UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q





(MARK
ONE)





x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30,
  2010.




o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934 FOR THE TRANSITION PERIOD FROM ________ TO
  __________





COMMISSION
FILE NUMBER: 0-52549




RINO
International Corporation


(EXACT
NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)





NEVADA
            
            41-1508112(STATE
      OR OTHER JURISDICTION OF
            
            (I.R.S.
      EMPLOYER IDENTIFICATION NO.)INCORPORATION
      OR ORGANIZATION




11
Youquan Road, Zhanqian Street, Jinzhou District


Dalian,
People’s Republic of China 116100


(ADDRESS
OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)





REGISTRANT’S
TELEPHONE NUMBER, INCLUDING AREA CODE:+86-411-87661222





Indicate
by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x
  No o.





Indicate
by check mark whether the Registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Date File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
Registrant was required to submit and post such files). Yes o No o




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.




Large
      accelerated filer o
            Accelerated
      filer oNon-accelerated
      filer o
            Smaller
      reporting company x




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act.) Yes o No x




The
number of shares of Common Stock of the Registrant, par value $.0001 per share,
outstanding on August 13, 2010 was 28,605,321.










RINO
INTERNATIONAL CORPORATION





INDEX
TO JUNE 30, 2010 FORM 10-Q




Page
              NumberPart
      I - Financial Information
            
            3Item
      1 - Financial Statements
            
            3Consolidated
      Balance Sheets as of June 30, 2010 (unaudited) and December 31,
      2009
            
            3Consolidated
      Statements of Income and Other Comprehensive Income for the Three Months
      and the Six Months ended June 30, 2010 and 2009
(unaudited)
            
            4Consolidated
      Statement of Shareholders’ Equity (unaudited)
            
            5Consolidated
      Statements of Cash Flows for the Six Months ended June 30, 2010 and 2009
      (unaudited)
            
            6Notes
      to the Consolidated Financial Statements (unaudited)
            
            7Item
      2 - Management's Discussion and Analysis of Results of Operations and
      Financial Condition
            
            30Item
      4 - Controls and Procedures
            
            50Part
      II - Other Information
            
            51Item
      2 - Unregistered Sales of Equity Securities and Use of
      Proceeds
            
            54Item 5
      - Other InformationItem
      6 - Exhibits
            
            54Signature
      Page
            
            55




2




PART
I - FINANCIAL INFORMATION





Item
1. Financial Statements





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS


AS OF
JUNE 30, 2010 AND DECEMBER 31, 2009





2010
                      
                      
                      2009(UNAUDITED)ASSETSCURRENT
      ASSETSCash
      and cash equivalents
                      
                      $
                      88,036,608
                      
                      
                      $
                      134,487,611Restricted
      cash
                      
                      
                      3,388,392
                      
                      
                      
                      -Notes
      receivable
                      
                      
                      469,960
                      
                      
                      
                      440,100Due
      from shareholders
                      
                      
                      -
                      
                      
                      
                      3,005,386Accounts
      receivable, trade, net of allowance for doubtful accounts of $562,822 and
      $273,446 as of June 30, 2010 and December 31, 2009,
      respectively
                      
                      
                      68,389,279
                      
                      
                      
                      57,811,171Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
                      
                      
                      38,902,971
                      
                      
                      
                      3,258,806Inventories
                      
                      
                      4,401,228
                      
                      
                      
                      5,405,866Advances
      for inventory purchases
                      
                      
                      64,425,996
                      
                      
                      
                      34,056,231Other
      current assets and prepaid expenses
                      
                      
                      879,076
                      
                      
                      
                      629,506Total
      current assets
                      
                      
                      268,893,510
                      
                      
                      
                      239,094,677PLANT
      AND EQUIPMENT, NET
                      
                      
                      13,020,836
                      
                      
                      
                      12,265,389OTHER
      ASSETSInvestment
      in unconsolidated affiliate
                      
                      
                      441,900
                      
                      
                      
                      -Advances
      for non current assets
                      
                      
                      9,492,531
                      
                      
                      
                      6,570,378Intangible
      assets, net
                      
                      
                      9,026,114
                      
                      
                      
                      1,144,796Total
      other assets
                      
                      
                      18,960,545
                      
                      
                      
                      7,715,174Total
      assets
                      
                      $
                      300,874,891
                      
                      
                      $
                      259,075,240LIABILITIES
      AND SHARE HOLDERS' EQUITYCURRENT
      LIABILITIESAccounts
      payable
                      
                      $
                      7,202,192
                      
                      
                      $
                      4,281,353Short
      term bank loans
                      
                      
                      3,682,500
                      
                      
                      
                      1,467,000Notes
      payable
                      
                      
                      3,388,392
                      
                      
                      
                      -Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
                      
                      
                      3,385,163
                      
                      
                      
                      -Customer
      deposits
                      
                      
                      351,630
                      
                      
                      
                      4,984,801Deferred
      revenue
                      
                      
                      1,333,127
                      
                      
                      
                      -Liquidated
      damages payable
                      
                      
                      20,147
                      
                      
                      
                      20,147Due
      to shareholders
                      
                      
                      535,895
                      
                      
                      
                      -Taxes
      payable
                      
                      
                      3,261,799
                      
                      
                      
                      4,003,709Other
      payables and accrued liabilities
                      
                      
                      508,564
                      
                      
                      
                      496,411Total
      current liabilities
                      
                      
                      23,669,409
                      
                      
                      
                      15,253,421Long-term
      loan
                      
                      
                      8,101,500
                      
                      
                      
                      -Warrant
      Liabilities
                      
                      
                      97,798
                      
                      
                      
                      15,172,712REDEEMABLE
      COMMON STOCK ($0.0001 par value, 5,464,357 shares issued with conditions
      for redemption outside the control of the company)
                      
                      
                      24,480,319
                      
                      
                      
                      24,480,319COMMITMENTS
      AND CONTINGENCIESSHAREHOLDERS'
      EQUITYPreferred
      Stock ($0.0001 par value, 50,000,000 shares authorized, none issued and
      outstanding)
                      
                      
                      -
                      
                      
                      
                      -Common
      Stock ($0.0001 par value, 100,000,000 shares authorized, 28,605,321 and
      28,603,321 shares issued and outstanding as of June 30, 2010 and December
      31, 2009)
                      
                      
                      2,860
                      
                      
                      
                      2,860Additional
      paid-in capital
                      
                      
                      107,201,125
                      
                      
                      
                      107,135,593Retained
      earnings
                      
                      
                      115,517,443
                      
                      
                      
                      78,983,794Statutory
      reserves
                      
                      
                      14,314,417
                      
                      
                      
                      11,755,312Accumulated
      other comprehensive income
                      
                      
                      7,490,020
                      
                      
                      
                      6,291,229Total
      shareholders' equity
                      
                      
                      244,525,865
                      
                      
                      
                      204,168,788Total
      liabilities and shareholders' equity
                      
                      $
                      300,874,891
                      
                      
                      $
                      259,075,240




The
accompanying notes are an integral part of these consolidated
statements.


3





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME (LOSS)


FOR THE
THREE AND SIX MONTHS ENDED JUNE 30, 2010 AND 2009


(UNAUDITED)





Three Months Ended June 30,
                        
                        
                        Six Months Ended June 30,2010
                        
                        
                        2009
                        
                        
                        2010
                        
                        
                        2009REVENUESContracts
                        
                        $
                        64,496,123
                        
                        
                        $
                        40,469,182
                        
                        
                        $
                        112,263,690
                        
                        
                        $
                        75,835,318Services
                        
                        
                        887,545
                        
                        
                        
                        253,068
                        
                        
                        
                        979,225
                        
                        
                        
                        495,05165,383,668
                        
                        
                        
                        40,722,250
                        
                        
                        
                        113,242,915
                        
                        
                        
                        76,330,369COST
      OF SALESContracts
                        
                        
                        41,638,121
                        
                        
                        
                        26,123,509
                        
                        
                        
                        72,613,173
                        
                        
                        
                        45,249,005Services
                        
                        
                        494,649
                        
                        
                        
                        268,912
                        
                        
                        
                        494,649
                        
                        
                        
                        592,830Depreciation
                        
                        
                        170,767
                        
                        
                        
                        162,260
                        
                        
                        
