As of June 30, 2009, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates, computed by reference to the price at which the common equity was last sold, was approximately $22,169,314.  Solely for the purposes of this calculation, “affiliate” has the meaning defined in Rule 12b-2 of the Exchange Act.

The total number of shares of common stock of the registrant that were outstanding on the latest practicable date, March 17, 2010, was 19,449,832  shares.

 

 

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TABLE OF CONTENTS

 

		Page
PART I
Item 1. Business		4
Item 1A. Risk Factors		13
Item 2. Properties		20
Item 3. Legal Proceedings		21
Item 4. Removed and Reserved		21
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters  and Issuer Purchases of Equity Securities		22
Item 6. Selected Financial Data		24
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations		25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk		31
Item 8. Financial Statements and Supplementary Data		33
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		71
Item 9A(T). Controls and Procedures		71
Item 9B. Other Information		73
PART III
Item 10. Directors, Executive Officers and Corporate Governance		74
Item 11. Executive Compensation		77
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		83
Item 13. Certain Relationships and Related Transactions and Director Independence		84
Item 14. Principal Accountant Fees and Services		85
PART IV
Item 15. Exhibits, Financial Statement Schedules		87
Signatures		90
Certifications

 

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Overview

 

We are a supplier of high-grade metallurgical coking coal to the industrial sector in the People’s Republic of China (the “PRC” or “China”). Our processed coking coal is primarily purchased by coke and steel producers for the purpose of making the coke required for the steel manufacturing process. Our operations are conducted exclusively by an entity in China, Shanxi Puda Coal Group Co., Ltd (“Shanxi Coal”), which we control through 90% indirect equity ownership.

 

We clean raw coking coal sourced from third-party coal mines primarily located in Liulin County, Shanxi Province, and market the cleaned, high quality coking coal to coke and steel makers in our geographic market. Our current primary geographic markets include Shanxi Province, Inner Mongolia Autonomous Region, Hebei Province, Beijing and Tianjin, China.

 

We focus on value-added coal washing processes and specialize in providing the high quality, cleaned coking coal, which is the quality level required to produce steel. The demand for the form of high quality coking which we produce is primarily driven by China’s industrial expansion and advancement, which depends on the availability of large amounts of steel for building infrastructure.  We currently purchase raw coal from a diversified pool of local coal mines in Shanxi Province.

 

The central area of Shanxi Province, where our three coal washing plants are located, is known for its high quality coking coal reserves.  We are strategically located in proximity to some of the highest quality coking coal reserves suitable for steel making. Our three coal washing plants are located in Liulin County, Zhongyang County and Linshi County, all of which are within approximately 150 miles of our headquarters in Taiyuan City.  Our accumulated coal washing capacity is about 3.5 million MT per year. As a large-volume supplier, we expect to continue to enjoy certain advantages as we believe that our primary customers will continue to focus on suppliers that can deliver large volume, consistently high-quality coking coal. We also expect to be well positioned to serve the demand for steel production in China - mostly, coking companies that supply the steel mills and steel mills with their own coking facilities. These customers are mostly located in Shanxi Province, Inner Mongolia Autonomous Region, Hebei Province, Beijing and Tianjin, all of which are accessible by railroad which is the most cost effective method for coal transportation.

 

We have three coal washing plants:  Shanxi Liulin Jucai Plant, located in Liulin County, about 2 miles away from Jucai Coal, has an annual cleaning capacity of 1.1 million MT; Shanxi Zhongyang Ruixu Plant, located in Zhongyang County, has an annual clean coal washing capacity of 1.2 million MT; Linshi Dongqiang Plant, located in Linshi County, has an annual coal washing capacity of 1.2 million MT. In 2009, we produced about1.9 million MT cleaned coal, which is 54% of the 3.5 million MT annual production capacity.

To diversify our source of revenue and increase our gross margin, our board of directors has approved a change in its business strategy to permit us to enter into coal mining business, which can be operated separately from or synergistically with, our coal washing business.  In December 2009, Puda announced that our subsidiary, Shanxi Coal, had entered into agreements with two companies to acquire assets and mining rights with respect to two coal mines.

On May 14, 2009, Shanxi Coal entered into an Agreement of Shares Transfer with two unrelated individuals to purchase their 18% ownership in Shanxi Jianhe Coal Industry Limited Company (“Jianhe Coal”) for an aggregate purchase price of RMB 100 million (approximately $14.6 million).  The transaction was closed on December 3, 2009.  According to the agreement, Shanxi Coal, will be paid dividends semiannually based on its 18% ownership in Jianhe Coal and aggregate dividend to be declared will be no less than 80% of the net profits of Jianhe Coal.  In addition, Shanxi Coal has first priority in the right to purchase other shares of Jianhe Coal within the 24-month period following execution of the agreement.

On September 28, 2009, the Shanxi provincial government appointed Shanxi Coal as a consolidator of eight coal mines in Pinglu County Yucheng City. Shanxi Coal has the government’s permission to acquire and consolidate the eight coal mines into five, which should increase their total annual capacity from approximately 1.6 million to 3.6 million metric tons.

On December 11, 2009, Shanxi Coal entered into a Mining Right and Mining Assets Transfer Agreement  (the “Da Wa Agreement”) with Pinglu County Da Wa Coal Industry Co., Ltd. (“Da Wa Coal”), pursuant to which Shanxi Coal will purchase from Da Wa Coal all its tangible assets and coal mining right with respect to a coal mine located in Pinglu County, Yuncheng City, Shanxi Province of China.  As consideration, Shanxi Coal will pay Da Wa Coal an aggregate purchase price of RMB 190 million (approximately $27.8 million) in cash, of which RMB 46.6 million ($6.8 million) is for the tangible assets and RMB 143.4 million ($21.0 million) is for the mining right and compensation to Da Wa Coal.  On December 11, 2009, Shanxi Coal also entered into a Mining Right and Mining Assets Transfer Agreement (the “Guanyao Agreement”) with Pinglu County Guanyao Coal Industry Co., Ltd. (“Guanyao Coal”), pursuant to which, Shanxi Coal will purchase from Guanyao Coal all its tangible assets and coal mining right with respect to a coal mine located in Pinglu County, Yuncheng City and Yuanqu County, Shanxi Province of China.  As consideration, Shanxi Coal will pay Guanyao Coal an aggregate purchase price of RMB 94.80 million (approximately $13.9 million) in cash, of which RMB 37.6 million ($5.5 million) is for the tangible assets and RMB 57.2 million ($8.4 million) is for the mining rights and compensation of Guanyao Coal.

 

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As of the date of this report, we have paid 15% of the purchase price of each of the Da Wa Agreement and Guanyao Agreement. The consummation of the transactions are expected to take place in April 2010 upon the transfer of the registrations, ownership certificates of the mining rights and land and property deeds.

Following the appointment by the Shanxi provincial government as the consolidator of eight coal mines located Pinglu County, Yuncheng City, Shanxi Province, Shanxi Coal received an approval in March 2010 by the Shanxi provincial government to acquire and consolidate four additional coking coal mines into one coal mine located in Huozhou County, Lingfen City of Shanxi Province.  Management believes that after the consolidation, the total annual capacity of the mines should increase from current approximately 720,000 metric tons to 900,000 metric tons. As of the reporting date, no definitive agreement was signed on the project.

 

Our principal executive office is located at 426 Xuefu Street, Taiyuan City, Shanxi Province, China. Our telephone number is +86 (351) 2281302 and our facsimile number is +86 (351) 7034404.

 

History and Background of the Company

Puda Coal, Inc. (formerly Purezza Group, Inc.) (the “Company” or “Puda”) was initially incorporated in Florida on August 9, 2001 under Florida law.  On July 30, 2009, the Company was reincorporated in the State of Delaware.  From September 8, 2005 to September 22, 2009, the Company’s common stock was traded on the over-the-counter Bulletin Board. Since September 22, 2009, the Company’s common stock has been trading on the NYSE Amex LLC Exchange (the “NYSE Amex”) under the ticker symbol “PUDA.”

On July 15, 2005, through a reverse merger, the Company acquired all the outstanding capital stock and ownership interests of Puda Investment Holding Limited (“BVI”), an International Business Company organized in the British Virgin Islands with registered capital of $50,000, and BVI became a wholly-owned subsidiary of the Company. In exchange, Puda issued to the BVI Members (Ming Zhao, Yao Zhao and Worldwide Gateway Co. Ltd.)  1,000,000 shares of Series A convertible preferred stock, par value $0.01 per share, of the Company, which are convertible into 678,500,000 shares of Puda’s common stock. The purchase agreement provided that the preferred shares would immediately and automatically be converted into shares of Puda’s common stock (the “Mandatory Conversion”), following an increase in the number of authorized shares of Puda’s common stock from 100,000,000 to 150,000,000, and a 1-for-10 reverse stock split of Puda’s outstanding common stock (the “Reverse Split”). The share data has been retroactively adjusted for the Reverse Split.

 

On August 2, 2005, the authorized number of shares of common stock of the Company was increased from 100,000,000 shares to 150,000,000 shares. On September 8, 2005, Puda completed the Reverse Split. Following the Mandatory Conversion of preferred shares and the Reverse Split, the BVI Members received, in the aggregate, approximately 67,850,000 shares of the total of 73,750,000 of Puda’s common stock, representing 92% of the outstanding shares of Puda’s common stock.

BVI, in turn, owns all of the registered capital of Shanxi Putai Resources Limited (formerly, Taiyuan Putai Business Consulting Co., Ltd.) (“Putai”), a wholly foreign owned enterprise (“WFOE”) registered under the wholly foreign-owned enterprises laws of the People’s Republic of China (“PRC”). Putai was incorporated on November 5, 2004 and has a registered capital of $20,000. Putai did not have any operating activities from November 5, 2004 (inception) until June 24, 2005 when it entered into certain Operating Agreements with Shanxi Puda Coal Group Co., Ltd. (formerly, Shanxi Puda Resources Co. Ltd.) (“Shanxi Coal”), a company with limited liability established under the laws of the PRC. The Operating Agreements provided Putai control over Shanxi Coal, and the risks and rewards associated with equity ownership.

