baorun Industrial (collectively, the “Company”). All significant inter-company accounts and transactions have been eliminated in consolidation.
 
Use of Estimates
 
In preparing the financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting year. Significant estimates, required by management, include the recoverability of long-lived assets, allowance for doubtful accounts, and the reserve for obsolete and slow-moving inventories. Actual results could differ from those estimates.
 
Cash and Cash Equivalents
 
For purposes of the statement of cash flows, the Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
 
5

 
Accounts Receivable
 
The Company’s policy is to maintain reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Based on historical collections, no allowance was deemed necessary at September 30, 2010 and December 31, 2009 as the Company did not experience any uncollectible accounts receivable and bad debt write-off over the past years.
 
Advance to Suppliers
 
Advance to suppliers consist of prepayments to the suppliers for products that have not yet been received. Any amount paid to the suppliers prior to the Company’s acceptance of petroleum products and biodiesel feedstock are recorded as advance to suppliers. The Company will record the prepayment as inventory at the time of accepting delivery of petroleum products and biodiesel feedstock from suppliers. Advance to suppliers as of September 30, 2010 and December 31, 2009 were $33,065,887 and $34,544,100, respectively. Based on the customers’ purchase plans and our inventory needs, we usually work with suppliers by advancing prepayments to secure needed inventory to ensure on time delivery to meet customers’ demands.
 
Inventories
 
Inventories are valued at the lower of cost or market with cost determined on a moving weighted average basis. Cost of work in progress and finished goods comprises direct material, direct labor, and an allocated portion of production overheads.
 
Advances from Customers
 
Advances from customers consist of prepayments to the Company for products that have not yet been shipped to the customers. Any amounts received prior to satisfying the Company’s revenue recognition criteria are recorded as deferred revenue or advances from customers. The Company will recognize the prepayments from the customers as revenue at the time the delivery of goods is made. Advances from customers as of September 30, 2010 and December 31, 2009 were $12,104,710 and $1,903,124, respectively.
 
Property, Plant, and Equipment
 
Property, plant, and equipment are stated at the actual cost on acquisition less accumulated depreciation and amortization. Depreciation and amortization are provided for in amounts sufficient to relate the cost of depreciation assets to operations over their estimated service lives, principally on a straight-line basis. Most property, plant and equipment have a residual value of 5% of actual cost. The estimated lives used in determining depreciation are:
   
Years
 
Building
   
20
 
Vehicle
   
5
 
Office Equipment
   
5
 
Production Equipment
   
10
 
 
In accordance with Statement of accounting standards codification, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company examines the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable. There was no fixed asset impairment.
 
Impairment of Long-Lived Assets
 
Long-lived assets, which include property, plant and equipment and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
 
6

 
Recoverability of long-lived assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the assets. Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable.
 
Intangible Assets
 
Our intangible assets consist of definite-lived assets subject to amortization such as gas station operating rights, land usage rights of a gas station, and land usage right of agricultural plantation for a pilot program cultivating biodiesel feedstock. In January 2010,and in July 2010, we acquired Jinzheng retail gas station and Xinyuan gas station, respectively; and allocated the purchase prices to tangible assets, gas station operating rights, and land usage rights, based on appraised value. The useful lives of the gas station operating rights and land usage rights are determined by the gas station purchase agreements. The gas station operating right and land usage right of Jinzheng gas station are each forty years. The gas station operating right and land usage right of Xinyuan gas station are each seventeen and one half years.  The useful life of the agricultural plantation is seventy years and determined by the purchase agreement, as well. We calculate amortization of the definite-lived intangible assets on a straight-line basis over the useful lives of the related intangible assets.
 
Income Taxes
 
The Company utilizes accounting standards codification, “Accounting for Income Taxes,” which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
 
The Company adopted the provisions of accounting standards codification, “Accounting for Uncertainty in Income Taxes,” on January 1, 2007. As a result of the implementation of the accounting standards codification, the Company made a comprehensive review of its portfolio of tax positions in accordance with recognition standards established by the accounting standards codification. As a result of the implementation of the accounting standards codification, the Company recognized no material adjustments to liabilities or stockholders equity. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest associated with unrecognized tax benefits are classified as interest expense and penalties are classified in selling, general and administrative expenses in the statements of income. The adoption of the accounting standards codification did not have a material impact on the Company’s financial statements.
 
Revenue Recognition
 
The Company’s revenue recognition policies are in compliance with Securities and Exchange Commission (SEC) Staff Accounting Bulletin. For distribution of finished oil, heavy oil products, and biodiesel, sales revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are recorded as unearned revenue.  For gas station retail sales, revenue is recognized and cash is collected upon completion of fuel sales to customers.
 
7

 
Sales revenue represents the invoiced value of goods sold, net of value-added tax (“VAT”). All of the Company’s products that are sold in the PRC are subject to Chinese value-added tax of 17% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials or services included in the cost of producing their finished product. The Company records VAT payable and VAT receivable net of payments in the financial statements. The VAT tax return is filed offsetting the payables against the receivables.
 
There were no sales returns and allowances for the three months ended September 30, 2010 and 2009. The Company does not provide unconditional right of return, price protection or any other concessions to its customers.
 
Cost of Goods Sold
 
Cost of goods sold consists primarily of material costs, direct labor, manufacturing overhead and related expenses, which are directly attributable to the production of products. Write-down of inventory to lower of cost or market is also recorded in cost of goods sold.
 
Concentration of Credit Risk
 
Financial instruments that potentially subject the Company to credit risk consist primarily of accounts receivable and other receivables. The Company does not require collateral or other security to support these receivables. The Company conducts periodic reviews of its customers’ financial conditions and customer payment practices to minimize collection risk on accounts receivable.
 
The operations of the Company 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.
 
Statement of Cash Flows
 
In accordance with accounting standards codification, “Statement of Cash Flows,” cash flows from the Company’s operations is calculated based upon the local currencies. As a result, amounts related to assets and liabilities reported on the statement of cash flows may not necessarily agree with changes in the corresponding balances on the balance sheet due to fluctuation in currency exchange.
 
Foreign Currency Translation and Comprehensive Income (Loss)
 
The Company’s functional currency is the Renminbi (“RMB”). For financial reporting purposes, RMB has been translated into United States dollars (“USD”) as the reporting currency. Assets and liabilities are translated at the exchange rate in effect at the balance sheet date, except for fixed assets, intangible assets, and prepaid rent that are stated at the historical cost. Revenues and expenses are translated at the average rate of exchange prevailing during the reporting period. Translation adjustments caused by different exchange rates from period to period are included as a component of stockholders’ equity as “Accumulated other comprehensive income.” Gains and losses resulting from foreign currency transactions are included in income. There has been no significant fluctuation in exchange rate for the conversion of RMB to USD after the balance sheet date.
 
On July 21, 2005, the central government of China allowed the RMB to fluctuate, ending its decade old valuation peg to the U.S. dollar. Historically, the Chinese government has benchmarked the RMB exchange ratio against the U.S. dollar, thereby mitigating the associated foreign currency exchange rate fluctuation risk. Since then the RMB has strengthened and risen more than 21% against the USD.  On June 19, 2010, the Chinese central bank announced that it would further the reform the RMB exchange rate mechanism to improve flexibility. At September 30, 2010, Renminbi appreciated approximately 1.34% from June 30, 2010. The Company anticipates that appreciation of Renminbi will continue. The Company does not believe the currency fluctuation risk is significant. This fluctuation of the exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People’s Bank of China.
 
8

 
The Company uses Statement of accounting standards codification “Reporting Comprehensive Income.” Comprehensive income is comprised of net income and all changes to the statements of stockholders’ equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders. Comprehensive income for the three months ended September 30, 2010 and 2009 were included net income and foreign currency translation adjustments.
 
Fair value of financial instruments
 
The accounting standards codification, “Disclosures about Fair Value of Financial Instruments,” requires that the Company disclose estimated fair values of financial instruments. The carrying amounts reported in the statements of financial position for current assets and current liabilities qualifying as financial instruments are a reasonable estimate of fair value.
 
On January 1, 2008, the Company adopted accounting standards codification, “Fair Value Measurements.” The accounting standards codification defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosures requirements for fair value measures. The carrying amounts reported in the balance sheets for receivables and current liabilities each qualify as financial instruments and are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization and their current market rate of interest. The three levels are defined as follow:
 
·  
Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
 
·  
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
 
·  
Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.
 