                        355,442
                        
                        
                        
                        370,32742,303,537
                        
                        
                        
                        26,554,681
                        
                        
                        
                        73,463,264
                        
                        
                        
                        46,212,162GROSS
      PROFIT
                        
                        
                        23,080,131
                        
                        
                        
                        14,167,569
                        
                        
                        
                        39,779,651
                        
                        
                        
                        30,118,207OPERATING
      EXPENSESSelling,
      general and administrative expenses
                        
                        
                        4,958,664
                        
                        
                        
                        4,146,294
                        
                        
                        
                        11,771,338
                        
                        
                        
                        7,517,018Stock
      compensation expense
                        
                        
                        46,036
                        
                        
                        
                        9,263
                        
                        
                        
                        65,532
                        
                        
                        
                        9,263TOTAL
      OPERATING EXPENSES
                        
                        
                        5,004,700
                        
                        
                        
                        4,155,557
                        
                        
                        
                        11,836,870
                        
                        
                        
                        7,526,281INCOME
      FROM OPERATIONS
                        
                        
                        18,075,431
                        
                        
                        
                        10,012,012
                        
                        
                        
                        27,942,781
                        
                        
                        
                        22,591,926OTHER
      INCOME (EXPENSES), NETOther
      expense, net
                        
                        
                        (110,664
                        )
                        
                        
                        3,871
                        
                        
                        
                        (113,879
                        )
                        
                        
                        (5,779
                        )Change
      in fair value of warrants
                        
                        
                        4,889,118
                        
                        
                        
                        (1,833,745
                        )
                        
                        
                        15,074,914
                        
                        
                        
                        (1,810,134
                        )Interest
      income (expense), net
                        
                        
                        70,162
                        
                        
                        
                        (72,974
                        )
                        
                        
                        140,444
                        
                        
                        
                        (191,933
                        )Gain
      on liquidated damage settlement
                        
                        
                        -
                        
                        
                        
                        1,746,120
                        
                        
                        
                        -
                        
                        
                        
                        1,746,120TOTAL
      OTHER INCOME (EXPENSES), NET
                        
                        
                        4,848,616
                        
                        
                        
                        (156,728
                        )
                        
                        
                        15,101,479
                        
                        
                        
                        (261,726
                        )INCOME
      BEFORE PROVISION FOR INCOME TAXES
                        
                        
                        22,924,047
                        
                        
                        
                        9,855,284
                        
                        
                        
                        43,044,260
                        
                        
                        
                        22,330,200PROVISION
      FOR INCOME TAXES
                        
                        
                        2,487,799
                        
                        
                        
                        -
                        
                        
                        
                        3,951,506
                        
                        
                        
                        -NET
      INCOME
                        
                        
                        20,436,248
                        
                        
                        
                        9,855,284
                        
                        
                        
                        39,092,754
                        
                        
                        
                        22,330,200OTHER
      COMPREHENSIVE INCOME (LOSS):Foreign
      currency translation adjustment
                        
                        
                        1,065,043
                        
                        
                        
                        (10,019
                        )
                        
                        
                        1,198,791
                        
                        
                        
                        (137,639
                        )COMPREHENSIVE
      INCOME
                        
                        $
                        21,501,291
                        
                        
                        $
                        9,845,265
                        
                        
                        $
                        40,291,545
                        
                        
                        $
                        22,192,561WEIGHTED
      AVERAGE NUMBER OF SHARES:Basic
                        
                        
                        28,603,517
                        
                        
                        
                        25,070,356
                        
                        
                        
                        28,603,431
                        
                        
                        
                        25,055,668Diluted
                        
                        
                        28,609,452
                        
                        
                        
                        25,070,940
                        
                        
                        
                        28,610,245
                        
                        
                        
                        25,055,668EARNINGS
      PER SHARE:Basic
                        
                        $
                        0.71
                        
                        
                        $
                        0.39
                        
                        
                        $
                        1.37
                        
                        
                        $
                        0.89Diluted
                        
                        $
                        0.71
                        
                        
                        $
                        0.39
                        
                        
                        $
                        1.37
                        
                        
                        $
                        0.89




The
accompanying notes are an integral part of these consolidated
statements.


4





RINO INTERNATIONAL CORPORATION AND
SUBSIDIARIES


CONSOLIDATED
STATEMENT OF SHAREHOLDERS' EQUITY





Common StockPar Value $0.0001
                        
                        
                        Additional
                        
                        
                        Retained Earnings
                        
                        
                        Accumulated otherNumber
                        
                        
                        Common
                        
                        
                        Paid-in
                        
                        
                        Unrestricted
                        
                        
                        Statutory
                        
                        
                        comprehensiveof shares
                        
                        
                        stock
                        
                        
                        capital
                        
                        
                        earnings
                        
                        
                        reserve
                        
                        
                        income
                        
                        
                        TotalsBALANCE,
      January 31, 2009
                        
                        
                        25,040,000
                        
                        
                        $
                        2,504
                        
                        
                        $
                        25,924,007
                        
                        
                        $
                        28,570,948
                        
                        
                        $
                        6,196,478
                        
                        
                        $
                        6,221,943
                        
                        
                        $
                        66,915,880Cumulative
      effect of reclassification of warrants
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (1,058,702
                        )
                        
                        
                        (420,070
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (1,478,772
                        )Shares
      issued to settle liquidated damage payable
                        
                        
                        48,438
                        
                        
                        
                        5
                        
                        
                        
                        216,999
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        217,004Stock
      issued for service
                        
                        
                        2,000
                        
                        
                        
                        -
                        
                        
                        
                        8,960
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        8,960Imputed
      interest on advances from a shareholder
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        13,557
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        13,557Net
      income
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        22,330,200
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        22,330,200Allocation
      to statutory reserve
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (2,477,427
                        )
                        
                        
                        2,477,427
                        
                        
                        
                        
                        
                        
                        
                        -Foreign
      currency translation gain
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (137,639
                        )
                        
                        
                        (137,639
                        )BALANCE,
      June 30, 2009 (Unaudited)
                        
                        
                        25,090,438
                        
                        
                        $
                        2,509
                        
                        
                        $
                        25,104,821
                        
                        
                        $
                        48,003,651
                        
                        
                        $
                        8,673,905
                        
                        
                        $
                        6,084,304
                        
                        
                        $
                        87,869,190Stock
      compensation expense
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        38,425
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        38,425Non
      cash exercise of warrant at $5.38
                        
                        
                        260,851
                        
                        
                        
                        26
                        
                        
                        
                        5,881,081
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        5,881,107Stock
      issuance for cash for $30.75
                        
                        
                        3,252,032
                        
                        
                        
                        325
                        
                        
                        
                        76,111,266
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        76,111,591Net
      income
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        34,061,550
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        34,061,550Allocation
      to statutory reserve
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (3,081,407
                        )
                        
                        
                        3,081,407
                        
                        
                        
                        
                        
                        
                        
                        -Foreign
      currency translation gain
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        206,925
                        
                        
                        
                        206,925BALANCE,
      December 31, 2009
                        
                        
                        28,603,321
                        
                        
                        $
                        2,860
                        
                        
                        $
                        107,135,593
                        
                        
                        $
                        78,983,794
                        
                        
                        $
                        11,755,312
                        
                        
                        $
                        6,291,229
                        
                        
                        $
                        204,168,788Stock
      compensation expense
                        
                        
                        2,000
                        
                        
                        
                        -
                        
                        
                        
                        65,532
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        65,532Net
      income
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        39,092,754
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        39,092,754Allocation
      to statutory reserve
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (2,559,105
                        )
                        
                        
                        2,559,105
                        
                        
                        
                        
                        
                        
                        
                        -Foreign
      currency translation gain
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        1,198,791
                        
                        
                        
                        1,198,791BALANCE,
      June 30, 2010 (Unaudited)
                        
                        
                        28,605,321
                        
                        
                        
                        2,860
                        
                        
                        
                        107,201,125
                        
                        
                        
                        115,517,443
                        
                        
                        
                        14,314,417
                        
                        
                        
                        7,490,020
                        
                        
                        
                        244,525,865




The
accompanying notes are an integral part of these consolidated
statements.


