The following discussion and analysis of the results of our operations and financial condition for the three and nine months ended March 31, 2012 and 2011, should be read in conjunction with our financial statements and the notes thereto that are included elsewhere in this report. All monetary figures are presented in U.S. dollars, unless otherwise indicated.

Overview

We are a vertically-integrated coal and coke producer based in Henan Province, People's Republic of China ("China" or "PRC"). We use coal that we extract and buy to produce basic and value-added coal products including raw (unprocessed) coal, washed coal, medium coal and coal slurries (by-products of the coal-washing process), and coke products including chemical and metallurgical coke and coal tar (a by-product of the coke manufacturing process).

Our business operations are conducted through Henan Province Pingdingshan Hongli Coal & Coke Co., Ltd. ("Hongli"), a PRC company that we control by a series of contractual arrangements between Hongli and Pingdingshan Hongyuan Energy Science and Technology Development Co., Ltd. ("Hongyuan"). Hongyuan is a PRC company wholly-owned by Top Favour Limited, a British Virgin Island company and our wholly-owned subsidiary.

Presently, our coke related activities are carried out by Hongli's branch operation, Baofeng Coking Factory ("Baofeng Coking"), coal related activities by four of Hongli's subsidiaries, namely Baofeng Hongchang Coal Co., Ltd. ("Hongchang Coal"), Baofeng Shuangrui Coal Mining Co., Ltd. ("Shuangrui Coal"), Baofeng Xingsheng Coal Mining Co., Ltd. ("Xingsheng Coal") and Baofeng Shunli Coal Mining Co., Ltd. ("Shunli Coal"), and electricity generation by another Hongli subsidiary, Baofeng Hongguang Environment Protection Electricity Generating Co., Ltd. ("Hongguang Power").

In addition, we intend to operate our new coking plant through a newly established subsidiary of Hongli, Baofeng Hongrun Coal Chemical Co., Ltd. ("Hongrun"). We currently expect to complete the plant by the end of December 2012.

After the provincial-wide mining moratorium was imposed in June 2010, Hongchang Coal operated at approximately 50% capacity while operations at our other three coal mine companies were halted. In August 2011, both Hongchang Coal and Xingsheng Coal received clearance to resume operations from Henan Province Coal Seam Gas Development and Utilization Co., Ltd. ("Henan Coal Seam Gas"), a state-owned enterprise and qualified provincial-level coal mine consolidator with whom we formed a joint-venture, Henan Hongyuan Coal Seam Gas Engineering Technology Co., Ltd. ("Hongyuan CSG"). In September 2011, Hongchang Coal halted operations to complete certain mine engineering works and safety upgrades, which were completed by the end of September 2011. Henan Coal Seam Gas has also applied with the appropriate provincial-level agencies to confirm the clearances it has issued to Hongchang Coal and Xingsheng Coal. However, due to an accident in November 2011 at one of the mines owned by Yima Coal Group, a state-owned enterprise and one of the six provincial level consolidators in Henan, all mid-scale mines in Henan Province were ordered to undergo safety checks and inspections by the relevant authorities. This requirement applies to all four of our mines, and at present, we do not know when clearance to resume mining operations can be issued. As such, we continue to meet our coal requirements largely from outside of Henan, and our coal-related revenue for the periods discussed below are largely from coal-trading activities.

We intend to operate our four mines through Hongyuan CSG, by transferring shares into the JV, although such transfer has not been carried out as of the date of this report. Management believes that such transfer would reduce the Company's risk of loss relating to mine safety issues and mining policy changes. However, after such transfer and assuming that all of our four mines operate at full capacity, the income from Hongchang Coal and Shunli Coal would be reduced by 31%, and the income from Shuangrui Coal and Xingsheng Coal would be reduced by 7%.

Results of Operations

Three and Nine months Ended March 31, 2012 as Compared to Three and Nine months Ended March 31, 2011

General. Our overall revenue for the three and nine months ended March 31, 2012 decreased by 15.44% and increased by 13.35%, respectively, from the same periods a year ago. Coal supply in Henan Province remained tight as production activities throughout the industry continued to remain well below capacity in light of the mining moratorium. Since the shutdown of mining operations in late June 2011, Hongchang Coal had been operating at approximately 50% capacity until it halted its operation in September 2011 in order to complete certain mine engineering work and safety upgrades which were completed by the end of September 2011. As of March 31, 2012, all of our mines were still waiting for governmental confirmation to resume operations. As a result, volume of raw coal sold decreased in the third quarter of fiscal 2012. However, because we have been accumulating washed coal in anticipation of the commencement of operations at our new coking facility that is still under construction, our inventory was sufficient to enable us to also engage in trading, the sales from which, in addition to favorable average selling price, greatly contributed to our overall revenue increase.