As of September 30, 2010, the Company did not identify any assets and liabilities that are required to be presented on the balance sheet at fair value.
 
Stock-Based Compensation
 
The Company accounts for its stock-based compensation in accordance with the accounting standards codification, “Share-Based Payment.” The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and other equity-based compensation to employees and non-employees, and recognizes that cost over the requisite service period. For the three months ended September 30, 2010, the Company recorded $1,090,211 of stock compensation expense, for the nine months ended September 30, 2010, the Company recorded $ 3,374,359 of stock compensation expense that was included in the selling, general and administrative expenses, in accordance with accounting standards codification, “Share-Based Payment.”  Refer to Note 17 for additional information regarding the Company’s stock non-qualified plan (Plan).
 
Consolidation of Variable Interest Entities
 
VIE’s are entities that lack one or more voting interest entity characteristics. The Company consolidates VIEs in which it is the primary beneficiary of the VIEs economic gains or losses. The FASB has issued the accounting standards codification (Revised December 2004), “Consolidation of Variable Interest Entities.” The accounting standards codification clarifies the application of Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. It separates entities into two groups: (1) those for which voting interests are used to determine consolidation and (2) those for which variable interests are used to determine consolidation. The accounting standards codification clarifies how to identify a variable interest entity and how to determine when a business enterprise should include the assets, liabilities, non-controlling interests and results of activities of a variable interest entity in its consolidated financial statements.
 
9

 
Reclassification
 
Certain reclassifications have been made to the prior years’ financial statements to conform to the current year presentation. In presenting the Company’s condensed consolidated statements of cash flow for the nine months ended September 30, 2009, the Company presented $ 6,404,662 in the decrease in other receivables deposits and prepaid expenses. In presenting the Company’s condensed consolidated statements of cash flow for the nine months ended September 30, 2010, the 2009 comparative figures have been reclassified to conform to the current period’s presentation. After the reclassification, the Company presented $ 3,638,603 in the decrease in other receivables deposits and $ 10,043,265 in the increase in prepaid rents for the nine months ended September 30, 2009. These reclassifications had no effect on previously reported results or retained earnings.
 
Litigation
 
In the normal course of business, the Company may be involved in legal proceedings. The Company accrues a liability for such matters, when it is probable that a liability has been incurred and the amount can be reasonably estimated. When only a range of possible loss can be established, the most probable amount in the range is accrued. If no amount within this range is a better estimate than any amount within the range, the minimum amount in the range is accrued. The accrual for a litigation loss contingency might include, for example, estimates of potential damages, outside legal fees and other directly related costs expected to be incurred. There is no material litigation against the Company.
 
New Accounting Pronouncements
 
Stock based Compensation
 
In April 2010, the FASB issued an Accounting Standard update, an amendment of the accounting standards codification Topic 718, “Compensation – Stock Compensation.” The amendment clarifies that a 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, such an award should not be classified as a liability if it otherwise qualifies as equity.
 
The amendment in the update is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The amendment in this update should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings. The cumulative-effect adjustment should be calculated for all awards outstanding as of the beginning of the fiscal year in which the amendment is initially applied, as if the amendment had been applied consistently since the inception of the award. The cumulative-effect adjustment should be presented separately. Earlier application is permitted. The Company does not believe that amendment of the accounting standards codification would have material effect on the Company’s financial statements and disclosures.
 
2.  CASH IN BANK ACCOUNTS
 
Cash includes cash on hand and demand deposits in accounts maintained with state-owned banks within the PRC. Total cash in state-owned banks at September 30, 2010 and December 31, 2009 amounted to $76,732,225 and $41,905,658, respectively, of which no deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts.
 
10

 
3.  PREPAID RENT
 
Prepaid expenses mainly consisted of prepaid rents for the gas stations (see Note 13 - Commitments) and other expenses. At September 30, 2010 and December 31, 2009, the current portion of prepaid rental expenses of gas stations was $2,721,361 and $2,732,546, respectively. At September 30, 2010 and December 31, 2009, the noncurrent portion of prepaid expenses amounted $30,355,870 and $24,620,685, respectively, which represents the prepaid rents that will be expensed after one year.
 
4.  INVENTORIES
 
Inventories consisted of the following:
 
   
September 30,
2010
(Unaudited)
   
December 31,
2009
 (Audited)
 
Finished goods
           
Petroleum
  $ 11,057,700     $ 10,449,525  
Diesel
    6,384,879       5,601,725  
Raw material for manufacturing biodiesel
    5,690,302       4,903,601  
Total
  $ 23,132,881     $ 20,954,851  
 
5.  OTHER RECEIVABLES AND DEPOSITS
 
At September 30, 2010, other receivables mainly represented deposits made for acquisitions and purchase of equipment in the amount of $4,729,002, of which $2,989,313 was a deposit to acquire Shenmu Gas Station located in Yulin City, Shaanxi Province and $1,494,657 was a deposit to acquire Chongqing Tianrun Energy Co., Ltd located in Chongqing City. At December 31, 2009, other receivables represented deposits made for purchase of equipments and short term cash advances to third parties in the amount of $7,231,586, of which $6,973,439 was a deposit for the purchase of Jinzheng gas station, which was completed in the first quarter of 2010.
 
6.  PROPERTY, PLANT, AND EQUIPMENT, NET
 
   
September 30,
2010
   
December 31,
2010
 
   
(Unaudited)
   
(Audited)
 
Building
  $ 525,908     $ 336,051  
Biodiesel Processing Equipment
    8,415,141       8,360,404  
Office Equipment
    142,987       145,456  
Other Equipment
    299,435       34,047  
Motor Vehicles
    945,129       1,142,029  
Total Cost
  $ 10,328,600     $ 10,017,987  
Less: Accumulated Depreciation
    (2,826,408 )     (2,456,080 )
Net book value
    7,502,192       7,561,907  
Construction in progress
    12,800,346       -  
Total
  $ 20,302,538     $ 7,561,907  
 
Depreciation expense for the nine months ended September 30, 2010 and 2009 were $787,560 and $883,778, respectively; and $271,523 and $297,000 for the three months ended September 30, 2010 and 2009, respectively.
 
7.  INTANGIBLE ASSETS
 
In January 2010, the Company completed an acquisition of an agricultural plantation, located in Xianyan Chuanhua, Shaanxi Province, PRC, with 20,000 Mu (approximately 3,295 acres) in size.  The agricultural plantation will used for pilot programs exploring and experimenting with new feedstock for the Company’s biodiesel production.  The purchase price of the plantation was $1,025,521 (RMB 7,000,000) for a 70-year land usage right, where the land is owned by the government.  The payment was made in 2009 and recorded as a deposit.  The amount was reclassified as agricultural plantation land usage right upon completion of transfer of title in January 2010. See note 14 for gas station operating right and gas station land usage right.
 
11

 
Intangible assets are summarized as follows:
 
   
September 30,
2010
 (Unaudited)
   
December 31,
2009
(Audited)
 
Gas station operating right
  $ 9,882,628     $  
Gas station land usage right
    3,608,800        
Agricultural plantation land usage right
    1,025,521        
 
    14,516,949        
Less: Accumulated Amortization
    (227,479 )      
Total
  $ 14,289,470     $  
 
Amortization expense for the nine months ended September 30, 2010 and 2009 were $227,479 and $-0-, respectively; and $101,171 and $-0-for the three months ended September 30, 2010 and 2009, respectively. Future amortization of intangible assets is as follow:
 
Years Ending December 31,
    Amount  
2011
  $ 486,000  
2012
    486,000  
2013
    486,000  
2014
    486,000  
2015
    486,000  
Years thereafter
    11,717,000  
Total
  $ 14,147,000  
 
8.  MAJOR CUSTOMERS AND VENDORS
 
For the three months ended September 30, 2010, ten customers accounted for approximately 43.3% of the Company’s total sales; of which three major customers accounted for approximately 25.3% of the Company’s total sales, and these three customers accounted for approximately 19.3% of the Company’s outstanding accounts receivable. No other major customers accounted for over 5% of the Company’s total sales. For the three months ended September 30, 2009, one major customer accounted for approximately 25.6% of the Company’s total sales, and this customer accounted for approximately 19.8% of the Company’s outstanding accounts receivable.
 