5





RINO INTERNATIONAL CORPORATION AND
SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


FOR THE
SIX MONTHS ENDED JUNE 30, 2010 AND 2009


(UNAUDITED)





2010
                      
                      
                      2009CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income
                      
                      $
                      39,092,754
                      
                      
                      $
                      22,330,200Adjustments
      to reconcile net income to cash (used in) provided by operating
      activities:Depreciation
                      
                      
                      466,837
                      
                      
                      
                      478,251Amortization
                      
                      
                      86,273
                      
                      
                      
                      33,377Allowance
      for bad debt
                      
                      
                      287,064
                      
                      
                      
                      205,687Imputed
      interest on advances from shareholders
                      
                      
                      -
                      
                      
                      
                      13,556Amortization
      of long term prepaid expenses
                      
                      
                      39,166
                      
                      
                      
                      7,329Stock
      issued for services
                      
                      
                      -
                      
                      
                      
                      9,263Stock
      compensation expense and shares placed in escrow
                      
                      
                      65,532
                      
                      
                      
                      -Gain
      (expense) on Liquidated damage settlement
                      
                      
                      -
                      
                      
                      
                      (1,746,120
                      )Change
      in fair value of warrants
                      
                      
                      (15,074,914
                      )
                      
                      
                      1,810,134Changes
      in operating assets and liabilities:Notes
      receivable
                      
                      
                      (27,944
                      )
                      
                      
                      806,516Accounts
      receivable
                      
                      
                      (10,585,899
                      )
                      
                      
                      (21,802,792
                      )Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
                      
                      
                      (35,483,281
                      )
                      
                      
                      -Inventories
                      
                      
                      1,022,495
                      
                      
                      
                      81,194Advances
      for inventory purchases
                      
                      
                      (30,105,286
                      )
                      
                      
                      6,308,955Other
      current assets and prepaid expenses
                      
                      
                      (246,017
                      )
                      
                      
                      (131,544
                      )Accounts
      payable
                      
                      
                      2,891,305
                      
                      
                      
                      (823,508
                      )Customer
      deposits
                      
                      
                      (4,634,288
                      )
                      
                      
                      (3,549,925
                      )Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
                      
                      
                      3,371,144
                      
                      
                      
                      -Other
      payables and accrued liabilities
                      
                      
                      10,077
                      
                      
                      
                      (329,915
                      )Deferred
      revenue
                      
                      
                      1,327,607
                      
                      
                      
                      -Taxes
      Payable
                      
                      
                      (755,144
                      )
                      
                      
                      6,038,867Net
      cash (used in) provided by operating activities
                      
                      
                      (48,252,519
                      )
                      
                      
                      9,739,525CASH
      FLOWS FROM INVESTING ACTIVITIESPayment
      for investment in unconsolidated affiliate
                      
                      
                      (440,070
                      )
                      
                      
                      -Purchase
      of equipment
                      
                      
                      (1,169,547
                      )
                      
                      
                      (28,051
                      )Advances
      for non current assets
                      
                      
                      (2,922,462
                      )
                      
                      
                      -Purchase
      of intangible assets
                      
                      
                      (7,930,290
                      )Net
      cash used in investing activities
                      
                      
                      (12,462,369
                      )
                      
                      
                      (28,051
                      )CASH
      FLOWS FROM FINANCING ACTIVITIESChange
      in restricted cash
                      
                      
                      (3,374,360
                      )
                      
                      
                      1,030,317Proceeds
      from notes payable - banks
                      
                      
                      3,374,360
                      
                      
                      
                      88,382Proceeds
      from short term bank loans
                      
                      
                      3,667,250
                      
                      
                      
                      21,985,500Payments
      on short term bank loans
                      
                      
                      (1,466,900
                      )
                      
                      
                      -Payments
      on liquidated damage settlement
                      
                      
                      -
                      
                      
                      
                      (615,018
                      )Payment
      on due to shareholder
                      
                      
                      (321,810
                      )
                      
                      
                      (824,808
                      )Proceeds
      from shareholder
                      
                      
                      3,862,842
                      
                      
                      
                      668,449Proceeds
      from long term bank loans
                      
                      
                      8,067,950
                      
                      
                      
                      -Net
      cash provided by financing activities
                      
                      
                      13,809,332
                      
                      
                      
                      22,332,822EFFECT
      OF EXCHANGE RATE ON CASH
                      
                      
                      454,553
                      
                      
                      
                      (42,094
                      )(DECREASE)
      INCREASE IN CASH AND CASH EQUIVALENTS
                      
                      
                      (46,451,003
                      )
                      
                      
                      32,002,202CASH
      AND CASH EQUIVALENTS, beginning
                      
                      
                      134,487,611
                      
                      
                      
                      19,741,982CASH
      AND CASH EQUIVALENTS, ending
                      
                      $
                      88,036,608
                      
                      
                      $
                      51,744,184SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATIONCash
      paid for Interest expense
                      
                      $
                      206,830
                      
                      
                      $
                      369,146Cash
      paid for income taxes
                      
                      $
                      2,388,504
                      
                      
                      $
                      229,848




The
accompanying notes are an integral part of these consolidated
statements.


6




RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





NOTE
1 – NATURE OF BUSINESS





RINO
International Corporation (the “Company” or “RINO”) was originally incorporated
in 1984 in accordance with the laws of the State of Minnesota. On December 27,
2006, the shareholders of the Company approved a proposal to re-domicile the
Company from the State of Minnesota to the State of Nevada. The Company through
its 100% owned subsidiaries and Variable Interest Entities (“VIEs”), engages in
designing, developing, manufacturing, and installation of environmental
protection and energy saving industrial equipments in the People’s Republic of
China (PRC).





Current
Development





On March
9, 2010, Dalian Rino Environment Engineering Science and Technology Co., Ltd.
(“Dalian RINO”) and three other unrelated Chinese based companies formed Dalian
Environmental Exchange Center (“DEEC”) under the laws of the PRC. Dalian RINO
invested approximately $441,900 (RMB 3 million) in cash which is accounted for
as its 30% uncontrolling interest of the total registered capital of $1,467,000
(RMB 10 million). The company provides services in environmental protection and
energy saving, services in connection with comprehensive trading of the
technologies of environmental protection, energy saving, and greenhouse gases
(carbon dioxide). DEEC also offers services in project consulting, design
planning and project value evaluations, providing management, information and
technology for project investments. See Note 8 for investment in unconsolidated
affiliate.





NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Basis of
Presentation





The
accompanying consolidated financial statements of the Company have been
prepared in accordance with accounting principles generally accepted in the
United States of America and reflect the activities of the following
subsidiaries and VIEs.  All material intercompany transactions
and balances have been eliminated in the consolidation.





Place
                    incorporated
                  
                  Ownership
                    percentageInnomind
      Group Limited (“Innomind”)
                  
                  BVI
                  
                  
                  100
                  %Dalian
      Innomind Environment Engineering Co., Ltd. (“Dalian
    Innomind”)
                  
                  Dalian,
      China
                  
                  
                  100
                  %Rino
      Investment (Dalian) Co., Ltd. (“Dalian Investment”)
                  
                  Dalian,
      China
                  
                  
                  100
                  %Dalian
      RINO Heavy Industry Co., Ltd. (“Dalian Rino Heavy)
                  
                  Dalian,
      China
                  
                  
                  100
                  %Dalian
      Rino Environment Engineering Science and Technology Co., Ltd. (“Dalian
      Rino”)
                  
                  Dalian,
      China
                  
                  VIERino
      Technology Corporation (“Rino Technology)
                  
                  Nevada,
      USA
                  
                  VIEDalian
      Rino Environmental Engineering Project Design Co., Ltd. (“Dalian Rino
      Design”)
                  
                  Dalian,
      China
                  
                  VIEDalian
      Rino Environmental Construction & Installation Project Co., Ltd.
      (“Dalian Rino Installation”)
                  
                  Dalian,
      China
                  
                  VIE





In
accordance with the interpretation of Generally Accepted Accounting Principles
(GAAP), VIEs are generally entities that lack sufficient equity to finance their
activities without additional financial support from other parties or whose
equity holders lack adequate decision making ability.  All VIEs with
which the Company is involved must be evaluated to determine the primary
beneficiary of the risks and rewards of the VIE. The primary beneficiary is
required to consolidate the VIE for financial reporting purposes. There is
no restriction on the ability of the Company’s VIEs and subsidiaries to transfer
moneys to the Company.