Shanxi Coal was established on June 7, 1995. Shanxi Coal mainly processes and washes raw coal and sells from its plants in Shanxi Province, high-quality, low sulfur refined coal for industrial clients mainly in Central and Northern China. Shanxi Coal has a registered capital of RMB22,500,000 ($2,717,000) which is fully paid.

Prior to our acquisition of 90% of the capital stock of Shanxi Coal on November 8, 2007, the owners of Shanxi Coal were Mr. Ming Zhao (80%) and Mr. Yao Zhao (20%). Ming Zhao is the chairman and chief executive officer of Puda before June2008. Yao Zhao was the chief operating officer of Puda until his resignation became effective on November 20, 2006. Ming Zhao and Yao Zhao are brothers.

 

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On September 13, 2007, pursuant to an Exclusive Option Agreement between Putai and Shanxi Coal, Putai exercised the Option to acquire 90% of the total registered capital of Shanxi Coal at an acquisition price of RMB20,250,000 (approximately $2,692,000). Upon the Option exercise, Putai entered into a Share Transfer Agreement with the owners of Shanxi Coal, Ming Zhao and Yao Zhao, respectively. The acquisition price of $2,692,000 was fully paid as of December 31, 2008.  After the acquisition, Putai became a 90% owner of Shanxi Coal, and the Exclusive Option Agreement, Exclusive Consulting Agreement, Operating Agreement, Technology License Agreement and Authorization, each entered into on June 24, 2005, among Putai, Shanxi Coal, Ming Zhao and Yao Zhao, were terminated.

As of December 31, 2009, the percentages owned by Mr. Ming Zhao and Mr. Yao Zhao in the Group companies are as follows:

·

Puda Coal, Inc.: Mr. Ming Zhao (approximately 48%); Mr. Yao Zhao (approximately 12%) held directly.

·

Puda Investment Holding Limited: Mr. Ming Zhao (approximately 48%); Mr. Yao Zhao (approximately 12%) held indirectly through Puda.

·

Shanxi Putai Resources Limited: Mr. Ming Zhao (approximately 48%); Mr. Yao Zhao (approximately 12%) held indirectly through Puda and BVI.

·

Shanxi Puda Coal Group Co., Ltd.: Mr. Ming Zhao (8%); Mr. Yao Zhao (2%) held directly, Mr. Ming Zhao (approximately 43%); Mr. Yao Zhao (approximately 11%) held indirectly through Puda, BVI and Putai.

Effective on July 30, 2009 (the “Effective Date”), the Company completed a reincorporation from a Florida corporation to a Delaware corporation.  Each issued and outstanding share of common stock, par value $0.001 per share, of the Florida-incorporated Company was automatically converted into 0.142857 issued and outstanding share of common stock, par value $0.001 per share, of the Delaware-incorporated Company (the “7-to-1 Share Conversion”).  No fractional shares were or will be issued in connection with the conversion; instead, the Company rounded up any fractional share to the nearest whole number. Any common shares exercised from the warrants or stock options which were issued before the Effective Date were also subject to the conversion ratio of 7 to 1. The total number of authorized shares of common stock and preferred stock did not change as a result of the conversion.  Although the 7-to-1 Share Conversion occurred on July 30, 2009, it was retroactively reflected in the consolidated financial statements as if the reverse split was effective from January 1, 2007.

 

Corporate Structure

Our company has an offshore holding structure commonly used by public companies with operations in China. We are a Delaware corporation which owns Puda Investment Holding Limited or BVI, an International Business Company incorporated in the British Virgin Islands; BVI owns Putai, a wholly foreign-owned enterprise established under the laws of the PRC. Our operations are conducted exclusively through our 90% subsidiary Shanxi Coal, a PRC limited liability company.

As of December 31, 2009, our organizational structure is as follows:

Puda Coal, Inc. “Puda”
| 100%
Puda Investment Holding Limited “BVI”		Ming Zhao (8%) and Yao Zhao (2%)
|  100%		|
Shanxi Putai Resources Limited "Putai"	90% —>	Shanxi Puda Coal Group Co., Ltd. “Shanxi Coal”

 

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Our Business

 

Coal Cleaning

 

Coal cleaning is the physical process and the stage in coal production when the raw “run-of-mine” coal is processed into a range of cleaned, graded and uniform coal products suitable for the commercial market. Shanxi Coal specializes in providing cleaned coking coal for the steel making industry and is located in Shanxi Province - the heartland of China’s raw coal and coke production. High-quality, cleaned coking coal is best suited for making coke for purposes such as steel manufacturing.

 

Cleaned coking coal contains fewer impurities, and the cleaning process can reduce the ash content of raw coal by 50% and lower emissions of carbon dioxide (CO2) and sulfur dioxide (SO2). High-quality, cleaned coking coal provides increased commercial value, reduced ash content, reduced SO2 and CO2 emissions, and reduced transportation requirements compared to raw coking coal. Depending on customers’ specifications and requirements, we purchase different qualities of raw coking coal as inputs, mix them together and prepare them into a consistent quality, cleaned coking coal. With Shanxi Coal’s over ten years experience in mixing coal and our raw coal supply sources, we consistently provide cleaned coking coal with an external, or total, ash content of less than 9.5% and maximum 0.6% sulfur content, the industry specification for coking coal, which can be further processed (through a coking process) into coke - a primary feedstock for iron and steel making. We consistently meet or exceed these industry specifications for cleaned coking, although most steel and coke makers are forced to accept off-specification coking coal (external ash content exceeding 9.5%) due to the limited supply of specification grade coking coal.

To produce consistent quality clean coking coal meeting steel makers specifications (less than 9.5% external ash content and 0.6% maximum sulfur content), we mix about 55% to 60% of high quality raw coking coal by weight with 40% to 45% lower quality raw coking coal by weight. Although the supply of high quality raw coking coal is limited even in Shanxi Province, we currently have direct access to an adequate supply of the high quality raw coking coal through Jucai Coal, two related party mines and two non-related party mines. Meanwhile, the lower quality raw coking coal is available in more supply and is less difficult to source.

 

Two coal cleaning processes predominate in the industry: dense medium (“DM”) separation and jig washing. Both processes are widely applied throughout the world. Jig washing is perceived as a simpler, lower-cost option than DM separation and a range of improved jigs has continued to find wide application in Germany, India, and China. During the coal cleaning process, either water (for wet washing method) or air (dry washing method) can be used as the medium for the cleaning and beneficiation. The dry coal beneficiation process was widely used in Europe and the United States during the period 1930-1965, but was later abandoned largely because separation was not accurate, available technology severely restricted feed size and throughput and moisture presented a major inhibiting factor on performance. There remain a small number of dry coal beneficiation units in operation, particularly in some areas of China where water is scarce.

 

Our cleaning facilities use a proprietary, water supported jig washing technology that management believes gives it a competitive advantage in providing high quality, cleaned coking coal for China’s steel making industry.  

 

We also have our own wells as a water source for our coal cleaning process and, together with the recycling of water from the coal cleaning system, our plants have a sufficient and reliable supply of water for our existing operations.

 

Coal Washing Industry in China

 

Coal plays a fundamental role in the global economy. China is both one of the largest consumers and producers of coal in the world. Based on China’s official statistics, in 2009, the raw coal production was 2.96 billion MT, a 12.7% increase over 2008, when the raw coal production was 2.626 billion MT.  Coal, in its raw or processed forms, is mainly used in four major industries:  coal fired power plants, steel manufacturing, metallurgy of non-ferrous metals and cement production.

 

Steel production is highly dependent on high quality coking coal feedstock. Based on the statistics of International Iron and Steel Institute, China was the largest steel producer in the world, who produced about 567 million MT and 500 million MT raw steel in 2009 and 2008 respectively, representing 46% and 38% of the world’s total steel production in 2009 and 2008. Large Chinese steel industry led China's coking coal industry, which stimulates cleaned coal industry.

However, in recent years, as China’s demand for steel grows, government authorities have taken the initial steps to modernize the coal, coking and steel making industries. On September 2, 2008, the Shanxi government issued an implementation opinion on accelerating mergers and acquisitions of the coal mining enterprises. Pursuant to the opinion, through different alternative ways such as merger, transfer, joint restructuring and equity investing, large coal production enterprises are encouraged to merge with or acquire small coal mines, and restructuring within large coal enterprises is also encouraged.

 

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By utilizing modern cleaning facilities and adhering to Shanxi Province’s emissions standards, we believe we have adopted a business strategy that should fit the industry’s development path. Because of our long-standing relations with our customers - mostly, coking companies that supply the steel mills and steel mills with their own coking facilities - we may in the future increase our market share of cleaned coking coal sold in Shanxi Province.

 

In China, many coal mines do not have their own coal cleaning facilities or have inadequate cleaning capacities. Coal cleaning companies, such as Shanxi Coal, were established to meet the demand for cleaned coal. With our capacity of 3.5 million MT of annual cleaned coal, we believe that we should be able to participate in the early stages of China’s modernization of the coal, coking and steel making industries.

 

Although there are many coal cleaning plants located in the northeast China, the lower quality of the raw coal in that region makes these plants less competitive in the cleaned coal market, especially in the coking coal market which serves the steel making industry and coal-fired electric utilities. Lower quality coal markets include metallurgy of non-ferrous metals and cement production - neither of which are attractive market segments for us.

 

Raw Coal Supply

 

One of our competitive advantages is our access to the high-quality raw coking coal in Liulin County, Shanxi Province - an area known as China’s “King of Coal”, which has the highest processing yield and the lowest processing cost of any coking coal in China. As of the date of this report, we are not a coal mining operation and do not own any coal mines. However, our coal cleaning facilities are located in Shanxi Province, where high quality of coking coal reserves exists. Proximity to this high quality raw coking coal is critical to us for many reasons, including:

 

·

High-quality raw coking coal is needed to consistently meet our customer specifications for cleaned coking coal, with our larger customers insisting on even greater levels of quality consistency to improve the operating efficiency, pollution control and profits of our own operations.