For the three months ended September 30, 2010, ten vendors accounted for approximately 79.8% of the Company’s total purchase; of which two vendors provided approximately 33.9% of the Company’s total purchases, and each of these vendors provided more than 10% of the Company’s total purchase.  For the three months ended September 30, 2009, one vendor accounted for approximately 50.3% of the Company’s total purchases. There were no accounts payables due to this vendor at September 30, 2010.
 
For the nine months ended September 30, 2010, three major customers accounted for approximately 37.2% of the Company’s total sales, and each of these customers provided more than 10% of the Company’s total sales.
 
For the nine months ended September 30, 2010, ten vendors accounted for approximately 69.0% of the Company’s total purchase; two vendors provided approximately 30.1% of the Company’s total purchases, and each of these vendors provided more than 10% of the Company’s total purchase.
 
9.  TAX PAYABLE
 
Tax payable consisted of the following at September 30, 2010 and December 31, 2009:
 
   
September 30,
2010
(Unaudited)
   
December 31,
2009
(Audited)
 
Value added tax payable
  $ 788,108     $ 1,150,725  
Urban maintenance and construction tax payable
    55,168       80,551  
Other tax payable
    13,575       11,655  
    $ 856,851     $ 1,242,931  
 
12

 
10.  INCOME TAXES
 
Baorun Industrial obtained approval from the PRC tax authority for the exemption of income taxes from 2004 to the end of 2010 as the incentive from the Government for bio energy products.
 
Effective January 1, 2008, the PRC government implemented a new corporate income tax law with a new maximum corporate income tax rate of 25%. Despite the income tax exemption of Baorun Industrial, the Company is governed by the Income Tax Law of the PRC concerning privately-run enterprises, which are generally subject to tax at a statutory rate of 25% (33% prior to 2008) on income reported in the statutory financial statements after appropriate tax adjustments. Redsky had a net operating loss of approximately $20,000 and $4,000 for the nine months ended September 30, 2010 and 2009, respectively; and $309 and  $-0-  for the three months ended September 30, 2010 and 2009, respectively.  A 100% valuation allowance has been established due to the uncertainty of its realization.
 
Baorun China Group Limited is subject to Hong Kong profits tax rate of 16.5%, and has insignificant net operating losses for three months ended September 30, 2010 and 2009, and has loss carryover of approximately $178,600 at December 31, 2009.  The net operating loss carries forward infinitely for the Hong Kong profits tax, and may be available to reduce future years’ taxable income. Management believes that the realization of the benefits from these losses appears not more than likely due to the Company’s limited operating history and continuing losses for the Hong Kong profits tax purpose. Accordingly, the Company has provided a 100% valuation allowance on the deferred tax asset benefit to reduce the asset to zero. Management will review this valuation allowance periodically and make adjustments as needed.
 
The parent company, China Integrated Energy, Inc. is incorporated in the United States and has incurred an aggregate net operating loss of $3,374,000 and $389,000 for the nine months ended September 30, 2010 and 2009, respectively; and approximately $1,090,000 and $183,000 for the three months ended September 30, 2010 and 2009, respectively,subject to the Internal Revenue Code Section 382, which places a limitation on the amount of taxable income that can be offset by net operating losses after a change in ownership. The net operating loss carries forward for the United States income taxes, and may be available to reduce future years’ taxable income. These carryforwards will expire, if not utilized, through 2029. Management believes that the realization of the benefits from these losses appears not more than likely due to the Company’s limited operating history and continuing losses for the United States income tax purposes. Accordingly, the Company has provided a 100% valuation allowance on the deferred tax asset benefit to reduce the asset to zero. Management will review this valuation allowance periodically and make adjustment as warranted
 
The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the taxable years.
 
   
2010
   
2009
 
US statutory rates
    34 %     34 %
Tax rate difference
    (9 )%     (9 )%
Effect of tax holiday
    (25 )%     (25 )%
Valuation allowance
    - %     - %
Tax per financial statements
    -       -  
 
The following table gives the unaudited consolidated pro forma financial impact had the PRC taxes not been abated.
 
   
For the three months ended
September 30,
   
For the nine months ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Net income before income taxes
  $ 13,743,653     $ 9,873,448     $ 38,502,597     $ 26,294,718  
Tax provision
    (3,709,213 )     (2,514,186 )     (10,487,492 )     (6,573,680 )
Net income
    10,034,440       7,359,262       28,015,105       19,721,038  
Earnings per share (Basic)
  $ 0.30     $ 0.27     $ 0.83     $ 0.72  
Earnings per share (diluted)
  $ 0.23     $ 0.20     $ 0.65     $ 0.56  
 
13

 
11.  OTHER PAYABLES AND ACCRUALS
 
Other payables mainly consisted of payables for the unpaid acquisition cost of the gas station, payables for purchase of equipment and other obligations. Other payables balances at September 30, 2010 and December 31, 2009 were $1,046,248 and $2,700,988, respectively. At December 31, 2009, there was payable of $1,816,610 for remaining unpaid leasing cost of the new gas station.
 
12.  LOANS PAYABLE
 
The Company was obligated under one short term loan from a commercial bank in the PRC. The loan was entered into on October 26, 2009 with maturity to October 25, 2010. The principal will be repaid at maturity and the interest is payable per quarter, currently the Company’s rate is at 5.841% per annum. This loan is guaranteed by Xi’an City Economic & Technology Investment Guarantee Co., Ltd and Shaanxi Security & Trust Guarantee Co. Xi’an City Economic & Technology Investment Guarantee Co insured $2,930,017 (RMB 20,000,000). Shaanxi Security & Trust Guarantee Co insured $1,465,008 (RMB 10,000,000). The guarantee fee was 2.375% of total loan amount or $110,478 (RMB 754,110). Mr. Gao Xincheng, Chairman and CEO, provided counter guarantee to the guarantee companies to secure the loan. The Company collateralized its diesel processing equipment and inventory in the value of approximately $3,516,000 (RMB 24,000,000) for the guarantee. At September 30, 2010 and December 31, 2009, the loan carried a balance of $4,483,970 and $4,395,025 (RMB 30,000,000), respectively. On October 25, 2010, the loan was repaid, and the Company is in the process of renewing the annual revolving credit facility..
 
13.  COMMITMENTS
 
Lease Agreements
 
On January 4, 2010, the Company entered into a 15-year non-cancelable and renewable operating lease agreement with Northwest Naihuo Material Factory from January 5, 2010 to January 4, 2025 for the purpose of constructing a new 50,000-ton biodiesel production plant.  The annual lease payment is $117,000 (RMB 800,000). The Company has paid approximately $352,000 (RMB 2,400,000) in advance. The amount represented prepaid lease payments over the next three years and will be amortized accordingly.
 
On January 5, 2010, the Company leased a gas station for operation under a ten-year operating lease with expiration date on January 7, 2010. The annual lease payment is approximately $381,000 (RMB 2,600,000). The Company is required to pay in advance of 80% of the sum of the ten year lease payments approximately $3,047,000 (RMB 20,800,000) upon executing the lease agreement, and pay the remaining 20% of the sum of the ten-year lease payments approximately $762,000 (RMB 5,200,000) upon delivery of operating permits and related documents from the lessor.
 
On January 9, 2010, the Company leased a gas station for operation under a fifteen-year operating lease with expiration date on January 9, 2025. The annual lease payment is approximately $337,000 (RMB 2,300,000). The Company is required to pay in advance of 80% of the sum of the fifteen-year lease payments approximately $4,043,000 (RMB 27,600,000) upon executing the lease agreement, and pay the remaining 20% of the sum of the fifteen-year lease payments approximately $1,011,000 (RMB 6,900,000) upon delivery of operating permits and related documents from the lessor.
 
These operating lease agreements require that the Company pays certain operating expenses applicable for the leased premises. According to the lease agreements, the Company has prepaid lease payments for some or all of the lease terms, and recorded prepaid lease payments as prepaid rent that will be amortized over the terms of the lease agreements. Future minimum rental expense recognitions and total obligations required under these operating leases are as follows:
 
Years Ending December 31,
    Amount  
2011
  $ 3,790,000  
2012
    3,790,000  
2013
    3,755,000  
2014
    3,686,000  
2015
    3,686,000  
Years thereafter
    33,233,000  
Total
  $ 51,940,000  
 
14

 
Total rental expense for the nine months ended September 30, 2010 and 2009 amounted to approximately $2,601,000 and $1,606,000, respectively; and approximately $870,000 and $595,000 for the three months ended September 30, 2010 and 2009, respectively.
 