ASC 810
addresses whether certain types of entities referred to as VIEs, should be
consolidated in a Company’s consolidated financial
statements.  Pursuant to an Entrusted Management Agreement by and
between Dalian Innomind and Dalian Rino, dated October 3, 2007, Dalian Rino and
its shareholders agreed to entrust the operations and management of the Business
to Dalian Innomind and Dalian Innomind is entitled to Dalian Rino’s net
profit as an entrusted management fee. In accordance with the provisions of
ASC 810, the Company has determined that Dalian Rino and its 100% owned
subsidiaries Dalian Rino Design, Rino Technology and Dalian Rino
Installation are VIEs and that the Company is the primary beneficiary, and
accordingly, the financial statements of Dalian Rino, Dalian Rino Design, Rino
Technology and Dalian Rino Installation are consolidated into the financial
statements of the Company.





7





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





The
carrying amount of the VIEs’ assets and liabilities are as follows:





June30,2010
                  
                  
                  December31,2009(Unaudited)Current
      assets
                  
                  $
                  169,064,701
                  
                  
                  $
                  145,870,479Plant
      and equipment
                  
                  
                  11,048,140
                  
                  
                  
                  11,270,034Other
      noncurrent assets
                  
                  
                  22,301,543
                  
                  
                  
                  7,713,576Total
      assets
                  
                  
                  202,414,384
                  
                  
                  
                  164,854,089Total
      liabilities
                  
                  
                  184,559,081
                  
                  
                  
                  150,218,805Net
      assets
                  
                  $
                  17,855,303
                  
                  
                  $
                  14,635,284




VIE’s
liabilities as of June 30, 2010 consists of the following:





June30,2010(Unaudited)Current
      liabilities
                  
                  $Accounts
      payable
                  
                  
                  7,019,623Short-term
      bank loan
                  
                  
                  3,682,500Payable
      to Rino International to be eliminated
                  
                  
                  156,541,384Billing
      in excess of costs and estimated earnings on uncompleted
      contracts
                  
                  
                  3,385,163Customer
      deposits
                  
                  
                  351,630Liquidated
      damages payable
                  
                  
                  -Other
      payable and accrued liabilities
                  
                  
                  410,144Notes
      payable
                  
                  
                  3,241,092Due
      to a stockholder
                  
                  
                  85,523Unearned
      revenue
                  
                  
                  1,333,127Tax
      payable
                  
                  
                  407,395176,457,581Noncurrent
      liabilitiesLong-term
      loan
                  
                  
                  8,101,500Warrant
      liabilities
                  
                  
                  -Total
      liabilities
                  
                  $
                  184,559,081





The
interim unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States,
or GAAP, for interim financial information and with the instructions to
Securities and Exchange Commission, or SEC, Form 10-Q and Article 10 of SEC
Regulation S-X and consistent with the accounting policies stated in the
Company’s 2009 Annual Report on Form 10-K. Certain information and note
disclosures normally included in financial statements prepared in accordance
with GAAP have been condensed or omitted pursuant to such rules and regulations.
Therefore, these financial statements should be read in conjunction with our
audited consolidated financial statements and notes thereto for the year ended
December 31, 2009, included in our Annual Report on Form 10-K filed with
the SEC.





The
interim consolidated financial statements included herein are unaudited;
however, they contain all normal recurring accruals and adjustments that, in the
opinion of management, are necessary to present fairly our consolidated
financial position as of June 30, 2010, and our consolidated results of
operations and cash flows for the six and three months ended June 30, 2010 and
2009. The results of operations for the six and three months ended June 30, 2010
are not necessarily indicative of the results to be expected for future quarters
or the full year.





8





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Use of
Estimates





The
preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions about future events. These estimates and the
underlying assumptions affect the reported amounts of assets, liabilities,
revenue and expenses, and disclosures about contingent assets and
liabilities. Such estimates and assumptions by management affect accrued
expenses, the valuation of accounts receivable, inventories, and long-lived
assets, legal contingencies, lives of plant and equipment, lives of intangible
assets, calculation of warranty accruals, taxes, share-based compensation and
others. Management believes that the estimates used in preparing its financial
statements are reasonable and prudent. Actual results could differ from
those estimates.





Foreign Currency
Transactions





The
reporting currency of the Company is the US dollar. The functional currency is
the Chinese Renminbi (”RMB”). The Company’s PRC subsidiaries and
VIEs conduct business in RMB, and maintain their accounting records in RMB.
Innomind Group Limited, the Company’s 100% owned BVI subsidiary headquartered in
Hong Kong, maintains its accounting records in its local currency, Hong Kong
Dollars.





The
financial statements of the Company’s PRC subsidiaries and VIEs are translated
into US dollars using period-end exchange rates of $0.14730 and
$0.1467 at June 30, 2010 and December 31, 2009, respectively as to
assets and liabilities and weighted average exchange rates for the periods of
$0.14669 and $0.14657 for the six months ended June 30, 2010 and 2009,
respectively, as to the income and cash flow statement. The financial
statements of the Company’s Hong Kong subsidiary are translated into US dollars
using period-end exchange rates of $0.12850 and $0.12900 at June 30, 2010 and
December 31, 2009, respectively, as to assets and liabilities and weighted
average exchange rates of $0.12869 and $0.12899 for the six months ended June
30, 2010 and 2009, respectively. The equity accounts are translated at
their historical exchange rates.  Resulting translation
adjustments are recorded as a component of accumulated other comprehensive
income within shareholders’ equity. The resulting translation gains
and losses that arise from exchange rate fluctuations on transactions
denominated in a currency other than the functional currency are included in the
results of operations as incurred. Translation adjustments resulting from
this process amounted to $1,198,791, and $(137,639) for the six months ended
June 30, 2010 and 2009, respectively, and $1,065,043 and $(10,019) for the three
months ended June 30, 2010 and 2009, respectively.





GAAP
requires cash flows from the Company's operations calculated based upon the
local currencies using the weighted average translation rate. As a result,
amounts related to assets and liabilities reported on the consolidated
statements of cash flows will not necessarily agree with changes in the
corresponding balances on the consolidated balance sheets.




Transaction
gains and losses that arise from exchange rate fluctuations on transactions
denominated in a currency other than the functional currency are included in the
results of operations as incurred. Gains and losses from foreign currency
transactions are included in the results of operations for the periods
presented. Transaction losses amounted to $108,210 and $108,210 for the six and
three months ended June 30, 2010, respectively. No material transaction gains
and losses occurred for the six and three months ended June 30,
2009.





Concentration and
Risks





Cash in
Bank





The
Company considers all highly liquid investments with original maturities of
three months or less at the time of purchase to be cash equivalents, for cash
flow statement purposes.  Cash includes cash on hand and demand
deposits in accounts maintained with state owned banks within the PRC, Hong
Kong and the United States.





The
Company maintains balances at financial institutions which, from time to time,
may exceed Hong Kong Deposit Protection Board insured limits for the banks
located in Hong Kong.  Balances at financial institutions or state
owned banks within the PRC are not covered by insurance.  As of June
30, 2010 and December 31, 2009, the Company has $90,685,727 and $134,070,387
cash balances not covered by FDIC insurance in the United States,
respectively.  The Company has not experienced any losses in such
accounts and believes it is not exposed to any significant risks on its cash in
bank accounts.





Major
Customers





During
the three months ended June 30, 2010, no customer accounted for more than 10% of
the Company’s total sales.  During the three months ended June 30,
2009, three customers accounted for 44% of the Company’s total
sales.





During
the six months ended June 30, 2010, two customers accounted for 22% of the
Company’s total sales, with each customer individually accounting for 12%
and 10%, respectively. Accounts receivable from those four customers totaled
$9,184,003 as of June 30, 2010.  During the six months ended June 30,
2009, four customers accounted for 44% of the Company’s total sales, with
each customer individually accounting for 12%, 11%, 11% and 10%, respectively.





9





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Major
Suppliers





Two major
suppliers provided approximately 90% of the Company’s purchases of raw materials
for the three months ended June 30, 2010, with each supplier individually
accounting for 48% and 42%, respectively. Two major suppliers provided
approximately 100% of the Company’s purchases of raw materials for the three
months ended June 30, 2009.