On a macro level, management has observed the following trends, which may have a direct impact on our operations in the near future: (1) the continuing effects of the ongoing mine consolidation in Henan Province and the availability of metallurgical coal in the region, and on the prices of coal products in the short- and mid-terms; (2) the central government's continuing control on the inflation and CPI index, which affects the market demand for coke products.

Revenue. Revenue for the three months ended March 31, 2012, decreased by $3,068,404 or 15.44% from a year ago, due to decreased sales of coal tar and raw coal, offset by increased sales of coke and washed coal. 51.83% of the revenue came from coke products and 48.17% from coal products, as compared to 44.82% from coke products and 55.18% from coal products for the same period a year ago. The percentage changes reflect the inadequate raw coal supply in Henan that should continue at least for the near term until the mining moratorium can be lifted. Overall volume of coke and coal products sold decreased by 2.22% and 26.18% from a year ago, respectively, due to the decreased coal tar and raw coal sales.

Revenue for the nine months ended March 31, 2012, increased by $6,626,469, or 13.35%, from the same period a year ago, due to increased sales of coke and washed coal, offset by decreased sales of coal tar and raw coal. 50.93% of the revenue came from coke products and 49.07% from coal products, as compared to 55.58% from coke products and 44.42% from coal products for the same period a year ago. The percentage changes mainly resulted from increased sales of washed coal and decreased sales of raw coal. Nevertheless, overall volume of coal products sold decreased by 9.09% from a year ago as Henan's tight raw coal supply limited how much raw coal we sold. On the other hand, overall volume of coke products sold increased by 2.96% from a year ago despite a drop in the volume of coal tar sold.

Revenue and quantity sold by product category for the three months ended March 31, 2012 and 2011 are as follows:

                                              Revenues
                                       Coke              Coal
                                     Products          Products           Total
Revenue
Three months ended March 31, 2011   $ 8,906,225      $ 10,966,236      $ 19,872,461
Three months ended March 31, 2012     8,708,731         8,095,326        16,804,057
Decrease in $                       $  (197,494 )    $ (2,870,910 )    $ (3,068,404 )
Decrease in %                             (2.22 )%         (26.18 )%         (15.44 )%

Quantity sold (metric tons)
Three months ended March 31, 2011        37,656            94,307           131,963
Three months ended March 31, 2012        38,674            54,203            92,877
Increase (decrease)                       1,018           (40,104 )         (39,086 )
% increase (decrease)                      2.70 %          (42.53 )%         (29.62 )%

Revenue and quantity sold by product category for the nine months ended March 31, 2012 and 2011 are as follows:

                                             Revenues
                                       Coke             Coal
                                     Products         Products           Total
Revenue
Nine months ended March 31, 2011   $ 27,579,810     $ 22,046,445      $ 49,626,255
Nine months ended March 31, 2012     28,647,194       27,605,530        56,252,724
Increase in $                      $  1,067,384     $  5,559,085      $  6,626,469
Increase in %                              3.87 %          25.22 %           13.35 %

Quantity sold (metric tons)
Nine months ended March 31, 2011        117,998          210,115           328,113
Nine months ended March 31, 2012        121,494          191,009           312,503
Increase  (decrease)                      3,496          (19,106 )         (15,610 )
% increase (decrease)                      2.96 %          (9.09 )%          (4.76 )%

Coke products include finished coke, a key raw material for producing steel, and coal tar, a byproduct of the coke manufacturing process which can be used for various industrial applications. Coal products include unprocessed metallurgical coal, processed coal (washed coal), and by-products during the coal processing which are used by customers primarily for electricity generation and heating applications. We categorized unprocessed metallurgical coal and by-products as raw coal, and processed coal as washed coal.

Average selling prices per metric ton for our four principal product types for the three months ended March 31, 2012 and 2011 are as follows:

                                     Coke         Coal Tar       Raw Coal       Washed Coal
Three months ended March 31, 2011   $   236      $      244     $       81     $         183
Three Months ended March 31, 2012       230             257             88               176

Average selling prices per metric ton for our four principal product types for the nine months ended March 31, 2012 and 2011 are as follows:

                                    Coke       Coal Tar       Raw Coal       Washed Coal
Nine months ended March 31, 2011   $  233     $      242     $       72     $         178
Nine months ended March 31, 2012      235            255             76               181
Increase  in $                          2             13              4                 3
Increase in %                        0.88 %         5.37 %         5.56 %            1.66 %

Generally, our selling prices are driven by a number of factors, including the particular composition and quality of the coal or coke we sell, their prevailing market prices locally and throughout China, as well as in the global marketplace, timing of sales, delivery terms, and our relationships with our customers and our negotiations of their purchase orders.