Shipping Agreement
 
In February 2010, the Company entered a shipping agreement with a transportation company for transporting petroleum products among the Company’s facilities from February 1, 2010 through January 31, 2011. The shipping cost varies ranging from RMB 10/ton, RMB 70/ton, and RMB 80/ton to transport petroleum products from facility to facility. For the nine months ended September 30, 2010 and 2009, the shipping cost paid to this transportation company was approximately $323,000 and $543,000, respectively; and approximately $111,000 and $224,000, respectively, for the three months ended September 30, 2010 and 2009.
 
Construction Contracts
 
On February 25, 2010, the Company entered into a contract with Tongchuan Gaoyuan Construction Co., Ltd. to contract infrastructure for a new 50,000-ton biodiesel production plant, which will be located at Northwest Naihuo Material Factory adjacent to the current 100,000-ton biodiesel production plant.  The construction began March 16, 2010 and was expected to be completed by July 30, 2010. As of October 31, 2010, there is still a small portion of the infrastructure that has yet to be completed due to inclement weather condition.  The total construction cost is approximately $1,977,400 (RMB 13,500,000).  Based on the contract, the Company paid approximately $585,900 (RMB 4,000,000) or 30% of total construction cost upon commencement of the construction, and will pay approximately $1,281,600 (RMB 8,7500,000) or 65% of the total construction cost within 3 days after a satisfactory inspection of completed infrastructure.  The remaining approximately $109,900 (RMB 750,000) serves as retainage for quality assurance, and will be paid by the Company 180 days after the commencement of operations.
 
On February 26, 2010, the Company entered into a contract with Northwest Naihuo Material Factory “the landlord” to reimburse the landlord approximately $292,900 (RMB 2,000,000) for the cost of demolition.  Based on the contract, the Company paid approximately $175,800 (RMB 1,200,000) within 10 days after execution of the agreement, and paid the remaining balance within 5 days after completion of demolition.
 
On April 30, 2010, the Company entered into a contract with Shaanxi Pinyi Decoration Construction Co., Ltd. to renovate storage tanks, raw material storage, production building, and research and development facility for the new 50,000-ton biodiesel production plant that located at Northwest Naihuo Material Factory adjacent to the current 100,000-ton biodiesel production plant.  The construction began May 1, 2010 and would be completed by July 30, 2010.  As of October 31, 2010, there is still a portion of the renovation work that has yet to be completed due to inclement weather condition.  The total construction cost is approximately $1,459,900 (RMB 9,900,000).  Based on the contract, the Company paid approximately $442,000 (RMB 3,000,000) or 30% of total construction cost upon commencement of the construction, and will pay approximately $943,700 (RMB 6,400,000) or 65% of the total construction cost within 3 days after a satisfactory inspection of completed infrastructure.  The remaining approximately $73,700 (RMB 500,000) serves as retainage for quality assurance, and will be paid by the Company 180 days after the commencement of operations.
 
15

 
Equipment Purchase Agreements
 
On March 5, 2010, the Company entered into an equipment purchase agreement with Japan Micro Energy Corporation (JMEC) to purchase biodiesel production equipment. The purchase price is approximately $5,858,900 (RMB 40,000,000).  At the execution of the purchase agreement, the Company paid approximately $3,808,300 (RMB 26,000,000) or 65% of the purchase price as a down payment, and paid approximately $1,757,700 (RMB 12,000,000) or 30% of the purchase price 5 days before of the shipment.  The remaining balance of approximately $292,900 (RMB 2,000,000) or 5% of purchase price will be paid within 12 months after the delivery.  JMEC is committed to deliver the equipment within 150 days after execution of the purchase agreement, and will provide technical personnel to assist installation, testing of the equipment.  As of September 30, 2010, a portion of the equipment was delivered to and received by the facility, and the residual pieces of the equipment were in the process of customs clearance. JMEC will further provide training to the Company’s personnel to operate and maintain the equipment, and provide free service and maintenance in one year after satisfactory installation and testing of the equipment.
 
On March 8, 2010, the Company entered into an equipment purchase agreement with Japan Shinwa Shouji Co., Ltd. (JSSC) to purchase biodiesel production equipment.  The purchase price is approximately $3,368,900 (RMB 23,000,000). At the execution of the purchase agreement, the paid approximately $1,516,000 (RMB 10,350,000) or 45% of the purchase price as a down payment, and paid approximately $1,684,400 (RMB 11,500,000) or 50% of the purchase price 7 days before of the shipment.  The remaining balance of approximately $168,400 (RMB 1,150,000) or 5% of purchase price will be paid within 12 months after the delivery.  JSSC is committed to deliver the equipment within 150 days after execution of the purchase agreement, and will provide technical personnel to assist installation, testing of the equipment.  As of September 30, 2010, a portion of the equipment was delivered to and received by the facility, and the residual pieces of the equipment were in the process of customs clearance. JMEC will further provide training to the Company’s personnel to operate and maintain the equipment, and provide free service and maintenance in one year after satisfactory installation and testing of the equipment.
 
14.  BUSINESS ACQUISITION
 
In January 2010, the Company completed an acquisition of 100% of Xianyang Jinzheng gas station, a privately owned service gas station, located in Xiangyang City, Shaanxi Province, PRC.  The acquisition furthers the Company’s growth strategy and expansion in operation of its retail gas station business segment.  The total purchase price of Xianyang Jinzheng gas station was approximately $9,962,202 (RMB 68,000,000) in cash with no assumption of liabilities.  The first installment payment of approximately $6,973,440 (RMB 47,600,000) was made in 2009 and recorded as a deposit.  In January 2010, the Company paid approximately $2.5 million of the unpaid balance.  The total amount was reclassified to fixed assets and intangible assets according to the appraised valuation.  Assets of Xianyang Jinzheng gas station consists of a 40-year land usage right of 7 Mu (approximately 1.15 acres) of land, which is owned by the government; a two-story building with 196 square meters (approximately 2,130 square feet) in size; 12 gas pumps; 5 petroleum storage tanks; and gas station including business office and fueling stations with 988 square meters (approximately 10,620 square feet) in size.
 
In July 2010, the Company completed an acquisition of 100% of Xinyuan gas station, a privately owned service gas station, located in Xi’an City, Shaanxi Province, PRC.  The Company previously leased the gas station. The acquisition furthers the Company’s growth strategy and expansion in operation of its retail gas station business segment.  The total purchase price of Xinyuan gas station was approximately $ 4,355,064 (RMB 29,600,000) in cash with no assumption of liabilities.  Assets of Xinyuan gas station consists of a 17.5-year land usage right of 7,000 square meters (approximately 10.5 Mu or 1.73 acres) of land, which is owned by the government; a building with 140 square meters (approximately 1,507 square feet) in size; 6 gas pumps; 4 petroleum storage tanks; and gas station including business office and fueling stations with 500 square meters (approximately 5,382 square feet) in size.
 
The acquisition was accounted for using the purchase method of accounting.  The total cost of the acquisition has been allocated to the assets acquired based on their appraised fair value at the date of the acquisition. Total assets and expected revenue of Xianyang Jinzheng and Xinyuan are immaterial to the Company’s total assets and total revenue, accordingly pro forma financial information was not presented.
 
16

 
The following represents the allocation of the total purchase price.
 
   
Purchase Price Allocation
 
Assets
 
Xianyang
Jinzheng (Unaudited)
   
Xinyuan
(Unaudited)
   
Total
(Unaudited)
 
Tangible fixed assets
  $ 443,640     $ 382,198     $ 825,838  
Land usage right
    2,490,009       1,118,791       3,608,800  
Gas station operating right
    7,028,553       2,854,075       9,882,628  
Total
  $ 9,962,202     $ 4,355,064     $ 14,317,266  
Paid in 2009 and transferred from other receivables and prepaid rents to intangible assets
    6,973,440       -       6,973,440  
Paid in period ended September 30, 2010
    2,490,040       4,355,064       6,845,104  
The unpaid balance as at September 30, 2010
  $ 498,722     $ -     $ 498,722  
 
15. BASIC AND DILUTED EARNING PER SHARES (EPS)
 
Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS is computed similar to basic net income per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Diluted net earnings per share is based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. The following table presents a reconciliation of basic and diluted earnings per share:
 
   
For the Three Months Ended,
September 30
   
For the Nine Months Ended,
September 30
 
(Unaudited)
 
2010
   
2009
   
2010
   
2009
 
Net income available to common shareholders
  $ 13,743,653     $ 9,873,448     $ 38,502,597     $ 25,901,434  
Weighted average shares outstanding – basic
    33,829,656       27,287,040       33,621,516       27,287,040  
Effect of dilutive securities:
                               
Convertible preferred stock
    6,101,208       6,893,259       6,308,974       6,893,259  
Unexercised warrants and options
    3,397,852       1,577,133       3,187,370       837,633  
Weighted average shares outstanding – diluted
    43,328,716       35,757,432       43,117,860       35,017,932  
Earnings per share – basic
    0.41       0.36       1.15       0.95  
Earnings per share – diluted
  $ 0.32     $ 0.28     $ 0.89     $ 0.74  
 
16.  STOCKHOLDERS’ EQUITY
 
On January 22, 2010, the Company and the investor executed agreements to amend the warrant anti-dilution protection provisions of the warrant agreements for series warrant A-1 and series warrant A-2 in relation to the Series A Convertible Preferred Stock Agreement, dated October 23, 2007. Certain expired terms were deleted from the agreements. Certain terms were modified to reflect current market conditions. The execution of the amendments solidified the prior verbal agreement.
 