 

·

If we are required to use a lower quality of raw coking coal, the yield, or the volume of cleaned coking coal produced from a MT of raw coking coal, will be reduced and adversely affect our gross margins.

 

·

The further the cleaning facilities are from the mines, the higher the cost to transport raw coal from the mines to the cleaning facilities, a cost typically absorbed by the coal cleaning facility. Our current and new cleaning facilities are all located in close proximity to our major raw coking coal sources, especially Jucai Coal and the other two related party mines.

 

Liulin County has the largest reserves of high-quality raw coking coal in China. Raw coking coal, which has a range of quality characteristics, has a maximum sulfur content of 0.6%, an internal ash content of 4% to 7%, and an external ash content of 10% to 14%. External ash content is the measure of the total ash content of the coal. The process of coal washing is applied to raw coking coal in order to reduce the amount of its external ash content, or total ash content, so that it can be used by steel manufacturers. Steel and coke makers generally require, although they do not always receive, cleaned coking coal to meet a minimum specification of maximum 0.6% sulfur content and 9.5% external, or total, ash content. Since the coal cleaning process does not reduce the internal ash content, higher quality raw coking coal is preferred for producing a consistent quality, cleaned coking coal meeting the steel and coke makers’ specifications.

 

We are supplied with raw coking coal by 17 coal mines, of which 12 mines are located in Liuling County in Shanxi Province. The high-quality raw coking coal we need to source and process to meet the quality level required by steel makers is more difficult to access in China than medium and low quality raw coal, which is a commodity and more readily available.

 

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One of our suppliers of high quality raw coking coal is Jucai Coal, a coal mine that is owned 75% by Yao Zhao, a manager at the coal washing plants of Shanxi Coal and brother of our Chairman, Ming Zhao, and a 19.79% (9.08% after the warrant exercise) stockholder of Puda. In addition to us, Jucai Coal also supplies high grade coal to other unrelated parties. Jucai Coal sold us 188,691MT and 343,758MT in 2009 and 2008, respectively. We currently have a preferred supply arrangement with Jucai Coal. This agreement gives us priority over its other customers and subject to its output capacity, Jucai Coal has agreed to supply us with our entire high quality raw coking coal requirements pursuant to a coal supply agreement. We receive favorable pricing terms which are at a RMB 30 (approximately $4) to RMB 50 (approximately $7)  discount per MT from the price Jucai Coal sells to its other customers. Payment terms are based on industry standards of 75% of the total purchase price is paid to Jucai Coal at delivery with the balance due within 30 days after delivery. Furthermore, Jucai Coal is required to maintain the quality of the coking coal at high quality which requires that such coking coal shall have a maximum 4% internal ash content, maximum 0.6% sulfur content, and external ash content of less than 10%. This preferred supply agreement expires by its terms on November 17, 2015 and may be terminated sooner if both parties agree to do so.

We are supplied and have access to lower quality coking coal from a number of other coal mines in Shanxi Province which produce raw coking coal with an internal ash content in excess of 7%. Sources of lower quality coking coal are plentiful around our cleaning facilities, and this lower quality coking coal typically sells at a discount to the prevailing high quality raw coking coal.

 

By the end of fiscal year 2009, we had 17 suppliers, with no one supplier who supplied more than 10% of our total raw coal purchase for year 2009.  In 2008, we had 19 raw coal suppliers, with no one supplier who supplied more than 10% of our raw coal purchase.

We also source raw coking coal from two major coal mines located in Liulin County near our cleaning facilities. These mines produce quality coking coal, although not at the quality level which Jucai Coal produces. These suppliers provide raw coking coal with maximum 0.6% sulfur content, 7% internal ash content, and 12 to 14% external ash content. These suppliers are:

 

·

Liujiazhuang Coal Mine - Shanxi Coal purchased about $8,065,596, $12,152,000 and $13,249,964 of raw coal from this mine in 2007, 2008 and 2009, respectively.

·

Liulin Dadongzhuang Coal Mine - Shanxi Coal purchased about $7,880,949, $12,839,000 and $13,180,846 of raw coal from this mine in 2007, 2008 and 2009, respectively.

  

Operations

 

We have three coal washing plants, of which one is located in Liulin County, one is located in Zhongyang County and one is located in Lingshi County. In 2009, we produced about 1.9 million MT clean coal, which is 54% of the total 3.5 million MT annual production capacity. The details about the three plants are as follows:

 

·

Shanxi Liulin Jucai Plant - located in Liulin County about 2 miles away from Jucai Coal, has an annual cleaning capacity of 1.1 million MT. Shanxi Coal purchased facility from Resources Group, a related party, at cost for approximately $5,800,000, of which $900,000 is for the 50-year land use rights, $1,000,000 is for the plant and $3,900,000 is for the equipment. Shanxi Coal purchases the plant under financial lease agreement with Resources Group. The financial lease loan due to Resources Group is amortized over 10 years and bears interest at a rate of 6% per annum payable quarterly.

 

·

Shanxi Zhongyang Ruixu Plant - located in Zhongyang County, started production in April of 2006. It has an annual clean coal washing capacity of 1.2 million MT. This plant plus land-use right is acquired by Shanxi Coal at a price of $7.2 million. Shanxi Coal purchases the plant under financial lease agreement with Resources Group. The financial lease loan due to Resources Group is amortized over 10 years and bears interest at a rate of 6% per annum payable quarterly.

 

·

Linshi Dongqiang Plant - This facility, which is located in Linshi County, has an annual coal washing capacity of 1.2 million MT. We purchased this facility through an asset exchange with Linshi Jinliao Coal & Chemical Co. on June 22, 2007.

Shanxi Coal, our operating company, has over 10 years of experience in sourcing and mixing different quality of raw coals. Since 1995, Shanxi Coal began the business of processing different quality raw coals, and we believe that long-term experience should allow us to produce the optimum raw coking coal mix which typically results in lower effective cost per MT of raw coking coal blended input. An optimum raw coal blended input also is a primary determinate in achieving high processing yield.

 

As substantially all of our business operations are conducted in China, our results of operations, financial condition and prospects are subject to economic, political and legal developments in China, currency fluctuations and other risks relating to doing business in China. For a detailed description of these risks, see risk factors sections under the sub-heading “Risks Relating to Doing Business in China,” starting from page 16.

 

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Strategic Expansion

By significant expansion of coking coal cleaning capacity, over the years, Puda’s coal washing business has grown steadily and it has become a mature and sustainable business, generating sufficient cash flows for daily operations. We believe that we should be well positioned to participate in the early stages of China’s modernization of the coal, coking and steel making industries. To diversify our source of revenue, achieve higher gross margin and continue to enhancing shareholder value, we have made a strategic move to enter the coal mining segment, which should enable the Company to enhance overall profit margins and solidify its position in the coal processing value chain.

On September 2, 2008, the Shanxi government issued an implementation opinion on accelerating the coal mining enterprises mergers and acquisitions.  Pursuant to the opinion, through different alternative ways such as merger, transfer, joint restructuring and equity investing, large coal production enterprises are encouraged to merge with or acquire small coal mines, and restructuring within large coal enterprises is also encouraged.  Electric power, metallurgy and chemical engineering enterprises, which are related to the coal industry, are encouraged to participate in, by investing as minority shareholders, mergers and acquisitions of coal mines in order to realize the holding of specialized management, coal and related industrial integration management.

On September 28, 2009, the Shanxi provincial government appointed Shanxi Coal as a consolidator of eight coal mines in Pinglu County. Shanxi Coal has the government’s permission to acquire and consolidate the eight coal mines into five, which could increase their total annual capacity from approximately 1.6 million to 3.6 million metric tons.

On December 4, 2009, Shanxi Coal purchased 18% ownership of Jianhe Coal for an aggregate purchase price of RMB 100 million (approximately $14.6 million).

On December 11, 2009, Shanxi Coal entered into a Mining Right and Mining Assets Transfer agreement with Da Wa Coal, pursuant to which Shanxi Coal will purchase from Da Wa Coal all its tangible assets and coal mining right located in Pinglu County.  As consideration, Shanxi Coal will pay Da Wa Coal an aggregate purchase price of RMB 190 million (approximately $27.8 million) in cash, of which RMB 46.6 million ($6.8 million) is for the tangible assets and RMB 143.4 million ($21.0 million) is for the mining right and compensation to Da Wa Coal.  On the same date, Shanxi Coal also entered into a Mining Right and Mining Assets Transfer Agreement with Guanyao Coal, pursuant to which, Shanxi Coal will purchase from Guanyao Coal all its tangible assets and coal mining right located in Pinglu County. As consideration, Shanxi Coal will pay Guanyao Coal an aggregate purchase price of RMB 94.80 million (approximately $13.9 million) in cash, of which RMB 37.6 million ($5.5 million) is for the tangible assets and RMB 57.2 million ($8.4 million) is for the mining right and compensation of Guanyao Coal.

As of the date of this report, the above two transactions have not been closed. The consummation of the two transactions is expected to take place in April 2010 upon the transfer of the registrations, ownership certificates of the mining right and land and property deeds.

Following the appointment by the Shanxi provincial government as the consolidator of eight coal mines located Pinglu County Yuncheng City Shanxi Province, Shanxi Coal received an approval in March 2010 by the Shanxi provincial government to acquire and consolidate four additional coking coal mines into one coal mine. After the consolidation, management believes that the Jianhe Project will have the ability to increase the total annual capacity of the four coal mines from 720,000 metric tons to 900,000 metric tons.

As of the reporting date, we have not signed any definitive agreement with any of the four coal mines.