We generally sell our raw coal inventory and other coal products when prices are stable at seasonally high levels, or at levels that are considered above historical norms. The average price of raw coal was calculated based on the weighted average price of unprocessed coal, coal byproducts and mixed thermal coal. In general, the price of unprocessed coal is higher than coal by-products and mixed thermal coal; therefore, the weight of the sales volume between unprocessed coal and the coal by-products is one of the key factors that influence the average selling price of raw coal. Market demand and the supply of coal are also key factors influencing the price of raw coal. We note that the average selling prices for coal products are also influenced by changes in the coal mixtures (with different grades and heat content) that we sell to our customers.

Revenue and quantity sold of each coke product for the three months ended March 31, 2012 and 2011 are as follows:

                                           Coke Products
                                       Coke          Coal Tar           Total
Revenue
Three months ended March 31, 2011   $ 7,807,796     $ 1,098,429      $ 8,906,225
Three months ended March 31, 2012     8,521,844         186,887        8,708,731
Increase (decrease) in $                714,048        (911,542 )       (197,494 )
Increase (decrease) in %                   9.15 %        (82.99 )%         (2.22 )%

Quantity sold (metric tons)
Three months ended March 31, 2011        33,153           4,503           37,656
Three months ended March 31, 2012        37,111           1,563           38,674
Increase (decrease)                       3,958          (2,940 )          1,018
% increase (decrease)                     11.94 %        (65.29 )%          2.70 %

Revenue and quantity sold of each coke product for the nine months ended March 31, 2012 and 2011 are as follows:

                                          Coke Products
                                       Coke          Coal Tar           Total
Revenue
Nine months ended March 31, 2011   $ 25,259,342     $ 2,320,468      $ 27,579,810
Nine months ended March 31, 2012     27,116,487       1,530,707        28,647,194
Increase (decrease) in $              1,857,145        (789,761 )       1,067,384
Increase (decrease) in %                   7.35 %        (34.03 )%           3.87 %

Quantity sold (metric tons)
Nine months ended March 31, 2011        108,407           9,591           117,998
Nine months ended March 31, 2012        115,476           6,018           121,494
Increase (decrease)                       7,069          (3,573 )           3,496
% increase (decrease)                      6.52 %        (37.24 )%           2.96 %

Revenue from coke for the three months ended March 31, 2012 increased by 9.15% from a year ago as a result of higher sales volume, despite a slightly lower average selling price from a year ago. Revenue from coke for the nine months ended March 31, 2012 increased by 7.35% from a year ago mainly attributed to the increase in sales volume. The increased sales volume for the nine-month period was mainly due to the increased demand for coke by steel mills during the quarter ended September 30, 2011. However, coke demand began to weaken in the quarter ended December 31, 2011 and continued into the quarter ended March 31, 2012, mainly due to China's inflation control policy. Such policy impacted the real estate industry directly and downstream industries such as ours and the steel industry indirectly. Thus, the higher sales volume during the quarter ended March 31, 2012 was achieved through slightly lowering our selling price.

Revenue from coal tar for the three and nine months ended March 31, 2012 decreased by 82.99% and 34.03% from the same respective periods a year ago, because of decreased production. In February 2011, our current coking plant was upgraded, which led to production of a higher-quality coal tar that pushed up our selling price. However, it also resulted in less coal tar produced while we were testing to achieve the best washed coal mix for our coking ovens.

Revenue and quantity sold of each coal product for the three months ended March 31, 2012 and 2011 are as follows:

                                            Coal Products
                                      Raw Coal        Washed Coal         Total
Revenue
Three months ended March 31, 2011   $  4,961,427      $  6,004,809     $ 10,966,236
Three months ended March 31, 2012      1,342,559         6,752,767        8,095,326
Increase (decrease) in $              (3,618,868 )         747,958       (2,870,910 )
Increase (decrease) in %                  (72.94 )%          12.46 %         (26.18 )%

Quantity sold (metric tons)
Three months ended March 31, 2011         61,437            32,870           94,307
Three months ended March 31, 2012         15,778            38,425           54,203
Increase (decrease)                      (45,659 )           5,555          (40,104 )
% increase (decrease)                     (74.32 )%          16.90 %         (42.53 )%