On March 17, 2010, the investor converted 300,000 shares of Series B Convertible Preferred stock to 300,000 shares of common stock.  The conversion had no cash impact.
 
On May 11, 2010, the investor converted 11,000 shares of Series A Convertible Preferred stock into 50,000 shares of common stock, at a conversion rate of one share of Series A Convertible Preferred stock for 4.54 shares of common stock. The conversion had no cash impact.
 
On May 13, 2010, the investor converted 210,000 shares of Series B Convertible Preferred stock to 210,000 shares of common stock.  The conversion had no cash impact.
 
17

 
Following is a summary of warrant activity for the nine months ended September 30, 2010:
 
   
Number of Shares
   
Average Exercise Price per Share
   
Weighed Average Remaining Contractual Term in Years
 
Outstanding at December 31, 2009
    4,007,273       3.82       3.43  
Exercisable at December 31, 2009
    3,977,273       3.80       3.44  
Granted
    30,000       10.00       2.29  
Exercised
                 
Forfeited
                 
Outstanding at September 30, 2010
    4,037,273       3.86       2.61  
Exercisable at September 30, 2010
    4,007,273       3.82       2.59  
 
17.  SHARED-BASED PAYMENT ARRANGEMENTS
 
On September 10, 2009, the Company issued a stock option to a financial advisory consultant to purchase 310,320 shares of common stock and to an investor relations consultant to purchase 206,880 shares of common stock. The exercise prices of both stock options are $4.50 per share. The stock options are provided as remuneration for the financial advisory and investor relations consulting services. The options were accounted for using the fair value method. The options expire one year from the date of grant and immediately vested on the grant date. The Company recognized compensation expense of  approximately $994,000 and $86,000 for the nine months ended September 30, 2010 and 2009, respectively; and approximately $284,000 and $86,000 for the three months ended September 30, 2010 and 2009, respectively.
 
On December 16, 2009, the Company issued a stock option to a financial advisory consultant to purchase 20,000 shares of common stock. The exercise price of the stock option is $7.09 per share. The stock option is a part of partial remuneration for the financial advisory consulting service to be provided over the course of 12 months. The option was accounted for using the fair value method. The option expires six years from the grant date and is vested annually. The Company recognized approximately $71,000 of compensation expense for this option for the nine months ended September 30, 2010; and approximately $24,000 for the three months ended September 30, 2010.
 
On January 4, 2010, the Company renewed service contracts with the three independent directors and issued non-transferable stock purchase options to two independent directors to purchase 20,000 shares of common stock each. The exercise price is at $7.30 per share. These options were accounted for using the fair value method. The option shall be terminated on the earlier of (i) the tenth anniversary of the date of the agreement or (ii) the date as of which the option has been fully exercised. The option is vested and becomes exercisable after three months from the grant date. The option is vested in a 25% increment every 3 months, in which each director provides directorship service to the Company.  The Company recognized approximately $182,100 of compensation expense for these options for the nine months ended September 30, 2010; and approximately $60,700 for the three months ended September 30, 2010.
 
In February 2010, the Company renewed the service contract with an investor relations consulting firm for investor relations services. As a part of investor relations consulting fee, the Company issued the investor relations consulting firm warrants to purchase 30,000 shares of the Company’s common stock with a strike price at $10.00 per share. The warrants vest on the one year anniversary of the contract signature date, are exercisable only for cash and will expire 18 months from the date of vesting.
 
Stock Option Grants under the 2003 Incentive Plan
 
On October 10, 2009, the Board of Directors and the Compensation Committee authorized and approved granting stock option awards to employees under the 2003 Incentive Plan (Plan). The Plan provides for the granting of non-qualified and incentive stock options to officers, employees, and others.  The stock option exercise price is determined by the grant-date fair value of the award.  On January 1, 2010, the Company granted 2,752,000 of options to employees with the exercise price at $7.04 per share. The options are vest ratably by quarter over a 5-year period and expire 6 years from the date of grant.
 
18

 
On June 23, 2010, the Company granted a 60,000 stock option award to the newly recruited vice president of investor relations. The exercise price of the stock option is $8.9 per share. The options vest ratably by quarter over a 5-year period and expire 6 years from the date of grant.
 
The Company uses the Black-Scholes option pricing model to estimate the fair value of the grants, and amortizes the fair value of the grants over the applicable vesting period.  The Black-Scholes option-pricing model incorporates expected various and highly subjective assumptions, including expected forfeiture and expected volatility. The Company estimates the expected forfeiture of the grants using the Company’s employment termination patterns, which it believes are representative of future behalf.  The Company estimates the expected volatility of of its common stock using a weighted-average historical volatility of the Company’s common stock. The risk free interest rate assumption is determined using the Federal Reserve nominal rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued.  The Company has not paid dividend and anticipates not to pay dividend over the term of the grants.  Therefore, there is no expected dividend yield. The accounting standards codification requires the Company to estimate option forfeiture at the time of grant and periodically revise those estimates in subsequent periods, if actual forfeitures differ from the estimates.  The Company records stock-based compensation expense only for those awards expected to vest using an estimated forfeiture rate.
 
Following is a summary of stock option activity through the year ended September 30, 2010:
 
   
Options
   
Weighted Average Exercise Price
   
Weighed Average Remaining Contractual Term in Years
   
Aggregate Intrinsic Value
 
Outstanding at December 31, 2009
    577,200     $ 4.56       1.41     $ 1,546,728  
Issued
    2,852,000     $ 7.08       6.31          
Exercised
    518,200                      
Cancelled/Forfeited
    25,000                      
Outstanding at September 30, 2010
    2,886,000     $ 7.04       6.46     $ -  
Exercisable at September 30, 2010
    343,100     $ 6.72       6.74     $ -  
 
Following is a summary of non-vested options as September 30, 2010 and changes during the three months then ended:
 
   
Options
   
Weighted Average Fair Value at Grant Date
 
Non-vested  options as of December 31, 2009
    20,000     $ 7.09  
Issued
    2,852,000     $ 7.08  
Exercised
    1,000     $ 7.04  
Cancelled/ Forfeited
    25,000     $ 7.04  
Vested
    330,200     $ 7.08  
Non-vested options as of September 30, 2010
    2,541,800     $ 7.09  
 
18. SEGMENT REPORTING
 
The accounting standards codification, “Disclosures about Segments of an Enterprise and Related Information” requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products, services, and channels.  The management has determined that the Company has three operating segments as defined by the accounting standards codification: wholesale distribution of finished oil and heavy oil products, production and sale of biodiesel, and operation of retail gas stations.
 