Customers

 

Most of our current customers are China coke producers (who then sell their coke to major steel makers) and steel mills that have their own coking facilities. In 2008, we sold 2,342,059 MT of cleaned coking coal to 19 different customers. In 2009, we sold 1,928,888 MT of cleaned coking coal to 19 different customers. This represents a decrease of 18% from 2008, due primarily to the weak demand from our customers and the economic downturn which had a negative impact on the steel plants’ production and sales.

In 2009 and 2008, we had 19 and 19 customers, respectively. In 2009 and 2008, no customer counted for more than 10% of our annual sales.

 

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With railway access to Shanxi Province, Inner Mongolia Antonomous Region, Hebei Province, Beijing and Tianjin, we can readily service the growing demand for steel production among our long-standing coke producing and steel mill customers. Our current primary geographic markets include Shanxi Province, Inner Mongolia Autonomous Region, Hebei Province, Beijing and Tianjin.

 

In Shanxi Province alone, the independent coke producers supply 50% of China’s coke and 80% of China’s exported coke. We believe that much of the demand for coking coal is currently satisfied by off-specification grade coking coal of a lower quality, in which case, management believes that the gap between market demand for and supply of premium cleaned coal presents an opportunity for us. This is the market which we intend to continue to pursue aggressively as we believe steel makers will continue to focus on suppliers that can deliver large volume, consistent quality, and specification grade coking coal at competitive prices.

 

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Employees

We had approximately 333 employees as of December 31, 2009 as compared to 328 employees as of December 31, 2008.  All of our employees are full-time employees. The following table shows the breakdown of the number of employees by department.

 

Department		Job Title / Responsibility		Number of  Employees
Corporate		President, Vice Presidents, Managers		8
Finance		Finance and Accounting		9
Supply; Marketing and Sales		Purchase raw coal and maintain relationship with suppliers; Sell cleaned coal, maintain relationship with customers, and acquire new customers		26
Transportation		Short-range truck drivers (within plant)		15
Production		Produce cleaned coal		213
Quality Control		Quality check on input (raw coal) and output (cleaned coal)		21
Reception and Security		Administrative matters on reception and security		41
Total				333

  

Distribution

We sell our clean coking coal through a direct sales force of approximately 19 full-time employees who market directly to our customers, who are mostly coking companies that supply steel mills and steel mills with their own coking facilities. We do not have any agreements with any third-party distributors or wholesalers. While individual sales might be made to a customer who is not subject to a supply agreement if requested and we had adequate capacity at the time, most of our sales are pursuant to agreements which are signed for one-year terms, with annual renewals. Our customers are mostly located in Shanxi Province, Inner Mongolia Autonomous Region, Hebei Province, Beijing and Tianjin, all of which are accessible by rail lines, which is the most cost effective method for coal transport.

 

Intellectual Property

Our cleaning facilities use a proprietary, water supported jig washing technology that management believes gives it a competitive advantage in providing high quality, cleaned coking coal for China’s steel making industry.  

We have no patents, trademarks, other licenses, franchises, concessions or royalty agreements. In 2009, 2008 and 2007, we did not incur any expenditure on research and development activities.

Governmental Approvals

We are not required to obtain any special governmental approvals for our products and we do not expect any probable government regulations on our products in the foreseeable future.

Available Information

We file electronically with the Securities and Exchange Commission, or SEC, our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The SEC maintains an Internet site that contains reports, proxy information and information statements, and other information regarding issuers that file electronically with the SEC. The address of that website is http:  www.sec.gov. The materials are also available at the SEC’s public Reference Room, located at 100 F Street, Washington, D.C. 20549. The public may obtain information through the public reference room by calling the SEC at 1-800-SEC-0330.

 

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Item 1A.  Risk Factors

We are subject to a number of risks, including those enumerated below. An investment in our common stock is speculative and involves a high degree of risk. You should carefully consider the following important risks and uncertainties in connection with any investment in our common stock. If the damages threatened by any of the following risks actually occur, our business, financial condition or results of operations, and cash flows would likely suffer significantly. In any of those cases, the value of our common stock could decline significantly, and you may lose all of part of your investment.

 

Risks Relating to Our Business

 

We are primarily a holding company and depend on distributions from our subsidiaries to meet our financial obligations.

 

Our company has an offshore holding structure commonly used by foreign investors with operations in China. We are a corporation which owns BVI, and BVI owns Putai. Our operations are conducted exclusively through Shanxi Coal, in which we own 90% of the equity interest. The operations of Shanxi Coal are our sole source of revenues. We have no operations independent of those of Putai and its subsidiaries. As a result, we are dependent upon the performance of Putai and its subsidiaries and will be subject to the financial, business and other factors affecting such subsidiaries as well as general economic and financial conditions. As substantially all of our operations are conducted through our subsidiaries, we are dependent on the cash flow of our subsidiaries to meet our obligations.

Because virtually all of our assets are held by our operating subsidiaries, the claims of our shareholders will be structurally subordinate to all existing and future liabilities and obligations, and trade payables of such subsidiaries. In the event of a bankruptcy, liquidation or reorganization of the Company, our assets and those of our subsidiaries’ will be available to satisfy the claims of our shareholders only after all of Putai and its subsidiaries’ liabilities and obligations have been paid in full.

  

If we do not successfully execute our strategy of growth through coal mine acquisitions, our future performance, particularly our profit margins, could be adversely affected.

We have adopted a business strategy to enter into coal mining business, including acquisitions of coal mines.  If we are unable to obtain or manage these external growth opportunities successfully, we will not be able to grow our business in the way that we currently expect.  The availability of high quality coal mines is limited and we are not certain that we will be able to identify suitable candidates or complete transactions on terms that are acceptable to us.  In order to pursue such opportunities, we may require significant additional financing, which may not be available to us on favorable terms, if at all.  The availability of such financing is further limited by the current global economic downturn. In addition, even if we are able to successfully identify and complete acquisitions, we may not be able to integrate them or take full advantage of them and therefore may not realize the benefits that we expect.  If we are unsuccessful in our external growth strategy, we may not be able to grow our business significantly and we may incur asset impairment charges as a result of acquisitions that are not successful.

 

Our future operating results have been and may continue to be affected by fluctuations in raw material prices. We may not be able to pass on cost increases to customers.

 

Our operating profits have been and may continue to be negatively affected by fluctuations in the price of raw coking coal. We are subject to short-term coal price volatility and have purchased and may continue to have to purchase  raw coking coal at higher prices. In the past, we were unable to pass the cost increase of raw coal on to customers and may not be able to do so in the future either. This has adversely affected and may continue to adversely affect our gross margins and profitability. Our sales agreements with customers generally contain provisions that permit the parties to adjust the contract price of the cleaned coking coal upward or downward at specified times. For example, we may adjust these contract prices because of increases or decreases in the price of raw coal from our mining suppliers, general inflation or deflation, or changes in the cost of producing raw or cleaned coking coal caused by such things as changes in taxes, fees, royalties or the laws regulating the mining, production, sale or use of coal. However, if we fail to agree on a price with our customer under these provisions, many agreements permit customers to terminate the contract or refuse to buy all of the quantities contracted for. Market prices for raw coking coal fluctuate in most regions in China. From the beginning of 2008 the price of raw coking coal rose significantly and the price arrived to historically highest level in October 2008, and then decreased afterwards. In 2009, the raw coal prices remained at a relatively higher level due to shortage in supply because many coal mines were temporarily shut down by the Shanxi provincial government during the processing of coal mine consolidation. We were not able to fully pass these cost increases on to our customers and may not be able to do so with any future increases in the cost of raw materials. Top quality raw coking coal is critical to our maintaining operating efficiencies and delivering cleaned coal to our customers which meets their specifications. Since top quality raw coking coal is more limited in supply, its price tends to be more volatile. A general rise in coking coal prices also may adversely affect the price of, and demand for, coke and products made with coke such as pig iron, steel and concrete. This may in turn lead to a fall in demand for our products.

 

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The demand for our product is cyclical and is affected by industrial economic conditions. Downturns in the economy may reduce demand for our product and our revenues could decline.

 

Because we do not export our product out of China, our business and operating results are primarily dependent upon China’s domestic demand for cleaned coking coal. However, because the domestic demand for coal in China is impacted by the international demand for coal, we are also susceptible to fluctuations in the international markets. The domestic and international coking coal markets are cyclical and exhibit fluctuation in supply and demand from year to year and are subject to numerous factors beyond our control, including, but not limited to, the economic conditions in China, the global economic conditions and fluctuations in industries with high demand for coal, such as the steel and power industries. A significant decline in demand or excess supply for cleaned coking coal may have a material adverse effect on our business and results of operations.

 

 In addition, nearly all of our sales are concentrated in the central and northern area of China. Accordingly, we are susceptible to fluctuations in business caused by adverse economic conditions in those regions. Difficult economic conditions in other geographic areas into which we may expand may also adversely affect our business, operations and finances.

 

If any of Shanxi Coal’s coal sales agreements terminates or expires, our revenues and operating profits could suffer.

 

A substantial portion of our sales are made under coal sales agreements, which are important to the stability and profitability of our coal washing operations. It is common business practice in China that coal purchase and sale agreements are signed for one year terms, with annual renewals. This practice makes it difficult for us to forecast long-term purchase and sale quantities and can negatively affect our ability to manage inventory. These agreements may expire or be terminated. Cleaned coal sales agreements also typically contain force majeure provisions allowing temporary suspension of performance by us or the customer during the duration of specified events beyond the control of the affected party. Moreover, even if sales agreements are in force, buyers are generally not obligated to take the quantities specified in the contracts.

 

Increases in transportation costs could make our operations less competitive and result in the loss of customers.