Revenue and quantity sold of each coal product for the nine months ended March 31, 2012 and 2011 are as follows:

                                           Coal Products
                                     Raw Coal        Washed Coal         Total
Revenue
Nine months ended March 31, 2011   $ 10,473,771      $ 11,572,674     $ 22,046,445
Nine months ended March 31, 2012      4,876,089        22,729,441       27,605,530
Increase (decrease) in $             (5,597,682 )      11,156,767        5,559,085
Increase (decrease) in %                 (53.44 )%          96.41 %          25.22 %

Quantity sold (metric tons)
Nine months ended March 31, 2011        144,933            65,182          210,115
Nine months ended March 31, 2012         65,254           125,755          191,009
Increase (decrease)                     (79,679 )          60,573          (19,106 )
% increase (decrease)                    (54.98 )%          92.93 %          (9.09 )%

Revenue from raw coal for the three and nine months ended March 31, 2012 decreased by 72.94% and 53.44% from the same periods a year ago, respectively, mainly from the lack of raw coal available to sell as extracting from mines in Henan including ours continue to be halted. As a result, our raw coal supply is largely limited by what we can secure from outside the province. We are currently exploring the availability of coal resources in northwest China in an effort to boost our access to raw coal.

Revenue from washed coal for the three and nine months ended March 31, 2012 increased by 12.46% and 96.41% from a year ago as a result of increased sales volume. We had originally stocked up on washed coal in anticipation of our new coking plant. Once the plant's construction completion date was delayed to December 2012, however, we began selling more washed coal.

Cost of Revenue. Cost of revenue for the three months ended March 31, 2012 increased by 12.11% to $14,166,799 as compared to a year ago. Cost of revenue for the nine months ended March 31, 2012 increased by 40.76% to $43,122,271 as compared to a year ago. The increase is the result of increased raw material costs, primarily for unprocessed coal and washed coal, driven by the lack of available raw coal in Henan. Since September 2011, we have been purchasing coal from other provinces, such as Gansu, Shanxi and Inner Mongolia, which significantly increased our cost.

Gross Profit. Gross profit for the three months ended March 31, 2012 decreased by $4,598,452 or 63.55% from a year ago to $2,637,258, as a result of both decreased revenue and increased cost of revenue. Gross profit for the nine months ended March 31, 2012 decreased by $5,859,987 or 30.86% from a year ago to $13,130,453, as a result of increased cost of revenue, despite increased revenue.

Gross profit as a percentage of revenue, or gross margin, across all products decreased to 15.69% for the three months ended March 31, 2012, from 36.41% a year ago. The decrease is mainly due to the significant increase in our coal purchase since September 2011, which significantly increased our cost of revenue. Gross margin across all products for the nine months ended March 31, 2012, decreased to 23.34% from 38.27% a year ago.

Operating Expenses. Operating expenses, which consist of selling and general and administrative expenses, decreased by 26.8% for the three months ended March 31, 2012 from a year ago, mainly due to decreases in travel expenses of $163,231, rental expenses of $50,657, various over-accruals of $16,310, depreciation and amortization expenses of $20,612 and other miscellaneous expenses of $51,691. Such decreases were offset by increased professional expenses of $34,201, as we engaged a consulting firm to assist us with designing and implementing our internal controls over financial reporting, and increased payroll expenses of $16,254. Operating expenses for the nine months ended March 31, 2012 decreased by 22.4% from a year ago largely due to decreases in over-accruals of $369,810, travel expenses of $288,799, rental expenses of $145,903, professional expenses of $146,516, training expense of $44,520, depreciation and amortization expenses of $36,481, and other miscellaneous expenses of $47,117. Such decreases were offset by a write off of $362,544 in uncollectable interest income from two unrelated individual borrowers whom we have determined are unlikely to repay the interest on their loans, which resulted in a net increase of $331,065 in bad debt expenses, and increased payroll expenses of $127,134 as we increased our executives' salaries starting in July 2011.

Other Income and Expense. Other income and expense includes interest income and expense, other finance expense, other income and expense not related to our principal operations, and change in fair value of warrants.

For the three months period ended March 31, 2012, we had bank interest income of $10,095 and interest income from loans to unrelated third parties of $212,488. We also had interest expense of $302,746 mainly from our loans with Bairui Trust Co., Ltd. (Bairui Trust"), and other finance expense of $34,002 from cashing bank guaranteed notes prior to their maturity and other unrelated bank charges. For the nine months period ended March 31, 2012, we had bank interest income of $39,467 and interest income from loans to unrelated third parties of $960,416. We also had interest expense of $1,033,768 from our loans with Bairui Trust, and other finance expense of $107,435 from cashing bank guaranteed notes prior to their maturity and other bank charges.