Two major
suppliers provided approximately 87% of the Company’s purchases of raw materials
for the six months ended June 30, 2010, with each supplier individually
accounting for 46% and 41%, respectively. Advances to these suppliers as of
June 30, 2010 amounted to $61,579,281.Two major suppliers provided approximately
98% of the Company’s purchases of raw materials for the six months ended June
30, 2009.





PRC
Risks





The
Company's operations are carried out in the PRC. Accordingly, the Company's
business, financial condition and results of operations may be influenced by the
political, economic and legal environments in the PRC, and by the general state
of the economy in the regions where the Company’s customers are located. The
Company's operations in the PRC are subject to specific considerations and
significant risks not typically associated with companies in the North America
and Western Europe. These include risks associated with, among others, the
political, economic and legal environments and foreign currency exchange. The
Company's results may be adversely affected by changes in governmental policies
with respect to laws and regulations, anti-inflationary measures, currency
conversion and remittance abroad, and rates and methods of taxation, among other
things.





The PRC
government imposes controls on the convertibility of RMB into foreign currencies
and, in certain cases, the remittance of currency out of the
PRC.  Under existing PRC foreign exchange regulations, payment of
current account items, including profit distributions, interest payments and
expenditures from the transaction, can be made in foreign currencies
without prior approval from the PRC State Administration of Foreign Exchange by
complying with certain procedural requirements.  However, approval
from appropriate governmental authorities is required where RMB is to be
converted into foreign currency and remitted out of the PRC to pay capital
expenses, such as the repayment of bank loans denominated in foreign
currencies.  The PRC government may also at its discretion restrict
access in the future to foreign currencies for current account
transactions.




Restricted
Cash





The
Company records cash deposits in banks or other institutions subject to
restrictions on the withdrawal or use of the funds as restricted
cash.





Notes
Receivable





Notes
receivable represent trade accounts receivable due from various customers where
the customers’ banks have guaranteed the payment of the notes.  This
amount is non-interest bearing and is normally paid within three to six
months.  The Company has the ability to submit requests for payment to
the customers’ bank earlier than the scheduled payment date, but will incur an
interest charge and a processing fee when it submits an early payment
request.  The Company had $469,960 and $440,100 in notes receivable as
of June 30, 2010 and December 31, 2009, respectively.





Accounts
Receivable





Accounts
receivable are presented net of an allowance for doubtful accounts. The Company
maintains reserves for potential credit losses on accounts receivable. The
Company grants credit to customers without collateral. Accounts receivable
balances are considered past due if payment has not been received within the
payment terms established on the sales contracts or granted by the Company,
typically up to one year. Management reviews the composition of accounts
receivable and analyzes historical bad debts, customer concentrations, customer
credit worthiness, current economic trends and changes in customer payment
patterns to evaluate the adequacy of these reverses. The estimated loss rate is
based on our historical loss experience and also contemplates current market
conditions. Delinquent account balances are written-off after management has
determined that the likelihood of collection is not probable, and known bad
debts are written off against allowance for doubtful accounts when identified.
The Company’s allowance for doubtful accounts amounted to $562,822 and $273,446
as of June 30, 2010 and December 31, 2009, respectively.





10





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Cost and Estimated Earnings
in Excess of Billings on Uncompleted Contracts





Costs and
estimated earnings in excess of billings on uncompleted contracts represent
revenues recognized in excess of amounts billed pursuant to the
percentage-of-completion method used to recognize contract
revenue.





Billings in Excess of Cost
and Estimated
Earnings on Uncompleted Contracts





Billings
in excess of costs and estimated earnings on uncompleted contracts represent
billings in excess of revenues recognized pursuant to the
percentage-of-completion method.





Inventories





Inventories
consist of raw materials and low cost consumption supplies used in the
manufacturing process and work in process. Inventories are valued at the lower
of cost or market, as determined on a first-in, first-out basis, using the
weighted average cost method. Management reviews its inventories
periodically to determine if any reserves are necessary for potential
obsolescence or if write downs are necessary due to the carrying value
exceeding its net realizable value.  Based upon managements’
review, there were no provisions for obsolete or slow moving inventories as
of June 30, 2010.





Plant and
Equipment





Plant and
equipment are stated at cost. Expenditures for maintenance and repairs are
charged to earnings as incurred; additions, renewals and betterments are
capitalized. When assets are retired or otherwise disposed of, the related cost
and accumulated depreciation are removed from the respective accounts, and any
gain or loss is included in operations. Depreciation of plant and equipment is
provided using the straight-line method for substantially all assets with
estimated lives as follows:





Buildings
              
              30
      YearsEquipment
      and machinery
              
              15
      YearsMotor
      vehicles
              
              10
      YearsFurniture
      and office equipment
              
              5
      Years





Construction
in progress represents direct costs of construction as well as acquisition and
design fees and interest expense incurred. Interest incurred during construction
is capitalized into construction in progress. All other interest is expensed as
incurred. Capitalization of these costs ceases and the construction in
progress is transferred to plant and equipment when substantially all the
activities necessary to prepare the assets for their intended use are completed.
No depreciation is provided until construction is completed and the asset is
ready for its intended use. Maintenance, repairs and minor renewals are
charged directly to expense as incurred. Major additions and betterments to
buildings and equipment are capitalized.





The
Company recognizes an impairment loss when estimated cash flows generated by
those assets are less than the carrying amounts of the asset. Based on
management review, the Company believes that there were no impairments as of
June 30, 2010.





Investment in Unconsolidated
Affiliate





Equity
method investments are recorded at original cost and adjusted to recognize the
Company’s proportionate share of the investee’s net income or losses and
additional contributions made and distributions received. The Company recognizes
a loss if it is determined that other than temporary decline in the value of the
investment exists. A subsidiary in which the Company has the ability to
exercise significant influence, but does not have a controlling interest is
accounted for using the equity method. Significant influence is generally
considered to exist when the Company has an ownership interest in the voting
stock between 20% and 50%, and other factors, such as representation on the
Board of Directors, voting rights and the impact of commercial arrangements, are
considered in determining whether the equity method of accounting is
appropriate.





Intangible
Assets





Intangible
assets consist of land use rights and patents. Land use rights are stated at
cost, less accumulated amortization and are amortized over the term of the
relevant rights of 50 years from the date of acquisition. Patent A and patent B
are stated at cost, less accumulated amortization and are amortized over patent
terms of 15 and 10 years, respectively.





11





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Certain
identifiable intangible assets are reviewed for impairment, at least annually
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. As of June 30, 2010, the Company expected all
of its intangible assets to be fully recoverable.





Accounting for Long-Lived
Assets





Long-lived
assets are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable. We assess
the recoverability of the assets based on the undiscounted future cash flow the
assets are expected to generate and recognize an impairment loss when estimated
undiscounted future cash flow expected to result from the use of the asset plus
net proceeds expected from disposition of the asset, if any, are less than the
carrying value of the asset. When we identify an impairment, we reduce the
carrying amount of the asset to its estimated fair value based on a discounted
cash flow approach or, when available and appropriate, to comparable market
values.  As of June 30, 2010, management believes there were no
impairments on the Company’s long-lived assets.





Fair Value of Financial
Instruments





On
January 1, 2008, the Company began recording financial assets and liabilities
subject to recurring fair value measurement at the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction
between market participants. On January 1, 2009 the Company began recording
non-recurring financial as well as all non-financial assets and liabilities
subject to fair value measurement under the same principles. These fair value
principles prioritize valuation inputs across three broad levels. The three
levels are defined as follows:





·
            Level
      1 inputs to the valuation methodology are quoted prices (unadjusted) for
      identical assets or liabilities in active
  markets.





·
            Level
      2 inputs to the valuation methodology include quoted prices for similar
      assets and liabilities in active markets, and inputs that are observable
      for the assets or liability, either directly or indirectly, for
      substantially the full term of the financial
  instruments.





·
            Level
      3 inputs to the valuation methodology are unobservable and significant to
      the fair value.




Effective
January 1, 2009, warrants to purchase 382,500 shares of the Company’s
common stock previously treated as equity pursuant to the derivative treatment
exemption are no longer afforded equity treatment because the strike price of
the warrants is denominated in the U.S. dollar, a currency other than the
Company’s functional currency, the Chinese Renminbi.  As a
result, the warrants are not considered indexed to the Company’s own stock, and
as such, all future changes in the fair value of these warrants will be
recognized currently in earnings until such time as the warrants are exercised
or expired.