 

Coal producers and processors depend upon rail, barge, trucking, overland conveyor and other systems to deliver coal to markets. While our customers typically arrange and pay for transportation of cleaned coking coal from our facilities to the point of use, any disruption of these transportation services because of weather-related problems, strikes, lock-outs or other events could temporarily impair our ability to supply coal to customers and thus could adversely affect our results of operations. For example, the high volume of raw coal shipped from all Shanxi Province mines could create temporary congestion on the rail systems servicing that region. If transportation for our cleaned coking coal becomes unavailable or uneconomic for our customers, our ability to sell cleaned coking coal could suffer. Transportation costs can represent a significant portion of the total cost of cleaned coal. Since our customers typically pay that cost, it is a critical factor in a distant customer’s purchasing decision. If transportation costs from our facilities to the customer’s are not competitive, the customer may elect to purchase from another company. Moreover, certain coal sales agreements permit the customer to terminate the contract if the cost of transportation increases by specified amounts in any given 12-month period.

We may not be able to meet quality specifications required by our customers and as a result could incur economic penalties or cancelled agreements which would reduce our sales and profitability.

 

Most of our coal sales agreements contain provisions requiring us to deliver coking coal meeting quality thresholds for certain characteristics such as BTUs, sulfur content, ash content, grindability and ash fusion temperature. If we are not able to meet these specifications, because, for example, we are not able to source coal of the proper quality, we may incur economic penalties, including price adjustments, the rejection of deliveries or termination of the contracts.

 

Our business is highly competitive and increased competition could reduce our sales, earnings and profitability.

 

The coal crushing, washing and processing business is highly competitive in China and we face substantial competition in connection with the marketing and sale of our products. Most of our competitors are well established, have greater financial, marketing, personnel and other resources, have been in business for longer periods of time than we have, and have products that have gained wide customer acceptance in the marketplace. The greater financial resources of our competitors will permit them to implement extensive marketing and promotional programs. We could fail to expand our market share, and could fail to maintain our current share.

 

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Increased competition could also result in overcapacity in the Chinese coal industry in general. The coal industry in China has experienced overcapacity in the past. During the mid-1970s and early 1980s, a growing coal market and increased demand for coal in China attracted new investors to the coal industry, spurred the development of new mines and resulted in added production capacity throughout the industry, all of which led to increased competition and lower processed coal prices. Similarly, an increase in future processed coal prices could encourage the development of expanded capacity by new or existing coal processors. Any overcapacity could reduce processed coal prices in the future and our profitability would be impaired.

 

We depend on key persons and the loss of any key person could adversely affect our operations.

 

We and our operating company, Shanxi Coal are highly dependent on the marketing ability and credit of Ming Zhao, our Chairman, and the loss of his service and support would have a material and adverse impact on our operations. We are also dependent upon our relationship with Ming Zhao and his brother, Yao Zhao’s other controlled businesses. None of our companies have applied for key-man life insurance on the lives of our executives. If we were to lose the services of Ming Zhao, our ability to operate would be impaired.

Significant assets are subject to a lien held by a company controlled by the Zhaos and their family. If we default on the payment of the obligations secured by the lien we could lose title to assets which are necessary for the operation of our business.

 

We financed the acquisition of the Shanxi Liulin Jucai Plant and the Zhongyang Plant through Resources Group, an entity owned 80% by Ming Zhao, 10% by Yao Zhao, 5% by Xue Ning, Ming Zhao’s wife, and 5% by Xue Yue, a second-generation cousin of Xue Ning, for an aggregate cost of $13 million paid through a 6% secured Facilities Loan amortized over 10 years. The note is secured by the assets purchased. If we default on the loan, the security could be enforced and title to the assets could be lost, having a significant negative impact on our ability to produce our products.

 

Since the Zhaos are equity owners of Resources Group they may have a conflict of interest with the Company. If the lien is enforced after a default, the secured assets would be transferred to an entity which is owned by them. Ming Zhao and Yao Zhao may have, or may develop in the future, conflicts of interest with us. As the equity owners of 10% of the registered capital of Shanxi Coal, they might personally profit if Shanxi Coal’s benefits of operation are not directed to us. In addition, the loan used to finance our recent facility expansions are held by Resources Group, a company which is owned by the Zhaos and their family. It could be in their economic interest to cause us to default on the payment of the loan with Resources Group since Resources Group could acquire the assets which are subject to the lien as a result of enforcement of the lien after a default. With their combined ownership of us (as of the date of report, 39.14% and 9.79% of our outstanding common stock), they can largely control the actions which we take. Ming Zhao is our Chairman of the board of directors. In addition, the Zhao brothers also control the mine, Jucai, of which is one of our suppliers. By limiting or eliminating our supply, they could adversely impact our production and revenue, which in turn could cause us to default on our loan to Resources Group. See also the risk below, “Our principal stockholders have significant control over the company and may have conflicts of interest with the company.”

 

We do not have any registered patents or other intellectual property and we may not be able to maintain the confidentiality of our processes.

 

We have no patents covering our cleaning processes and we rely on the confidentiality of our cleaning processes in producing a competitive product. The confidentiality of our know-how may not be maintained and we may lose any meaningful competitive advantage which might arise through our proprietary processes.

The current credit and financial market conditions have a negative impact on global business environment and may exacerbate certain risks affecting our business.

The financial markets are currently experiencing a downturn around the world. Many of our customers and suppliers may encounter much uncertainty and risks due to the weakened business environment and credit availability.  As a result, these customers and suppliers may be unable to satisfy their contract obligations, may delay payment, or may not repay our credit advance to them, which could negatively affect our business and financial performance.

 

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Terrorist attacks or military conflict could result in disruption of our business.

 

Terrorist attacks and threats, escalation of military activity in response to such attacks or acts of war may negatively affect our business, financial condition and results of operations. Our business is affected by general economic conditions, fluctuations in consumer confidence and spending, and market liquidity, which can decline as a result of numerous factors outside of our control, such as terrorist attacks and acts of war. Future terrorist attacks, rumors or threats of war, actual conflicts involving China or its allies, or military or trade disruptions affecting our customers may materially adversely affect our operations. As a result, there could be delays or losses in transportation and deliveries of processed coal to our customers, decreased sales of coal and extensions of time for payment of accounts receivable from customers. Strategic targets such as energy-related assets may be at greater risk of terrorist attacks than other targets. In addition, disruption or significant increases in energy prices could result in government-imposed price controls. Any, or a combination, of these occurrences could have a material adverse effect on Shanxi Coal’s business, financial condition and results of operations.

 

Risks Relating to Doing Business in China

 

Our Chinese operations pose certain risks because of the evolving state of the Chinese economy, political, and legislative and regulatory systems. Changes in the interpretations of existing laws and the enactment of new laws may negatively impact our business and results of operation.

 

Substantially all of our business operations are conducted in China. Accordingly, our results of operations, financial condition and prospects are subject to economic, political and legal developments in China. China’s economy differs from the economies of most developed countries in many respects, including its levels of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. Doing business in China involves various risks including internal and international political risks, evolving national economic policies as well as financial accounting standards, expropriation and the potential for a reversal in economic conditions. Since the late 1970s, the Chinese government has been reforming its economic system. These policies and measures may from time to time be modified or revised. While the Chinese economy has experienced significant growth in the past 20 years, growth has been uneven across different regions and among various economic sectors of China. Furthermore, while the Chinese government has implemented various measures to encourage economic development and guide the allocation of resources, some of these measures may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us. Also, since early 2004, the Chinese government has implemented certain measures to control the pace of economic growth including certain levels of price controls on raw coking coal. Such controls could cause our margins to be decreased. In addition, such measures may cause a decrease in the level of economic activity in China, which in turn could adversely affect our results of operations and financial condition. Adverse changes in economic policies of the Chinese government or in the laws and regulations, if any, could have a material and adverse effect on the overall economic growth of China, and could adversely affect our business operations.

 

There are substantial uncertainties regarding the application of Chinese laws, especially with respect to existing and future foreign investments in China. The interpretation and application of existing Chinese laws, regulations and policies, and the stated positions of the Chinese authorities may change and possible new laws, regulations or policies will impact our business and operations. For example, due to the uncertainties surrounding the interpretation of the transfer pricing rules relating to related party transactions in China, it is possible that tax authorities in China may challenge the transfer prices that we have used for related party transactions among our entities in China in the future. Because of the evolving nature of the law, it will be difficult for us to manage and plan for changes that may arise. Our business is and will continue to be subject central, provincial, local and municipal regulation and licensing in China. Compliance with such regulations and licensing can be expected to be a time-consuming, expensive process. Compliance with foreign country laws and regulations affecting foreign investment, business operations, currency exchange, repatriation of profits, and taxation, will increase the risk of investing in our stock.

 

We may have to incur unanticipated costs because of the unpredictability of the Chinese legal system.

 

The Chinese legal system has many uncertainties. The Chinese legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since 1979, Chinese legislation and regulations have enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently-enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the Chinese legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

 

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Our industry is heavily regulated and we may not be able to remain in compliance with all such regulations and we may be required to incur substantial costs in complying with such regulation.

 

We are subject to extensive regulation by China’s Mining Ministry, and by other provincial, county and local authorities in jurisdictions in which our products are processed or sold, regarding the processing, storage, and distribution of our product. Our processing facilities are subject to periodic inspection by national, province, county and local authorities. We may not be able to comply with current laws and regulations, or any future laws and regulations. To the extent that new regulations are adopted, we will be required to adjust our activities in order to comply with such regulations. We may be required to incur substantial costs in order to comply. Our failure to comply with applicable laws and regulations could subject us to civil remedies, including fines, injunctions, recalls or seizures, as well as potential criminal sanctions, which could have a material and adverse effect on our business, operations and finances. Changes in applicable laws and regulations may also have a negative impact on our sales. Certain of our contracts with customers permit the customers to terminate the contract in the event of changes in regulations affecting the industry that increase the price of coal beyond specified limits.