Change in fair value of warrants amounted to $163,394 and $4,526,330 in gain for the three and nine months ended March 31, 2012, respectively, as compared to $12,191,235 and $13,663,378 in gain for the same periods a year ago, respectively. Because our functional currency is denominated in the Chinese Renminbi ("RMB"), our warrants cannot be considered indexed to our own common stock and, as such, we must record them as derivative instruments and recognize any change in their fair value in our earnings. The primary factor affecting the fair value of the warrants is the price of our common stock during the relevant period.

Provision for Income Taxes. Provision for income taxes for the three and nine months ended March 31, 2012 decreased by $646,132 and $466,916 from the same periods a year ago, respectively, due to decreased income. In addition, Hongchang has not been required to accrue for its fixed annual income of approximately $380,000 (RMB 2,520,000) since in October 2011, after its operations were halted in September 2011.

We use non-GAAP adjusted net income to measure the performance of our business internally by excluding non-cash charges related to warrants, and believe that such non-GAAP financial measure allows us to focus on managing business operating performance because the measure reflects the Company's essential operating activities and provides a consistent method of comparison to historical periods. We believe that providing such non-GAAP financial measure is useful to investors for a number of reasons. The non-GAAP financial measure provides a consistent basis for investors to understand our financial performance in comparison to historical periods without variation of non-recurring items and non-operating related charges. In addition, it allows investors to evaluate the Company's performance using the same methodology and information that are used by our management. Non-GAAP financial measures are subject to inherent limitations because they do not include all of the expenses included under GAAP and because they involve the exercise of judgment regarding which charges are excluded. However, we compensate for these limitations by providing the relevant disclosure of excluded charges.

The following table provides our adjusted net income and a reconciliation of such non-GAAP financial measure to our GAAP net income:

                                             Three months ended                Nine months ended
                                                  March 31,                         March 31,
                                            2011             2011             2012             2011
Net income                              $  1,417,663     $ 17,138,441     $ 12,372,080     $ 25,630,716
Change in fair value of warrant
liabilities                                  163,394       12,191,235        4,526,330       13,663,378
Adjusted net income                     $  1,254,269     $  4,947,206     $  7,845,750     $ 11,967,338

Earnings per share - basic              $       0.07     $       0.81     $       0.59     $       1.22
Earnings per share - diluted            $       0.07     $       0.81     $       0.59     $       1.22
Adjusted earnings per share - basic     $       0.06     $       0.24     $       0.37     $       0.57
Adjusted earnings per share - diluted   $       0.06     $       0.23     $       0.37     $       0.57

Weighted average number of common
shares - basic                            21,090,948       21,043,206       21,090,948       20,927,453
Weighted average number of common
shares - diluted                          21,090,948       21,057,332       21,090,948       20,941,252
Adjusted average number of common
shares - basic                            21,090,948       21,043,206       21,090,948       20,927,453
Adjusted average number of common
shares - diluted                          21,090,948       21,057,332       21,090,948       20,941,252

Liquidity and Capital Resources



In summary, our cash flows are as follows:



                                                  Nine months ended
                                                       March 31
                                                2012              2011
Net cash used in operating activities       $  (7,239,188 )   $  (4,577,923 )
Net cash used in investing activities         (17,284,547 )     (10,266,874 )
Net cash provided by financing activities       1,499,228         2,344,166

Net Cash Used in Operating Activities

For the nine months ended March 31, 2012, net operating outflows was $7,239,188. Excluding non-cash adjustments, our cash outflow were mainly the result from:
(1) increased note receivables of approximately $1.57 million as we increased reliance on bank guaranteed notes over cash by major customers, (2) increased accounts receivable of approximately $3.51 million as we extended credit to major customers to maintain their business, (3) increase in other receivable of approximately $1.20 million as we have accrued interest receivable from a third party loan, (4) increased inventory of approximately $4.47 million to maintain sufficient level of washed coal for trading, (5) increased advances to suppliers of approximately $4.10 million to secure future inventory purchase, and (6) decreased tax payable of approximately $1.23 million as we paid off and accrued additional income tax and value-added tax.

Net cash used in operating activities for the nine months ended March 31, 2011 was $4,577,923. The cash inflows mainly resulted from an increase of depreciation, amortization and tax payable, in the amount of $1,074,925, $1,175,244, and $367,959, respectively. The cash inflows were offset by the . . .