19

 
For the three months ended September 30, 2010 and 2009
 
   
Wholesale Distribution of Finished Oil and Heavy Oil
   
Production and Sale of Biodiesel
   
Operation of Retail Gas Stations
   
Total
 
2010 (Unaudited)
                       
Sales
  $ 64,012,831     $ 20,291,638     $ 22,490,244     $ 106,794,714  
Cost of goods sold
    56,871,516       14,234,708       19,683,887       90,790,112  
Segment profit
    7,141,315       6,056,930       2,806,357       16,004,602  
Selling, general and administrative expenses
                            1,988,110  
Income from operations
                            14,016,492  
Non-operating income (expenses)
                            (272,839 )
Net income
                            13,743,653  
Segment assets
    134,329,151       34,162,791       48,006,643       216,498,585  
Capital expenditures
    81,193       4,421,177       4,355,064       8,857,434  
2009 (Unaudited)
                               
Sales
  $ 47,234,076     $ 14,941,786     $ 10,225,148     $ 72,401,010  
Cost of goods sold
    42,099,609       10,538,597       8,906,782       61,544,988  
Segment profit
    5,134,467       4,403,189       1,318,366       10,856,022  
Selling, general and administrative expenses
                            966,604  
Income from operations
                            9,859,418  
Non-operating income (expenses)
                            14,030  
Net income
                            9,873,448  
Segment assets
    82,004,195       20,270,489       18,540,992       120,815,676  
Capital expenditures
    113,470       -       -       113,470  
 
For the nine months ended September 30, 2010 and 2009
 
   
Wholesale Distribution of Finished Oil and Heavy Oil
   
Production and Sale of Biodiesel
   
Operation of Retail Gas Stations
   
Total
 
2010 (Unaudited)
                       
Sales
  $ 204,521,458     $ 53,668,922     $ 62,444,274     $ 320,634,654  
Cost of goods sold
    183,651,691       37,348,541       54,795,579       275,795,810  
Segment profit
    20,869,767       16,320,381       7,648,696       44,838,844  
Selling, general and administrative expenses
                            5,859,828  
Income from operations
                            38,979,016  
Non-operating income (expenses)
                            (476,419 )
Net income
                            38,502,597  
Segment assets
    134,329,151       34,162,791       48,006,643       216,498,585  
Capital expenditures
    91,990       12,744,538       6,845,104       19,681,632  
2009 (Unaudited)
                               
Sales
  $ 129,797,293     $ 40,137,252     $ 26,369,372     $ 196,303,917  
Cost of goods sold
    116,273,857       29,194,733       22,826,434       168,295,024  
Segment profit
    13,523,436       10,942,519       3,542,938       28,008,893  
Selling, general and administrative expenses
                            2,163,179  
Income from operations
                            25,845,714  
Non-operating income (expenses)
                            55,720  
Net income
                            25,901,434  
Segment assets
    82,004,195       20,270,489       18,540,992       120,815,676  
Capital expenditures
    204,646       -       -       204,646  
 
20

 
19. SUBSEQUENT EVENTS
 
On October 18, 2010, the Company entered and executed a definitive purchase agreement to acquire Chongqing Tianrun Energy Development Co., Ltd, a biodiesel production plant with 50,000 tons of biodiesel production capacity, for a total cash consideration of approximately $16.5 million (RMB 110,000,000). The acquisition furthers the Company’s growth strategy and expansion in production and sale of biodiesel business segment. The acquisition is accounted for asset purchase with no assumption of liabilities. Assets of Chongqing Tianrum Energy consists of land, tangible fixed assets including but not limited to biodiesel production equipment, building, and related infrastructure, intangible assets, intellectual properties of biodiesel production process. The Company will pay 60% of the total purchase price or approximately $9.9 million (RMB 66,000,000) upon execution of the definitive purchase agreement. The Company will pay 30% of the total purchase price or approximately $5.0 million (RMB 33,000,000) upon transfer of title of the assets. The remaining 10% or approximately $1.6 million (RMB 11,000,000) will be paid in 30 days after transfer of title.
 
On October 19, 2010, the Company completed an acquisition of 100% of Shenmu gas station, a privately owned service gas station, located in Shenmu County, Yulin City, Shaanxi Province, PRC. The acquisition furthers the Company’s growth strategy and expansion in operation of its retail gas station business segment.  The total purchase price of Shenmu gas station was approximately $ 9,180,235 (RMB 61,000,000) in cash with no assumption of liabilities.  Assets of Shenmu gas station consists of a 50-year land usage right of 13 Mu (approximately 2.14 acres) of land, which is owned by the government; 10 gas pumps; 6 petroleum storage tanks; and gas station including business office and fueling stations with 1,200 square meters (approximately 12,920 square feet) in size along with a diesel generator and a electricity transformer. Upon execution of the purchase agreement, the Company will pay 60% of the total purchase price or approximately $5,508,100 (RMB 36,660,000). The Company will pay 30% of the total purchase price or approximately $2,754,000 (RMB 18,300,000) upon transfer of the operation permits, gas station operating right and land usage right. The remaining 10% of the total purchase price or approximately $918,000 (RMB 6,100,000) will be paid on one year anniversary from the execution of the purchase agreement.
 
20.  OPERATING RISK
 
(a) Country risk
 
Currently, the Company’s revenues are mainly derived from sale of oil products and bio-diesel in the central and western region of PRC. The Company hopes to expand its operations in other regions of PRC, however, such expansion has not been commenced and there are no assurances that the Company will be able to achieve such an expansion successfully. Therefore, a downturn or stagnation in the economic environment of the PRC could have a material adverse effect on the Company’s financial condition.
 
(b) Products risk
 
The Company competes with larger companies, who have greater resources available for expansion, marketing, research and development and the ability to attract more qualified personnel. There can be no assurance that the Company will remain competitive with larger competitors.
 
(c) Exchange risk
 
The Company cannot guarantee that the current exchange rate will remain steady, therefore there is a possibility that the Company could post the same amount of profit for two comparable periods and because of a fluctuating exchange rate actually post higher or lower profit depending on exchange rate of Chinese Renminbi (RMB) converted to U.S. dollars on that date. The exchange rate could fluctuate depending on changes in the political and economic environments without notice.
 
21

 
(d) Political risk
 
Currently, the PRC is in a period of growth and is openly promoting business development in order to bring more business into the PRC. Additionally, the PRC allows a Chinese corporation to be owned by a United States corporation. If the laws or regulations are changed by the PRC government, the Company’s ability to operate in the PRC could be affected.
 
(e) Key personnel risk
 
The Company’s future success depends on the continued services of executive management in China. The loss of any of their services would be detrimental to the Company and could have an adverse effect on business development. The Company does not currently maintain key-man insurance on their lives. Future success is also dependent on the ability to identify, hire, train and retain other qualified managerial and other employees. Competition for these individuals is intense and increasing.
 
22

 
ITEM 2  
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Forward Looking Statements
 
This quarterly report on Form 10-Q and other reports filed by the Company from time to time with the Securities and Exchange Commission (collectively the “Filings”) contain or may contain forward-looking statements and information that are based upon the belief of, and information currently available to, the Company’s management, as well as estimates and assumptions made by Company management. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. When used in the filings, the words “anticipate,” “believe,” “estimate,” “expect,” “future,” “intend,” “plan,” or the negative of these terms and similar expressions as they relate to the Company or the Company’s management identify forward-looking statements. Such statements reflect the current view of the Company with respect to future events and are subject to risks, uncertainties, assumptions, and other factors (including the risks contained in the section of this report entitled “Risk Factors”) relating to the Company’s industry, the Company’s operations and results of operations, and any businesses that the Company may acquire. Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended, or planned.
 
Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance, or achievements. Except as required by applicable law, including the securities laws of the United States, the Company does not intend to update any of the forward-looking and consider the various disclosures made throughout the entirety of this quarterly report, as well as in the Company’s other Filings, which include other disclosures of the risks and factors that may affect our business, financial condition, results of operations, and prospects.
 
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the periods presented. Our financial statements would be affected to the extent there are material differences between these estimates and actual results. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result.
 
OVERVIEW
 
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand our operations and our present business environment. MD&A is provided as a supplement to—and should be read in conjunction with—our consolidated financial statements and the accompanying notes thereto contained in “Item 1. Financial Statements of this report. This overview summarizes the MD&A, which includes the following sections:
 
·  
Our Business—a general overview of our three business segments, the material opportunities and challenges of our business.
 
·  
Critical Accounting Policies and Estimates—a discussion of accounting policies that require critical judgments and estimates.
 
·  
Results of Operations—an analysis of our Company’s consolidated results of operations for the two years presented in our consolidated financial statements. Except to the extent that differences among our operating segments are material to an understanding of our business as a whole, we present the discussion in the MD&A on a consolidated basis.
 
·  
Liquidity, Capital Resources and Financial Position—an analysis of cash flows; an overview of financial position.
 
23

 
The following discussion contains forward-looking statements that involve risks, uncertainties, and assumptions such as statements of our plans, objectives, expectations, and intentions. Our actual results may differ materially from those discussed in these forward-looking statements because of the risks and uncertainties inherent in future events.
 