 

 

Dividend

 

In 2005, Shanxi Coal declared dividends, adjusted at exchange rate, equals to $1,715,470, payable to Ming Zhao (80%) and Yao Zhao (20%), of which $543,470 was paid in 2005 and $1,172,000 was paid in October 17, 2008. In September 2008, Shanxi Coal declared dividends equal to $1,170,754 to its shareholders as follows:  $1,053,678 to Putai, a 90% equity owner; $93,661 to Mr. Ming Zhao, an 8% owner, and $23,415 to Mr. Yao Zhao, a 2% owner. As of the date of this report, the declared dividend has not been paid.

Any future determination as to the declaration and payment of dividends on Puda’s common stock will be made at the discretion of Puda’s board of directors out of funds legally available for such purpose. Puda is under no contractual obligations or restrictions to declare or pay dividends on its common stock. In addition we currently have no plans to pay such dividends. However, even if we wish to pay dividends, because our cash flow is dependent on dividend distributions from our subsidiaries, we may be restricted from distributing dividends to our holders of common stock in the future if at the time we were unable to obtain sufficient dividend distributions from Shanxi Coal or Putai. We acquired 90% of the total capital stock of Shanxi Coal. Under current law there is no restriction on a PRC company’s ability to pay dividends to its shareholders because its shareholders are not Chinese, however, various factors could limit the ability of Shanxi Coal and Putai to distribute dividends to their shareholders, including the obligations of Shanxi Coal and Putai under the laws of China to maintain and continuously fund certain Chinese government mandated reserve accounts and foreign currency exchange regulations. The board of directors currently intends to retain all earnings for use in the business for the foreseeable future. See “Risk Factors.”

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Securities Authorized for Issuance under Equity Compensation Plans

 

The following table sets forth, as of December 31, 2009, information with respect to our equity compensation plans:

Plan Category

Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights

Weighted- Average Exercise Price of Outstanding Options, Warrants and Rights

Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans

Equity compensation plans approved by security holders:

Puda Coal, Inc. 2008 Equity Incentive Plan *

1,429

$

17.5

503,088

(1)

Equity compensation plans not approved by security holders:

None

N/A

N/A

 

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*	after the 7-to-1 Share Conversion

 

(1)

This number represents the number (after 7 to 1 Share Conversion) of securities available for future issuance under the Plan, excluding the shares that the Company is obligated to issue to the directors under the directors contracts and the shares issuable upon the exercise of 1,429 warrants hold by Mr. Ni.

 

Sales of Unregistered Securities

None.

Purchases of Equity Securities by Issuer

            None.

 

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Item 6. Selected Financial Data

SELECTED FINANCIAL DATA

The following selected financial data for the five years ended December 31, 2009 are derived from the audited consolidated financial statements of Puda Coal, Inc. The data should be read in conjunction with the consolidated financial statements, related notes, and other financial information.

 

		Year ended December 31,
		2009				2008				2007				2006				2005
OPERATIONS DATA		$’000				$’000				$’000				$’000				$’000
Revenues		$	214,066			$	242,338			$	165,267			$	137,771			$	51,710
Net income			5,481				17,061				10,874				1,354				965
Option holder  preference dividend			-				-				-				(2,717)				(2,717)
Income/(loss) applicable to common     shares		$	5,481			$	17,061			$	10,874			$	(1,363)			$	(1,752)
Income/(loss) per common share -     basic and diluted		$	0.36			$	1.12			$	0.77			$	(0.14)			$	(0.21)
Cash dividends declared per common     Share		$	0.00			$	0.00			$	--			$	--			$	0.14
BALANCE SHEET DATA
Total assets		$	111,201			$	98,632			$	81,264			$	62,984			$	46,701
Convertible notes and warrants		$	7,620			$	4,086			$	7,421			$	13,894			$	18,925
Other Long-term debt		$	6,500			$	7,800			$	9,100			$	10,400			$	11,700
Shareholders' equity		$	83,959			$	72,277			$	48,581			$	23,037			$	6,082

QUARTERLY FINANCIAL DATA

 

Unaudited quarterly results of operations for the years ended December 31, 2009 and 2008 should be read in conjunction with the consolidated financial statements, related notes and other financial information and the Company's quarterly reports on Form 10-Q for the fiscal years 2009 and 2008.

 

		First				Second				Third				Fourth
		Quarter				Quarter				Quarter				Quarter				Year
YEAR ENDED December 31, 2009
Revenues		$	49,721				47,990				56,106			$	60,249			$	214,066
Gross profit		$	3,871				3,602				5,375			$	5,309			$	18,157
Net income/(loss)		$	2,116				1,729				(621)			$	2,257			$	5,481
Option holder preference dividend		$	--				--				--			$	--			$	--
Income applicable to common    shares		$	2,116				1,729				(621)			$	2,257			$	5,481
Income/(loss) per common share -    basic and diluted		$	0.14				0.11				(0.04)			$	0.15			$	0.36
YEAR ENDED December 31, 2008
Revenues		$	50,598				53,188				74,051			$	64,501			$	242,338
Gross profit		$	7,453				6,697				10,190			$	5,996			$	30,336
Net income		$	4,295				2,863				6,539			$	3,364			$	17,061
Option holder preference dividend		$	--				--				--			$	--			$	--
Income applicable to common    shares		$	4,295				2,863				6,539			$	3,364			$	17,061
Income per common share -    basic and diluted		$	0.28				0.21				0.42			$	0.21			$	1.12

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following description of our results of operations and financial condition in conjunction with the audited financial statements contained herein. Unless otherwise specified, all dollar amounts are in U.S. dollars.

Overview

 

We process high-grade metallurgical coking coal and supply it to coke and steel manufacturers. High-grade, cleaned coking coal is an important input in the steel manufacturing process. We source raw coal from third-party coal mines located in Shanxi Province, China and after we process it to a quality which is required to produce steel, we sell it to our customers in and around Shanxi Province.

Results of Operations

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

Net Revenue. Net revenue was $214,066,000 for the year ended December 31, 2009, compared to $242,338,000 for the year ended December 31, 2008, a decrease of $28,272,000, or 12%. The decrease in revenue was primarily due to decreased tonnage sales of cleaned coal, which was partially offset by increased selling price.  The tonnage sales of cleaned coal decreased approximately 413,000 MT, or 18%, from approximately 2,342,000 MT for the year ended December 31, 2008 to approximately 1,929,000 MT for the year ended December 31, 2009. Approximately $42,539,000 of the total revenue decrease in the year ended December 31, 2009 is attributed to the decrease in tonnage sales of cleaned coal.  The selling price of cleaned coal increased approximately $8 or 8%, from approximately $103 per ton for the year ended December 31, 2008 to approximately $111 per ton for the year ended December 31, 2009.  This increase in average selling price offset the decrease in total revenue by approximately $15,432,000.  The decrease in tonnage sales were primarily due to decreased orders of cleaned coal from customers for the year ended December 31, 2009 as a result of general economic downturn.

 

Cost of Revenue. Cost of revenue was $195,909,000 for the year ended December 31, 2009, compared to $212,002,000 for the year ended December 31, 2008, a decrease of $16,093,000, or 8%.  This was primarily due to decreased tonnage sales of cleaned coal, which was partially offset by increased raw coal unit cost.  Approximately $35,518,000 of the decrease in the total cost of revenue in the year ended December 31, 2009 is attributable to the decrease in tonnage sales of cleaned coal.  The average unit cost of raw coal increased $9 or 10%, from approximately $86 per ton for the year ended December 31, 2008 to approximately $95 per ton for the year ended December 31, 2009.  This increase in average raw coal unit cost offset the decrease in cost of revenue by approximately $17,361,000.

Gross Profit. Gross profit was $18,157,000 for the year ended December 31, 2009, compared to $30,336,000 for the year ended December 31, 2008, a decrease of $12,179,000, or 40%. Gross profit margins for the year ended December 31, 2009 and 2008 were 8% and 13%, respectively. Such decrease in gross profit margins was primarily due to an increase in average purchase price of raw coal across the year ended December 31, 2009 which exceeded the increase in selling price.

Selling Expenses. Selling expenses were $2,453,000 for the year ended December 31, 2009, compared to $3,191,000 for the year ended December 31, 2008. This represents a decrease of $738,000, or 23%, primarily due to the decrease in sales volume in the year ended December 31, 2009.

General and Administrative Expenses. General and administrative expenses were $1,167,000 for the year ended December 31, 2009, compared to $2,207,000 for the year ended December 31, 2008. This represents a decrease of $1,040,000, or 47%, which was primarily a result of $979,000 reverse of accrual on overprovided staff welfare benefits.

Income from Operations. Income from operations was $14,537,000 for the year ended December 31, 2009, compared to $24,938,000 for the year ended December 31, 2008. The decrease of $10,401,000, or 42%, was primarily the result of decrease in gross profit of $12,179,000, which was partially offset by a decrease in operating expenses of $1,778,000.

Interest Income.  Interest income was $89,000 for the year ended December 31, 2009, compared to $406,000 for the year ended December 31, 2008.  This represents a decrease of $317,000, or 78%.  The decrease is primarily due to a decrease in interest income from a short-term loan to an unrelated party.

 

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Interest Expense. Interest expense was $518,000 for the year ended December 31, 2009, compared to $763,000 for the year ended December 31, 2008.  This represents a decrease of $245,000, or 32%, and such decrease was primarily due to a decrease in interest payments of $169,000 for the 8% convertible notes, and a decrease in interest payments of $76,000 for the 6% loan from Resources Group for the purchase of the Liulin and Zhongyang plants.

Debt Financing Costs. Debt financing costs were $nil for the year ended December 31, 2009, compared to $778,000 for the year ended December 31, 2008.   The decrease was primarily due to a decrease in amortization of discount on convertible notes and warrants of $399,000, and a decrease in penalty payment of $379,000 for not having the registration statement effective by March 17, 2006.

Derivative Unrealized Fair Value Loss. Derivative unrealized fair value loss of $5,036,000 for the year ended December 31, 2009 and derivative unrealized fair value gain of $394,000 for the year ended December 31, 2008, respectively represented a change in fair value of the warrants.