As such,
effective January 1, 2009, the Company reclassified the fair value of these
warrants from equity to a liability, as if these warrants were treated as a
derivative liability since their issuance in October, 2007 (“2007 Warrants”). On
January 1, 2009, the Company reclassified $1,058,702 from additional
paid-in capital, as a cumulative effect adjustment, $420,070 from beginning
retained earnings and $1,478,772 to warrant liabilities to recognize the fair
value of such warrants. The fair value of the warrants was $3,288,906 on June
30, 2009.  Therefore, the Company recognized a $1,833,746 loss and
$1,801,134 loss from the change in fair value of these warrants for the three
and six months ended June 30, 2009.  In July, August and
October of 2009, warrants to purchase 382,500 shares of the Company’s common
stock were exercised through cashless conversion.





On
December 7, 2009, the Company sold 3,252,032 shares of its common stock; Series
A Common Stock Warrants, which are exercisable within six months of the closing
date; to purchase up to an aggregate of 1,138,211 shares of Common Stock at an
exercise price of $34.50 per Warrant (the “2009 Series A Warrants”); and Series
B Common Stock Warrants, which are exercisable beginning on the six month one
day anniversary of the closing date until the one year one day anniversary of
the closing date, to purchase up to an aggregate of 1,138,211 shares of Common
Stock at an exercise price of $34.50 per Warrant (the “2009 Series B
Warrants”).  These warrants were treated as a derivative
liability because the strike price of the warrants is denominated in the
U.S. dollar, a currency other than the Company’s functional currency, the
Chinese Renminbi.  As a result, the warrants are not considered
indexed to the Company’s own stock, and as such, all future changes in the fair
value of these warrants will be recognized currently in earnings until such time
as the warrants are exercised or expired. All of the 2009 Series A Warrants
expired on June 7, 2010.  The outstanding warrants at the grant date,
as of December 31, 2009 and June 30, 2010 totaled 2,276,422, and 1,138,211,
respectively.  The fair value of the warrants on grant date, December
31, 2009 and June 30, 2010 amounted to $15,172,712 and $97,798,
respectively. The company recognized  $4,889,118 and $15,074,914 gains
from the change in fair value of warrants for the three and six months ended
June 30, 2010 , respectively.





12





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Warrants
referred to in the preceding paragraphs do not trade in an active securities
market, and as such, the Company estimates the fair value of these warrants
using the Black-Scholes option pricing model using the following
assumptions:





2009SeriesAWarrants
                              
                              June30,
                                2010
                              
                              
                              Issuance
                                Date(Unaudited)Annual
      dividend yield
                              
                              
                              -
                              
                              
                              
                              -Expected
      life (years)
                              
                              
                              -
                              
                              
                              
                              0.50Risk-free
      interest rate
                              
                              
                              -
                              %
                              
                              
                              0.16
                              %Expected
      volatility
                              
                              
                              -
                              %
                              
                              
                              68.56
                              %




2009SeriesBWarrants
                              
                              June30,
                                2010
                              
                              
                              IssuanceDate(Unaudited)Annual
      dividend yield
                              
                              
                              -
                              
                              
                              
                              -Expected
      life (years)
                              
                              
                              0.44
                              
                              
                              
                              1.00Risk-free
      interest rate
                              
                              
                              0.30
                              %
                              
                              
                              0.55
                              %Expected
      volatility
                              
                              
                              76.11
                              %
                              
                              
                              131.16
                              %





Expected
volatility is based on the Company’s historical stock pricing data (adjusting
for stock splits and dividends), which is a Level 3 inputs as historical
volatility typically does not represent current market participant expectations
about future volatility.  The Company-specific volatility is computed
annually by taking the base-10 logarithm of each daily stock closing
price divided by the previous stock closing price (adjusted for stock
splits and dividends).  The logarithm smoothes the daily results so
that percentage differences are computed and tailed.  Each annual
volatility calculation is weighted along with the other (non-excluded) annual
volatility result to produce the average historical volatility for the selected
period.    The Company believes this method produces an
estimate that is representative of the Company’s expectations of future
volatility over the expected term of these warrants. The expected life is based
on the remaining term of the warrants. The risk-free interest rate is based
on U.S. Treasury securities according to the remaining term of the
warrants.





The
following table sets forth by level within the fair value hierarchy of the
Company’s financial assets and liabilities that was accounted for at fair value
on a recurring basis as of June 30, 2010.




Carrying Value at
                              June 30,
                            
                            
                            FairValueMeasurementat
                              June30,20102010
                            
                            
                            Level 1
                            
                            
                            Level2
                            
                            
                            Level3(Unaudited)Warrant
      liability
                            
                            $
                            97,798
                            
                            
                            
                            -
                            
                            
                            
                            
                            
                            
                            $
                            97,798





The
Company did not identify any other non-recurring assets and liabilities that are
required to be presented on the balance sheet at fair value.




Revenue
Recognition





Contracts. The Company enters
into long-term fixed-price contracts with customers to manufacture and install
industrial equipment. Revenue on long-term fixed-price contracts is recognized
under the percentage-of-completion method.  Under the
percentage-of-completion method, management estimates the
percentage-of-completion based upon costs incurred to date as a percentage of
the total estimated costs to the customer. When total cost estimates exceed
revenues, the Company accrues for the estimated losses immediately. The use of
the percentage-of-completion method requires significant judgment in estimating
total contract revenues and costs, including assumptions relative concerning the
length of time to complete the project, the nature and complexity of the work to
be performed, and anticipated changes in estimated costs. Estimates of
total contract revenues and costs are continuously monitored during the term of
the contract, and recorded revenues and costs are subject to revision as the
contract progresses. When revisions in estimated contract revenues and costs are
determined, such adjustments are recorded in the period in which they are first
identified.





13





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Services.In
addition to the Company’s specialty equipment sales, the Company uses heavy
machining equipment to perform machining services for third parties. These
engagements, numbering several hundred per year, are essentially piecework and
are completed in usually less than one month. Each machining engagement is
governed by a separate contract, indicating existence of an
arrangement.  Revenue is recognized when service is performed, which
is usually concurrent with delivery to the customer, the contract price is set
by contract, and collectability is reasonably assured.





The
Company also provides technical professional services to its customers based on
a fixed-price time contract. The Company recognizes services-based revenue from
all of its contracts when the services have been performed, the customers have
approved the completion of the services and invoices have been issued and
collectability is reasonably assured.





BOT Contracts. Starting from
2010, the Company enters into long-term “build-operate-transfer” contracts (the
“BOT” contracts) with customers to manufacture and install, operate and maintain
the industrial equipments. The revenue and costs relating to construction or
upgrade services are recognized under the cost recovery method as the collection
of the receivable cannot be reasonably predicted. Under the cost recovery
method, no gross profit is recognized until the Company collected the cost of
the revenue, or until such time that the company considers the collections to be
probable and estimable and begins to recognize income based on the accrual
method. A BOT service contract has an indeterminable number of acts to be
performed over a specific period of time.  As such, revenue from a BOT
service contract is recognized on a straight-line basis unless it is possible to
estimate the stage of completion by some other method more reliably.  When
in a series of acts to be performed in rendering a service, a specific act is
much more significant than other acts, and then the recognition of income is
postponed until the significant acts are performed.





Enterprise Wide
Disclosure





The
Company’s chief operating decision-makers (i.e. chief executive officer and his
direct reports) review financial information presented on a consolidated basis,
accompanied by disaggregated information about revenues by business lines for
purposes of allocating resources and evaluating financial performance. The
Company is engaged in designing, developing, manufacturing, and installing
environmental protection and energy saving equipment for the Chinese iron and
steel industry and no other business segment. There are no segment managers
who are held accountable for operations, operating results and plans for levels
or components below the consolidated unit level. Based on qualitative and
quantitative criteria established by “Disclosures about Segments of an
Enterprise and Related Information,” the Company considers itself to be
operating within one reportable segment.