Our Business
 
Company Overview
 
We are a leading non-state-owned integrated energy company in China engaged in three business segments, wholesale distribution of finished oil and heavy oil products, production and sale of biodiesel, and operation of retail gas stations.
 
We now operate four oil depots located in Xi’an, Shaanxi Province, have access to a 2.65 kilometer special transportation rail track to transport petroleum products. We own and operate one 100,000 ton biodiesel production plant located in Tongchuan City, Shaanxi Province, China with a goal of doubling biodiesel production capacity to 200,000 tons in 2010 through both internal expansion and an acquisition. We are currently constructing a 50,000-ton biodiesel production plant in adjacent to the existing 100,000-ton biodiesel production facility. The completion of the newly-constructed 50,000-ton biodiesel production facility has been slightly delayed, due to recent inclement weather and a holdup on equipment clearance by customs.  However, we expect to commence testing and ramp-up of the newly constructed biodiesel production facility in December 2010. On October 18, 2010, we executed a definitive purchase agreement to acquire a 50,000 metric ton biodiesel production facility located in Chongqing City, China from Chongqing Tianrun Energy Development Co., Ltd. and expect to ramp up production and distribution of biodiesel product from this facility immediately after the acquisition. The acquired facility uses first generation biodiesel production technology, similar to the production process used in the Company’s current 100,000-ton production plant. The Company’s expertise in biodiesel production and its established distribution network should allow the acquired facility to achieve gross margins of approximately 30%, We are the only non-state owned biodiesel producer with a nationwide distribution license. We will pay approximately $16.5 million in cash for the Chongqing Tianrun biodiesel production facility. and expect the acquisition to add approximately $32 million in revenue and $8 million in pretax income in 2011. The Chongqing Tianrun biodiesel plant is subject to 15% corporate income tax rate. The Company will fund the acquisition with cash on hand, which was approximately $79.7 million as of September 30, 2010.
 
Our only market is China. Currently, our products are sold in 14 provinces and municipalities of China covering Shaanxi Province, Henan Province, Hebei Province, Shangdong Province, Shanxi Province, Hunan Province, Hubei Province, Sichuan Province, Guizhou Province, Yunnan Province, Fujian Province, Xinjiang Province, Beijing, and Shanghai.  On October 19, 2010, we acquired Shenmu gas station located in Ylin City, Shenmu County, Shaanxi Province, PRC. We have acquired land use right, gas station operating rights, and all of the assets of Shenmu gas station for a total cash payment of approximately $9.2 million  The gas station distributes both gasoline and diesel, which may include blended biodiesel in the future. During the past twelve months, the acquired gas station sold approximately 8,000 tons of fuel and generated revenues of approximately $8.2 million. For the fiscal year of 2011, the Company estimates the Shenmu gas station will sell approximately 12,000 tons of fuel and generate approximately $12.3 million in revenues. We currently also operate 13 gas stations surrounding Xi’an city.
 
Fluctuations in Fuel Prices During 2010
 
Until 2008, China’s fuel prices had been controlled by the National Development and Reform Commission (NDRC) and not set by market supply and demand. Effective January 1, 2009, the Chinese government implemented a new pricing regime for refined oil products, aimed to link domestic oil prices more closely to changes in the global crude oil prices in a controlled manner.
 
24

 
From 2006 to 2008, there were only two oil price adjustments in each year.  However, there were eight oil price adjustments in 2009. There have been two oil price adjustments in 2010. We expect that oil prices in China will be adjusted more frequently fluctuating in line with global oil prices.
 
In first quarter of 2010, the average sales price for our oil products, which include gasoline, diesel and heavy oil was $846 per ton (equivalent to approximately $2.48 per gallon of gasoline and $2.80 per gallon of petro-diesel), compared to an average price of $832 per ton (equivalent to approximately $2.44 per gallon of gasoline and $2.67 per gallon of petro-diesel), during the fourth quarter of 2009.  The global crude oil price had been stable from November 2009 to March 2010.
 
On April 14, 2010, NDRC subsequently increased the prices of gasoline and diesel by RMB 320 or $46.9 per ton or 4.5% and RMB 320 or $46.9 per ton or 5.0%, respectively, when global crude oil price reached $87 per barrel.
 
On June 1, 2010, NDRC subsequently decreased the prices of gasoline and diesel by RMB 230 or $33.7 per ton or 3.1% and RMB 220 or $32.2 per ton or 3.2%, respectively, when global crude oil price declined $74 per barrel.
 
On October 26, 2010, NDRC increased the retail selling price of gasoline and diesel by RMB 230 or $34.5 per ton or 3.2% and RMB 220 or $33.0 per ton or 3.4%, respectively, when global crude oil price stayed at $82 per barrel.
 
Tax Exemptions
 
NDRC, the Ministry of Finance and other governmental departments are formulating relevant policies such as subsidies, refund of Value Added Taxes (“VAT”), relief on consumption tax, corporate tax, and fuel tax to encourage bio-diesel consumption. As a result, Xi’an Baorun is exempt from the fuel tax and corporate income taxes.  Xi’an Baorun is exempted from the corporate income tax through the end of calendar year 2010.
 
Growth and Expansion Plans
 
Management plans to grow its biodiesel production, its distribution business, and expand the footprint of its retail gas stations with a focus on expanding the biodiesel segment. On the distribution and retail sides, we benefit from our advantageous location, well-established supplier relationships, as well as an extensive distribution network that has valuable railway access to reach remote parts of China that other distribution companies located in Shaanxi Province cannot currently reach. We plan to strengthen our outreach in certain key distribution areas. We have demonstrated growth in sales volume of our distribution business year-on-year, quarter-on-quarter as the results of our continuous efforts in expanding distribution territories and in-depth penetration of existing customer base creating more demand for oil products as their businesses grow and expand. For the nine months ended September 30, 2010, sales volume of wholesale distribution has increased by 32.5% from the same period in 2009. On October 19, 2010, we acquired Shenmu retail gas station located in Yulin City, Shenmu County, Shaanxi Province, for a total cash consideration of approximately $9.2 million. We also plan to add one or two more retail gas stations through acquisition or lease in 2010, which we believe will benefit our overall distribution profit margins. We are currently operating 13 gas stations including the Shenmu gas station that we just acquired.
 
We also plan to expand our current biodiesel production capacity of 100,000 tons to 200,000 tons, and we commenced construction to increase our current capacity in the third quarter of 2009. We anticipate $15 million in capital expenditures in 2010 to accomplish this goal. The completion of the newly-constructed 50,000-ton biodiesel production facility has been slightly delayed, due to recent inclement weather and a holdup on equipment clearance by customs.  However, we expect to commence testing and ramp-up of the newly constructed biodiesel production facility in December 2010. We have secured enough raw materials to supply 150,000 tons of capacity, but will also continue to work towards securing more long-term sources of raw materials and new technology in the bio-energy field. On October 18, 2010, we executed a definitive purchase agreement to acquire Chongqing Tianrun Energy Development Co., Ltd., a biodiesel production facility with 50,000 tons of biodiesel production capacity. We believe that profit margins of the acquired company are similar to our current biodiesel production. The acquisition cost approximately $17.1 million. We continue pursuing strategic acquisitions that will quickly provide financial benefits to us.
 
25

 
Management believes the increase in sales volume from these initiatives will not only offset the impact from fluctuations in fuel pricing, but also favorably impact overall profits and cash flow.
 
Basis of Presentations
 
Our financial statements are prepared in accordance with the U.S. GAAP and the requirements of Regulation S-X promulgated by the Securities and Exchange Commission.
 
Critical Accounting Policies and Estimates
 
Accounts Receivable
 
Our policy is to maintain reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves.  Based on historical collections, no allowance was deemed necessary at September 30, 2010 and December 31, 2009, as the Company did not experience any uncollectible accounts receivable and bad debt write-off over the past years.
 
Inventories
 
Inventories are valued at the lower of cost or market with cost determined on a moving weighted average basis.  Cost of work in progress and finished goods comprises direct material, direct labor and an allocated portion of production overheads.
 
Property, Plant and Equipment
 
Property, plant, and equipment are stated at the actual cost on acquisition less accumulated depreciation and amortization. Depreciation and amortization are provided for in amounts sufficient to relate the cost of depreciation assets to operations over their estimated service lives, principally on a straight-line basis. Most property, plant and equipment have a residual value of 5% of actual cost. The estimated lives used in determining depreciation are:

Building
20 years
Vehicle
5 years
Office Equipment
5 years
Production Equipment
10 years
 
In accordance with Statement of accounting standards codification, “Accounting for the Impairment or Disposal of Long-Lived Assets”, we examine the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable. The Company believes that there were no impairments of its long-lived assets as of September 30, 2010 and December 31, 2009,.
 