Other Income (Expense). Other income of $59,000 in the year ended December 31, 2009 represented the interest payments unclaimed by the convertible note investors.  Other expense of $719,000 in the year ended December 31, 2008 represented the donation for earthquake rescue efforts in Sichuan Province, PRC.

Income Before Income Taxes. Income before income taxes was $9,131,000 for the year ended December 31, 2009, compared to $23,478,000 for the year ended December 31, 2008. The decrease of $14,347,000, or 61%, was primarily the result of a decrease in operating profit of $10,401,000, an increase in derivative unrealized fair value loss of $5,430,000, and a decrease in interest income of $317,000, which was offset by a decrease in debt financing costs of $778,000, a decrease in other expense of $778,000, and a decrease in interest expense of $245,000 in the year ended December 31, 2009.

 

Income Taxes. Income taxes were $3,650,000 for the year ended December 31, 2009, compared to $6,417,000 for the year ended December 31, 2008, a decrease of $2,767,000, or 43%.  Income tax was imposed by the China Tax Bureau on income of Shanxi Coal, as calculated under Chinese GAAP and tax rules.  The decrease was primarily the result of the decrease in operating profit of Shanxi Coal from $25,160,000 in the year ended December 31, 2008 to $15,469,000 in the year ended December 31, 2009.

Net Income. Net income was $5,481,000 for the year ended December 31, 2009, compared to $17,061,000 for the year ended December 31, 2008, a decrease of $11,580,000, or 68%, mainly due to, a decrease in operating profit of $10,401,000, an increase in derivative unrealized fair value loss of $5,430,000, and a decrease in interest income of $317,000, which was offset by a decrease in income taxes of $2,767,000, a decrease in debt financing costs of $778,000, a decrease in other expense of $778,000, and a decrease in interest expense of $245,000 in the year ended December 31, 2009.

Inflation had no significant impact on the Company’s results of operations for the years ended December 31, 2009 and 2008.

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

Net Revenue. Net revenue was $242,338,000 for the year ended December 31, 2008, compared to $165,267,000 for the year ended December 31, 2007, an increase of $77,071,000, or 47%. The increase in revenue was primarily due to increased tonnage sales of cleaned coal and increased selling price.  The tonnage sales of cleaned coal increased approximately 329,000 MT, or 16%, from approximately 2,013,000 MT for the year ended December 31, 2007 to approximately 2,342,000 MT for the year ended December 31, 2008. Approximately $26,978,000 of the total revenue increase in the year ended December 31, 2008 is attributed to the increase in tonnage sales of cleaned coal.  The selling price of cleaned coal increased approximately $21 or 26%, from approximately $82 per ton for the year ended December 31, 2007 to approximately $103 per ton for the year ended December 31, 2008.  Approximately $49,182,000 of the total revenue increase in the year ended December 31, 2008 is attributed to the increase in average selling price. The increase in tonnage sales and selling price were primarily due to increased orders of cleaned coal from existing and new customers for the year ended December 31, 2008.

 

Cost of Revenue. Cost of revenue was $212,002,000 for the year ended December 31, 2008, compared to $136,652,000 for the year ended December 31, 2007, an increase of $75,350,000, or 55%.  This was primarily due to increased tonnage sales of cleaned coal and increased raw coal unit cost.   Approximately $21,385,000 of the increase in the total cost of revenue in the year ended December 31, 2008 is attributable to the increase in tonnage sales of cleaned coal.  The average unit cost of raw coal increased $21 or 32%, from approximately $65 per ton for the year ended December 31, 2007 to approximately $86 per ton for the year ended December 31, 2008. Approximately $49,182,000 of the increase in total cost of revenue in the year ended December 31, 2008 is attributable to the increase in raw coal unit cost.

 

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Gross Profit. Gross profit was $30,336,000 for the year ended December 31, 2008, compared to $28,615,000 for the year ended December 31, 2007, an increase of $1,721,000, or 6%. Gross profit margins for the year ended December 31, 2008 and 2007 were 13% and 17%, respectively. Such decrease in gross profit margins was primarily due to an increase in average purchase price of raw coal across the year ended December 31, 2008.

Selling Expenses. Selling expenses were $3,191,000 for the year ended December 31, 2008, compared to $2,975,000 for the year ended December 31, 2007. This represents an increase of $216,000, or 7%, primarily due to the increase in sales volume in the year ended December 31, 2008.

General and Administrative Expenses. General and administrative expenses were $2,207,000 for the year ended December 31, 2008, compared to $2,215,000 for the year ended December 31, 2007. This represents a decrease of $8,000, which was a result of cost saving policies implemented in the fourth quarter of 2008.

Income from Operations. Income from operations was $24,938,000 for the year ended December 31, 2008, compared to $23,425,000 for the year ended December 31, 2007. The increase of $1,513,000, or 6%, was primarily the result of an increase in gross profit of $1,721,000, which was offset by an increase in operating expenses of $208,000.

Interest Income.  Interest income was $406,000 for the year ended December 31, 2008, compared to $83,000 for the year ended December 31, 2007.  This represents an increase of $323,000, or 389%.  The increase is primarily due to an increase in interest income from a short-term loan to an unrelated party.

 

Interest Expense. Interest expense was $763,000 for the year ended December 31, 2008, compared to $1,577,000 for the year ended December 31, 2007.  This represents a decrease of $814,000, or 52%, and such decrease was primarily due to a decrease of $663,000 for the expensed portion of the discount on the conversion feature and warrants related to converted notes and exercised warrants, a decrease in interest payments of $80,000 for the 6% loan from Resources Group for the purchase of the Liulin and Zhongyang plants, and a decrease in interest payments of $71,000 for the 8% convertible notes.

Debt Financing Costs. Debt financing costs were $778,000 for the year ended December 31, 2008, compared to $2,422,000 for the year ended December 31, 2007.  This represents a decrease of $1,644,000, or 68%, primarily due to a decrease in penalty payment of $1,142,000 for not having the registration statement effective by March 17, 2006, a decrease in amortization of discount on convertible notes and warrants of $496,000, and a decrease in amortization of debt issue cost of $6,000.

Derivative Unrealized Fair Value Gain. Derivative unrealized fair value gain of $394,000 for the year ended December 31, 2008 and derivative unrealized fair value loss of $343,000 for the year ended December 31, 2008 and 2007, respectively represented a change in fair value of the warrants.

Other Expense. Other expense of $719,000 in the year ended December 31, 2008 represented the donation for earthquake rescue efforts in Sichuan Province, PRC.

Income Before Income Taxes. Income before income taxes was $23,478,000 for the year ended December 31, 2008, compared to $19,166,000 for the year ended December 31, 2007. The increase of $4,312,000, or 22%, was primarily the result of a decrease in debt financing costs of $1,644,000, an increase in operating profit of $1,513,000, a decrease in interest expense of $814,000, an increase in derivative unrealized fair value gain of $737,000, and an increase in interest income of $323,000, which was offset by an increase in other expense of $719,000 in the year ended December 31, 2008.

Income Taxes. Income taxes were $6,417,000 for the year ended December 31, 2008, compared to $8,292,000 for the year ended December 31, 2007, a decrease of $1,875,000, or 23%.  Income tax was imposed by the China Tax Bureau on income of Shanxi Coal, as calculated under Chinese GAAP and tax rules.  The decrease was primarily the result of reduction in the income tax rate from 33% to 25%, effective since January 1, 2008, which was offset by an increase in operating profit of Shanxi Coal from $23,980,000 in the year ended December 31, 2007 to $25,160,000 in the year ended December 31, 2008.

Net Income. Net income was $17,061,000 for the year ended December 31, 2008, compared to $10,874,000 for the year ended December 31, 2007, an increase of $6,187,000, or 57%, mainly due to, a decrease in income taxes of $1,875,000, a decrease in debt financing costs of $1,644,000, an increase in operating profit of $1,513,000, a decrease in interest expense of $814,000, an increase in derivative unrealized fair value gain of $737,000, and an increase in interest income of $323,000, which was offset by an increase in other expense of $719,000 in the year ended December 31, 2008.

Inflation had no significant impact on the Company’s results of operations for the years ended December 31, 2008 and 2007.

 

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Business Outlook

China’s 4 trillion yuan economic stimulus package, which was put in place in year 2009 has encouraged steel-intensive infrastructure development projects such as the construction of railway and motor vehicle manufacturing as well as real estate projects. It has driven the demand for steel, which is expected to increase over the next several years across infrastructure projects such as railroads, real estate and automobile construction.

China is expected to produce approximately 600mm MT of steel in 2010, roughly half the world’s total output, according to China Coal Resource.

 In response to record high steel prices driven by the demand in the infrastructure construction sector in China, the steel industry has begun increasing production levels.  We anticipate tonnage sales in 2010 will improve from current levels as steel inventories decline and our customers increase order volumes.

We expect that such demand will provide significant opportunities for suppliers of cleaned coking coal like Puda Coal.  As a result, the management believes the outlook for its coal washing operations is attractive, as the Company has maintained a stable increased customer base and supply tunnels.

It should be noted that, however, the financial markets are currently experiencing unprecedented volatility, stress, illiquidity and disruption around the world. Many of our customers and suppliers may encounter much uncertainty and risks due to the weakened business environment and credit availability. As a result, these customers and suppliers may be unable to satisfy their contract obligations, may delay payment, or may not repay our credit advance to them, which could negatively affect our business and financial performance.  See discussions under Item 1A “Risk Factors”.

 

The Company is currently operating at approximately 54% utilization of its production capacity and has the capacity to meet any reasonable increases in future demand. In addition, the Company has taken steps to execute its strategy of entering the coal mining business to increase profitability.   On May 14, 2009, Shanxi Coal entered into an agreement to purchase 18% ownership in Shanxi Jianhe Coal Industry Limited Company (“Jianhe Coal”) for an aggregate purchase price of RMB 100 million ($14,650,000).   The governmental registration of the share transfer was completed on December 3, 2009 and the purchase price was fully paid as of December 31, 2009. 