Government
Grant





The
Dalian municipal government approved grants to the Company to encourage
high-technology industry research and development. The grants are netted with
research and development expenses upon receipt from the local government. The
Company received  government grants in the amount of $184,829 and $43,971
during the three months ended June 30, 2010 and 2009, respectively. The
Company received government grants in the amount of $184,829 and $43,971
during the six months ended June 30, 2010 and 2009, respectively.





Research and Development
Costs





Research
and development (“R&D”) expenses include salaries, material, contract and
other outside service fees, facilities and overhead costs. Under the guidance of
GAAP, the Company expenses the costs associated with the R&D activities when
incurred.  R&D expenses of $146,690 and $73,786 incurred during
the six months ended June 30, 2010 and 2009, respectively. All of the
R&D expenses were incurred in the second quarter of 2010 and
2009.





Shipping and
Handling





Shipping
and handling for raw materials purchased are included in cost of goods sold.
Shipping and handling costs incurred for shipping of finished products to
customers are included in selling expenses. Shipping and handling expenses
included in selling expense for the three months ended June 30, 2010 and 2009,
amounted to $65,072 and $15,730, respectively. Shipping and handling expenses
included in selling expense for the six months ended June 30, 2010 and 2009,
amounted to $70,787 and $148,013, respectively.





14





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Stock-based
Compensation





We are
required to estimate the fair value of share-based awards on the date of grant.
The value of the award is principally recognized as expenses ratably over the
requisite service periods. The fair value of our restricted stock units is based
on the closing market price of our common stock on the date of grant. We have
estimated the fair value of stock options and stock purchase rights as of the
date of grant or assumption using the Black-Scholes option pricing model, which
was developed for use in estimating the value of traded options that have no
vesting restrictions and that are freely transferable. The Black-Scholes model
considers, among other factors, the expected life of the award and the expected
volatility of our stock price. We evaluate the assumptions used to value
stock options and stock purchase rights on a quarterly basis. The fair values
generated by the Black-Scholes model may not be indicative of the actual fair
values of our equity awards, as it does not consider other factors
important to those awards to employees, such as continued employment, periodic
vesting requirements and limited transferability.




The
Company is required to measure the cost of the equity instruments issued in
exchange for the receipt of goods or services from other than employees at the
estimated fair market value of the consideration received or the estimated fair
value of the equity instruments issued, whichever is more reliably determinable.
The value of equity instruments issued for consideration other than
employee services is determined on the earlier of a performance commitment or
completion of performance by the provider of goods or services.





Stock
compensation expense is recognized based on awards expected to
vest.  GAAP requires forfeitures to be estimated at the time of grant
and revised in subsequent periods, if necessary, if actual forfeitures differ
from those estimates.  There were no estimated forfeitures as the
Company has a short history of issuing options.





Income
Taxes





The
Company reports income taxes pursuant to FASB’s accounting standard for income
taxes. Under the asset and liability method of accounting for income taxes as
required by this accounting standard, deferred taxes are determined based on the
temporary differences between the financial statement and tax basis of assets
and liabilities using tax rates expected to be in effect during the years in
which the basis differences reverse. A valuation allowance is recorded when it
is more likely than not that some of the deferred tax assets will not be
realized.  FASB’s accounting standard for accounting for uncertainty
in income taxes requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
included in the financial statements or tax returns. As of January 1, 2007,
income tax positions must meet a more-likely-than-not recognition threshold to
be recognized. A tax position is recognized as a benefit only if it is
“more likely than not” that the tax position would be sustained in a tax
examination, with a tax examination being presumed to occur. The amount
recognized is the largest amount of tax benefit that is greater than 50%
likely of being realized on examination. For tax positions not meeting the “more
likely than not” test, no tax benefit is recorded.





Under
this method, deferred income taxes are recognized for the tax consequences in
future years of differences between the tax bases of assets and liabilities and
their financial reporting amounts at each period end based on enacted tax laws
and statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be
realized.  No material deferred tax amounts were recorded at June 30,
2010 and December 31, 2009. Penalties and interest incurred related to
underpayment of income tax are classified as income tax expense in the year
incurred.  No significant penalties or interest relating to income taxes
have been incurred during the six and three months ended June 30, 2010 and
2009.  GAAP also provides guidance on de-recognition, classification,
interest and penalties, accounting in interim periods, disclosures and
transition.





The
charge for taxation is based on the results for the reporting period as adjusted
for items, which are non-assessable or disallowed.  It is calculated
using tax rates that have been enacted or substantively enacted by the balance
sheet date.





The
Company and its VIE Rino Technology were incorporated in the United States
and has incurred net operating losses for income tax purposes for the six and
three months ended June 30, 2010 and 2009. The Company had estimated loss carry
forwards of approximately $2.35 million and $1.51 million as of June 30, 2010
and December 31, 2009, respectively, for U.S. income tax purposes, available for
offset against future taxable U.S. income expiring in 2028. Management believes
that the realization of the benefits from the loss carry forward appears
uncertain due to the Company’s historical operating income and continuing
losses. Accordingly, a 100% valuation allowance has been provided and no
deferred tax asset benefit has been recorded. The valuation allowance at June
30, 2010 and December 31, 2009 was approximately $801,559 and $505,000,
respectively. The net change in the valuation allowance was an increase of
approximately $269,559.





The
Company has cumulative undistributed earnings of foreign subsidiaries and VIE’s
of approximately $129,486,543 as of June 30, 2010 which is included in
consolidated retained earnings and will continue to be indefinitely reinvested
in international operations.  Accordingly, no provision has been made for
U.S. deferred taxes related to future repatriation of these earnings, nor is it
practicable to estimate the amount of income taxes that would have to be
provided if we concluded that such earnings will be remitted in the
future.





15





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





US Income
Taxes





The
Company and its VIE Rino Technology are incorporated in the State of Nevada
in the U.S., and are subject to a gradual U.S. federal corporate income tax of
15% to 35%. The State of Nevada does not impose any corporate state income
tax.





Hong Kong Income
Taxes





The
Company’s subsidiary, Innomind is incorporated in BVI and its office is located
in Hong Kong. Innomind did not earn any income that was derived in Hong Kong for
the six and three months ended June 30, 20010 and 2009 and therefore was not
subject to Hong Kong Profit Tax.





China Income
Taxes





The
Company conducts all its operating business through its operating subsidiaries
and VIEs, Dalian Innomind, Dalian Rino, Dalian Rino Design, Dalian Rino
Installation, Dalian Rino Heavy and Dalian Investment in China. The operating
subsidiaries and VIEs are governed by the income tax laws of the PRC and do not
have any deferred tax assets or deferred tax liabilities under the income tax
laws of the PRC because there are no temporary differences between financial
statement carrying amounts and the tax bases of existing assets and
liabilities.





The
Company’s subsidiaries and VIEs are governed by the Income Tax Law of the PRC
concerning Foreign Investment Enterprises and Foreign Enterprises and various
local income tax laws.





Starting
January 1, 2008, under new EIT law, Dalian Rino was subject to the new standard
EIT rate of 25%.  On December 10, 2008, Dalian Rino was approved for a
reduced tax rate at 15% for being qualified as an entity operating with high
technology.





Dalian
Innomind is in the environmental protection industry, and is qualified for a tax
exemption for two years and a 50% reduction for the following three years. As a
result, Dalian Innomind enjoys a 100% tax exemption for the years 2008 through
2009 and a 50% income tax reduction for the years 2010 through
2012.





Pursuant
to an Entrusted Management Agreement by and between Dalian Innomind and Dalian
Rino, dated October 3, 2007, Dalian Rino and its shareholders agreed to entrust
the operations and management of the Business to Dalian Innomind and Dalian
Innomind is entitled to Dalian Rino’s net profit as an entrusted management fee,
which resulted in no income tax provision for Dalian Rino.





Dalian
Investment, Dalian Rino Heavy, Dalian Rino Installation and Dalian Rino Design
are subject to an income tax rate of 25%.