Intangible Assets
 
Our intangible assets consist of definite-lived assets subject to amortization such as gas station operating right, land usage right of a gas station, and land usage right of agricultural plantation for a pilot program cultivating biodiesel feedstock. We calculate amortization of the definite-lived intangible assets on a straight-line basis over the useful lives of the related intangible assets.
 
26

 
Revenue Recognition
 
Our revenue recognition policies are in compliance with Securities and Exchange Commission Staff Accounting Bulletin 104. Sales revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured.  Payments received prior to meeting all relevant criteria for revenue recognition are recorded as unearned revenue.  For Retail gas station sales, revenue is recognized and cash is collected upon completion of fuel sales to customers,
 
Foreign Currency Translation
 
Our functional currency is the Renminbi (“RMB”). For financial reporting purposes, RMB has been translated into United States dollars (“USD”) as the reporting currency. Assets and liabilities are translated at the exchange rate in effect at the balance sheet date, except for fixed assets, intangible assets, and prepaid rent that are stated at the historical cost. Revenues and expenses are translated at the average rate of exchange prevailing during the reporting period. Translation adjustments caused by different exchange rates from period to period are included as a component of stockholders’ equity as “Accumulated other comprehensive income.” Gains and losses resulting from foreign currency transactions are included in income. On June 19, 2010, the Chinese central bank announced that it would further the reform of the RMB exchange rate mechanism to improve flexibility. At September 30, 2010, Renminbi has appreciated approximately 1.34% from June 30, 2010. The Company does not believe that its foreign currency exchange rate fluctuation risk is significant in a short period of time. We anticipate that appreciation of Renminbi will continue. This fluctuation of the exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People’s Bank of China. There has been no significant fluctuation in exchange rate for the conversion of RMB to USD after the balance sheet date.
 
Income Tax Recognition
 
We account for income taxes under accounting standards codification, “Accounting for Income Taxes.” “Accounting for Income Taxes” requires the recognition of deferred tax assets and liabilities for both the expected impact of differences between the financial statements and the tax basis of assets and liabilities, and for the expected future tax benefit to be derived from tax losses and tax credit carry forwards. “Accounting for Income Taxes” additionally requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets.
 
Xi’an Baorun Industrial has obtained income tax exemption for the years from 2004 to the end of 2010, due to the fact that it uses waste gas, water and residue in the production of its products. We believe that this exemption is in effect for all periods presented. Currently, the PRC is in a period of growth and is openly promoting business development in order to bring more business into the PRC. Tax exemption is one of the many methods used to promote such business development. If the exemption should be rescinded for future periods, Xi’an Baorun Industrial would be subjected to tax liabilities.  Had the abatement for income taxes not been in effect for Baorun Industrial, we estimate that the consolidated pro forma financial impact would be as follows:

   
For the three months ended
September 30,
   
For the nine months ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Net income before income taxes
  $ 13,743,653     $ 9,873,448     $ 38,502,597     $ 26,294,718  
Tax provision
    (3,709,213 )     (2,514,186 )     (10,487,492 )     (6,573,680 )
Net income
  $ 10,034,440     $ 7,359,262     $ 28,015,105     $ 19,721,038  
Earnings per share (Basic)
  $ 0.30     $ 0.27     $ 0.83     $ 0.72  
Earnings per share (diluted)
  $ 0.23     $ 0.20     $ 0.65     $ 0.56  
 
Xi’an Baorun Industrial and Redsky Industrial, two PRC companies, entered into a series of contracts whereby Redsky Industrial exercises significant control over Xi’an Baorun Industrial, including the right to receive 100% of the net income generated by Xi’an Baorun Industrial. While, as noted above, Xi’an Baorun Industrial is exempt from income tax for the years from 2004 through 2010, Redsky Industrial is not exempt from tax in those periods and is obligated for applicable PRC taxes under PRC tax laws. We account for all income taxes in accordance with “Accounting for Income Taxes” and “Accounting for Uncertainty in Income Taxes,”
 
27

 
We believe that the series of contracts entered into between Xi’an Baorun Industrial and Redsky Industrial do not constitute taxable income for the purposes of Redsky Industrial. Since commencement of these series of contracts, Xi’an Baorun Industrial has not remitted any income to Redsky Industrial, nor has Redsky Industrial demanded any remittance of income, nor is remittance expected in the future, as Xi’an Baorun Industrial is anticipating to use its undistributed earnings for future bio-energy development as was anticipated when it obtained its original tax exemption. We have examined our tax position and have determined that our tax position with regards to both these entities is in compliance with applicable PRC tax laws. Pursuant to the accounting standards codification, we have determined that we will reinvest indefinitely our earnings to the biodiesel production facility and biodiesel production technology, and accordingly no accrual of deferred tax liabilities was required as of September, 2010 and December 31, 2009  We have also analyzed the status of Redsky Industrial and have determined that based on the aforementioned series of contracts, if Redsky Industrial should be sold, dissolved or otherwise disposed of, the obligations of Xi’an Baorun Industrial would be terminated under the series of contracts, including Redsky Industrial’s right to 100% of Xi’an Baorun Industrial’s net income. In addition, in accordance with “Accounting for Uncertainty in Income Taxes”, we have examined our tax position in the context of “Accounting for Contingencies.”  Accounting for Uncertainty in Income Taxes is an accounting requirement that discusses tax issues that have an element of uncertainty. In accordance with “Accounting for Contingencies”, we have determined that it is probable that our tax position with regards to both Redsky Industrial and Xi’an Baorun Industrial is correct. Accordingly, no deferred tax liability has been provided for.
 
Consolidation of Variable Interest Entities
 
VIE’s are entities that lack one or more voting interest entity characteristics. The Company consolidates VIEs in which it is the primary beneficiary of its economic gains or losses. The FASB has issued an accounting standards codification (Revised December 2004), Consolidation of Variable Interest Entities. Consolidation of Variable Interest Entities clarifies the application of Accounting Research Bulletin, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. It separates entities into two groups: (1) those for which voting interests are used to determine consolidation and (2) those for which variable interests are used to determine consolidation. Consolidation of Variable Interest Entities clarifies how to identify a variable interest entity and how to determine when a business enterprise should include the assets, liabilities, non-controlling interests and results of activities of a variable interest entity in its consolidated financial statements.
 
In December 2009, the FASB issued guidance for Consolidations – Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities ( Topic 810 ). The amendments in this update are a result of incorporating the provisions of accounting standards codification, “Consolidation of Variable Interest Entities”, Amendments to accounting standards codification, “, and accounting standards codification, “Interpretation of Consolidation of Variable Interest Entities, revised December 2004.” Management believes this Statement will have immaterial impact on the financial statements of the Company.
 
Contingencies
 
Management assesses the probability of loss for certain contingencies and accrues a liability and/or discloses the relevant circumstances, as appropriate when Management believes that any liability to the Company that may arise as a result of having to pay out additional expenses that may have a material adverse effect on the financial condition of the Company taken as a whole.
 
Litigation
 
In the normal course of business, the Company may be involved in legal proceedings. The Company accrues a liability for such matters, when it is probable that a liability has been incurred and the amount can be reasonably estimated. When only a range of possible loss can be established, the most probable amount in the range is accrued. If no amount within this range is a better estimate than any amount within the range, the minimum amount in the range is accrued. The accrual for a litigation loss contingency might include, for example, estimates of potential damages, outside legal fees and other directly related costs expected to be incurred. There is no material litigation against the Company.
 
28

 
Results of Operations
 
For the three months ended September 30, 2010 and 2009

   
Wholesale 
Distribution of Finished Oil and Heavy Oil
   
Production and Sale of Biodiesel
   
Operation of Retail Gas Stations
   
Total
 
2010 (Unaudited)
                       
Sales
  $ 64,012,831     $ 20,291,638     $ 22,490,244     $ 106,794,714  
Cost of goods sold
    56,871,516       14,234,708       19,683,887       90,790,112  
Segment profit
    7,141,315       6,056,930       2,806,357       16,004,602  
Selling, general and administrative expenses
                            1,988,110  
Income from operations
                            14,016,492  
Non-operating income (expenses)