 

On September 28, 2009, the Shanxi provincial government appointed Shanxi Coal as a consolidator of eight coal mines in Pinglu County. Shanxi Coal has the government’s permission to acquire and consolidate the eight coal mines into five, which could increase their total annual capacity from approximately 1.6 million to 3.6 million metric tons.

On December 11, 2009, Shanxi Coal entered into a Mining Right and Mining Assets Transfer Agreement with Da Wa Coal, pursuant to which Shanxi Coal will purchase from Da Wa Coal all its tangible assets and coal mining right located in Pinglu County.  As consideration, Shanxi Coal will pay Da Wa Coal an aggregate purchase price of RMB 190 million (approximately $27.8 million) in cash, of which RMB 46.6 million ($6.8 million) is for the tangible assets and RMB 143.4 million ($21.0 million) is for the mining right and compensation to Da Wa Coal.  On the same date, Shanxi Coal also entered into a Mining Right and Mining Assets Transfer Agreement with Guanyao Coal, pursuant to which, Shanxi Coal will purchase from Guanyao Coal all its tangible assets and coal mining right located in Pinglu County. As consideration, Shanxi Coal will pay Guanyao Coal an aggregate purchase price of RMB 94.80 million (approximately $13.9 million) in cash, of which RMB 37.6 million ($5.5 million) is for the tangible assets and RMB 57.2 million ($8.4 million) is for the mining right and compensation of Guanyao Coal. The consummation of the above transactions is expected to take place around April 2010 upon the transfer of the registrations, ownership certificates of the mining right and land and property deeds.  Shanxi Coal’s obligation for payment is guaranteed by Ming Zhao. 

If the Company is unable to manage coal mines successfully, it will not be able to grow its business in the way that it currently expects. Also, in order to pursue such acquisition opportunities, depending on the size of the coal mine acquisition, the Company may need significant additional financing, which may not be available to it on favorable terms, if at all. The availability of such financing is further limited by the recent tightening of the global credit markets and the lack of investors’ confidence in the equity markets. See discussions under Item 1A “Risk Factors”.

 Liquidity and Capital Resources

Net cash provided by operating activities was $1,423,000 for the year ended December 31, 2009, compared to $26,513,000 for the year ended December 31, 2008, a decrease of $25,090,000. This decrease was primarily due to an increase in working capital needs resulting from increased accounts receivable and a decrease in net income.

 

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Net cash used in investing activities of $20,909,000 for the year ended December 31, 2009 was related to the 18% equity interest in Jianhe Coal, and the prepayments for the purchase of mining rights and assets of $6,259,000 in connection with the acquisition of Dawa Coal and Guanyao Coal.  Net cash used in investing activities of $895,000 for the year ended December 31, 2008 was related to the payment of $893,000 to Ming Zhao and Yao Zhao for the purchase of equity interest in Shanxi Coal, and the cash paid to acquire fixed assets of $2,000.  

Net cash provided by financing activities of $578,000 for the year ended December 31, 2009 include $1,878,000 from the exercise of warrants, which was offset by $1,300,000 for the repayment of the long-term debt to Resources Group. Net cash used in financing activities of $4,487,000 for the year ended December 31, 2008 was for the repayment of convertible notes upon maturity of $2,015,000, the repayment of long-term debt of $1,300,000, and the payment of 2005 dividends to owners of a subsidiary of $1,172,000.  

Our principal on-going capital requirements are to finance our coal washing operations and to fund the payment of the loans to Resources Group, with the outstanding balance of $7,800,000 as of December 31, 2009, for the acquisition of the  Liulin County plant and the Zhongyang County plant, and for the acquisition of coal mines and coal mining assets.

Warrants were also issued in the November 2005 Private Placement to acquire up to 1,831,475 shares of our common stock which are exercisable at price of $4.20 per share, or an aggregate of $7,692,000. We believe that the likelihood of  these warrants being exercised increases as our stock price increases and decreases as our stock price decreases, with a corresponding effect on the likelihood of our realizing proceeds from their exercise.

  Our business is heavily dependent on our coal inventory. Because of certain coal mining accidents, the Chinese government has been closing mines throughout China. In addition, in Shanxi Province, the authorities are not approving new mines that produce less than 300,000 MT output per year, are closing mines that produce less than 90,000 MT per year and are consolidating existing mines into larger mines with outputs between 300,000 MT and 900,000 MT. These activities may lead to increased competition for coal and result in higher prices for the raw coal we purchase, increasing our need for capital resources and reducing our gross profit margins if we are not able to increase the selling price of our products sufficiently to offset our increased costs.

In addition, while the Chinese steel industry has been expanding, over-supply could have the effect of depressing steel prices, reducing our net revenue and making the collection of our accounts receivable more difficult.

Our cash balance was $19,918,000 as of December 31, 2009. On February 18, 2010, we completed the offering and sale of 3,284,000 shares (including 428,348 overallotment shares to underwriters), for net proceeds of $14.5 million.  We believe that our cash will be adequate to satisfy our anticipated cash requirements for our legacy coal cleaning business as well as to fulfill our commitments to purchase the coal mining assets of Dawa and Guanyao in fiscal 2010, including requirements to maintain current operations, complete projects already underway and achieve stated objectives or plans, commitment for capital or other expenditure and other reasonably likely future needs. Cash requirements for developing our coal mining strategy and long-term business needs, including the funding of capital expenditure and debt service for outstanding financings, are expected to be financed by a combination of internally generated funds, the proceeds from the sale of our securities, borrowings and other external financing sources, etc., although adequate financing may not be available to us on acceptable terms when we need it.  Our belief concerning our liquidity is based on current information. If the current information proves to be inaccurate, or if circumstances change, we may not be able to meet our cash needs.

 

CRITICAL ACCOUNTING ESTIMATES

The discussion and analysis of Puda’s financial condition and results of operations is based upon Puda’s consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires Puda to make estimates and judgments that affect the reported amounts of assets and liabilities. On an on-going basis, Puda evaluates its estimates including the allowance for doubtful accounts, the salability and recoverability of inventory, income taxes and contingencies. Puda bases its estimates on historical experience and on various other assumptions that Puda believes to be reasonable under the circumstances, the results of which form Puda’s basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Allowance for doubtful accounts

Puda must make estimates of the collectability of accounts receivable. Puda analyzes historical write-offs, changes in its internal credit policies and customer concentrations when evaluating the adequacy of its allowance for doubtful accounts. Differences may result in the amount and timing of expenses for any period if Puda makes different judgments or uses different estimates.

 

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Impairment of long-lived assets

Property and equipment are evaluated for impairment whenever indicators of impairment exist. Accounting standards require that if  impairment indicators are present, Puda must assess whether the carrying amount of the asset is recoverable by estimating the sum of the future cash flows expected to result from the asset, including its use and eventual disposition, undiscounted and without interest charges. If the carrying amount is less than the recoverable amount, an impairment charge must be recognized, based on the fair value of the asset.

Impairment of investments

Investments are evaluated for impairment.  Investments carried at cost are adjusted for other-than-temporary declines in realizable value and additional investments.  When the decline is determined to be other-than-temporary, the cost basis for the investment is reduced and a loss is realized in the consolidated statement of operations in the period in which it occurs. When the decline is determined to be temporary, the unrealized losses are included in the shareholders' equity section in the consolidated balance sheets.  The Company makes such determination based upon a number of factors, including financial condition, operating results, sales forecasts and earnings growth of the investee.

Fair value measures

 

 Puda adopted Statement of Accounting Standard Codifications (“ASC”) 820 “Fair Value Measurements and Disclosures”. The Company utilizes the income approach to measure fair value for its financial assets and liabilities. Our major category of financial assets and liabilities required to be measured at fair value is derivatives.   The income approach includes option pricing models, such as Black-Scholes.  The option-pricing model is affected by our stock price as well as assumptions regarding a number of variables, including the expected stock price volatility over the term of the warrants (from which the derivatives arise), risk-free interest rate and expected dividends.

Share-based compensation

 

Share-based compensation expenses are recognized in accordance with ASC 718 “Compensation-Stock Compensation”, which requires us to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model.

 

CRITICAL ACCOUNTING POLICIES

 

Revenue recognition

 

Revenue from sales of processed coal is generally recognized when the coal is delivered, title passes to the customer and collectability is reasonably assured.  We assess collectability based primarily on the creditworthiness of the customer and customer’s payment history.

Foreign currency translation

Shanxi Coal’s functional currency is China’s Renminbi (“RMB”) and its reporting currency is the U.S. dollar. Shanxi Coal’s results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the end of period exchange rates. Translation adjustments resulting from this process are included in accumulated other comprehensive income in stockholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations from transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. Transaction gains and losses are not material to the consolidated financial statements for the years ended December 31, 2009, 2008 and 2007.  At December 31, 2009, 2008 and 2007, the exchange rates per US$1.00 were RMB 6.83, RMB 6.82 and RMB 7.30, respectively.

The PRC government imposes significant exchange restrictions on fund transfers out of the PRC that are not related to business operations. These restrictions have not had a material impact on Puda because it has not previously engaged in any significant transactions that are subject to the restrictions.

 

Off Balance Sheet Arrangements

None.

 

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Tabular Disclosure of Contractual Obligations

The contractual obligations presented in the table below represent our estimates of future payments under fixed contractual obligations and commitments as of December 31, 2009.

    

(In thousand dollars)

 

Obligations		Total Ending Balance				Less Than One Year				1-3 Years				3-5 Years				More than 5 Years
Long Term Debt Obligations		$	7,800			$	1,300				2,600				2,600				1,300
Capital Lease Obligations			-				-				-				-				-
Operating Lease Obligations		$	632			$	158				474				-				-
Purchase Obligations			35,500				27,100				8,400				-				-
Repayment Obligations under Line of Credit			-				-				-				-
Total		$	43,932			$	28,558				11,474				2,600				1,300