The
Company’s subsidiaries and VIEs were paying the following tax rate for the six
and three months ended June 30:





2010
                  
                  
                  2009SubsidiariesandVIEs
                  
                  Income
                    Tax
                    Exemption
                  
                  
                  Effective
                    Income
                    Tax Rate
                  
                  
                  Income
                    Tax
                    Exemption
                  
                  
                  Effective
                    Income
                    Tax RateDalian
      Innomind
                  
                  
                  12.5
                  %
                  
                  
                  12.5
                  %
                  
                  
                  25
                  %
                  
                  
                  0
                  %Dalian
      Investment
                  
                  
                  0
                  %
                  
                  
                  25
                  %
                  
                  
                  n/a
                  
                  
                  
                  n/aDalian
      Rino Heavy
                  
                  
                  0
                  %
                  
                  
                  25
                  %
                  
                  
                  n/a
                  
                  
                  
                  n/aDalian
      Rino
                  
                  
                  10
                  %
                  
                  
                  15
                  %
                  
                  
                  10
                  %
                  
                  
                  15
                  %Dalian
      Rino Installation
                  
                  
                  0
                  %
                  
                  
                  25
                  %
                  
                  
                  0
                  %
                  
                  
                  25
                  %Dalian
      Rino Design
                  
                  
                  0
                  %
                  
                  
                  25
                  %
                  
                  
                  0
                  %
                  
                  
                  25
                  %





The
provision for income taxes differs from the amount computed by applying the
statutory United States federal income tax rate to income before income taxes.
The following table reconciles the statutory rates to the Company’s effective
tax rate for the three months ended June 30, 2010 and 2009:





16





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





2010
                
                
                2009U.S.
      Statutory rate
                
                
                34.0
                %
                
                
                34.0
                %Foreign
      income not recognized in U.S.
                
                
                (34.0
                )
                
                
                (34.0
                )China
      income taxes
                
                
                25.0
                
                
                
                25.0China
      income tax exemption
                
                
                (12.1
                )
                
                
                (25.0
                )Other
      items (a)
                
                
                (2.0
                )
                
                
                -Effective
      income tax rate
                
                
                10.9
                %
                
                
                0.0
                %





(a)  The
(2.0)% represents the $4,111,557 of income and expenses incurred by the Company
that are not subject to income tax for the three months ended June 30,
2010.





The
following table reconciles the statutory rates to the Company’s effective tax
rate for the six months ended June 30, 2010 and 2009:





2010
                
                
                2009U.S.
      Statutory rate
                
                
                34.0
                %
                
                
                34.0
                %Foreign
      income not recognized in U.S.
                
                
                (34.0
                )
                
                
                (34.0
                )China
      income taxes
                
                
                25.0
                
                
                
                25.0China
      income tax exemption
                
                
                (11.6
                )
                
                
                (25.0
                )Other
      items (a)
                
                
                (4.2
                )
                
                
                -Effective
      income tax rate
                
                
                9.2
                %
                
                
                0.0
                %





(a)  The
(4.2)% represents the $14,034,964 of income and expenses incurred by the Company
that are not subject to income tax for the six months ended June 30,
2010.





The
estimated tax savings for the three months ended June 30, 2010 amounted to
$2,355,172. The net effect on earnings per share had the income tax been applied
would decrease basic and diluted earnings per share from $0.71 to
$0.63 in 2010.





The
estimated tax savings for the six months ended June 30, 2010 amounted to
$3,440,666. The net effect on earnings per share had the income tax been applied
would decrease basic and diluted earnings per share from $1.37 to
$1.25 in 2010.





No
provision for income tax was made for six and three months ended June 30,
2009.





Value Added
Tax





Enterprises
or individuals who sell commodities, engage in repair and maintenance or import
and export goods in the PRC are subject to a value added tax, or VAT, in
accordance with Chinese laws. The VAT standard rate is 17% of the gross sales
price. A credit is available whereby VAT paid on the purchases of semi-finished
products or raw materials used in the production of the Company’s finished
products can be used to offset the VAT due on sales of the finished
product.





VAT on
sales and VAT on purchased accounted to $14,284,498 and $9,433,065 for three
months ended June 30, 2010, respectively. VAT on sales and VAT on purchased
accounted to $12,376,832 and $9,948,262 for three months ended June 30, 2010,
respectively.


VAT on
sales and VAT on purchases amounted to $25,873,640 and $17,070,255 for the six
months ended June 30, 2010, respectively. VAT on sales and VAT on purchases
amounted to $23,938,124 and $18,807,298 for the six months ended June 30, 2009,
respectively.  Sales and purchases are recorded net of VAT collected
and paid as the Company acts as an agent because the VAT taxes are not impacted
by the income tax holiday. As of June 30, 2010 and December 31, 2009, the VAT
payable amounted to $191,823 and $3,260,613, respectively.





Comprehensive
income





GAAP
establishes standards for reporting and display of comprehensive income and its
components in financial statements. It requires that all items that are required
to be recognized under accounting standards as components of comprehensive
income be reported in financial statements that are displayed with the same
prominence as other financial statements.





17





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Earnings Per
Share





GAAP
requires presentation of basic and diluted earnings per share in conjunction
with the disclosure of the methodology used in computing such earnings per
share. Basic earnings per share excludes dilution and is computed by dividing
income available to common stockholders by the weighted average common shares
outstanding during the period. Diluted earnings per share takes into account the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised and converted into common stock using the treasury
method.





Common
stock equivalents represent the dilutive effect of the assumed exercise of the
outstanding stock options and warrants, using the treasury stock method, at
either the beginning of the respective period presented or the date of issuance,
whichever is later, and only if the common stock equivalents are considered
dilutive based upon the Company's net income (loss) position at the calculation
date.





Recently Adopted Accounting
Standards





In
January 2010, FASB issued ASU No. 2010-01– Accounting for Distributions to
Shareholders with Components of Stock and Cash. The amendments in this Update
clarify that the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a potential limitation on the total
amount of cash that all shareholders can elect to receive in the aggregate is
considered a share issuance that is reflected in EPS prospectively and is not a
stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings
Per Share). The amendments in this update are effective for interim and annual
periods ending on or after December 15, 2009, and should be applied on a
retrospective basis. The adoption of this ASU did not have impact on the
Company’s consolidated financial statements.





In
January 2010, FASB issued ASU No. 2010-02 – Accounting and Reporting for
Decreases in Ownership of a Subsidiary – a Scope Clarification. The amendments
in this Update affect accounting and reporting by an entity that experiences a
decrease in ownership in a subsidiary that is a business or nonprofit activity.
The amendments also affect accounting and reporting by an entity that exchanges
a group of assets that constitutes a business or nonprofit activity for an
equity interest in another entity. The amendments in this update are effective
beginning in the period that an entity adopts SFAS No. 160, “Non-controlling
Interests in Consolidated Financial Statements – An Amendment of ARB No. 51.” If
an entity has previously adopted SFAS No. 160 as of the date the amendments in
this update are included in the Accounting Standards Codification, the
amendments in this update are effective beginning in the first interim or annual
reporting period ending on or after December 15, 2009. The amendments in this
update should be applied retrospectively to the first period that an entity
adopted SFAS No. 160. The adoption of this ASU did not have a material impact on
the Company’s consolidated financial statements.





In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows: 1) Transfers in and out of Levels 1 and 2. A
reporting entity should disclose separately the amounts of significant transfers
in and out of Level 1 and Level 2 fair value measurements and describe the
reasons for the transfers. 2) Activity in Level 3 fair value measurements. In
the reconciliation for fair value measurements using significant unobservable
inputs (Level 3), a reporting entity should present separately information about
purchases, sales, issuances, and settlements (that is, on a gross basis rather
than as one net number). This update provides amendments to Subtopic 820-10 that
clarifies existing disclosures as follows: 1) Level of disaggregation. A
reporting entity should provide fair value measurement disclosures for each
class of assets and liabilities. A class is often a subset of assets or
liabilities within a line item in the statement of financial position. A
reporting entity needs to use judgment in determining the appropriate classes of
assets and liabilities. 2) Disclosures about inputs and valuation techniques. A
reporting entity should provide disclosures about the valuation techniques and
inputs used to measure fair value for both recurring and nonrecurring fair value
measurements. Those disclosures are required for fair value measurements
that fall in either Level 2 or Level 3. The new disclosures and clarifications
of existing disclosures are effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about purchases,
sales, issuances, and settlements in the roll forward of activity in Level 3
fair value measurements. These disclosures are effective for fiscal years
beginning after December 15, 2010, and for interim periods within those fiscal
years. The Company is currently evaluating the impact of this ASU, however, the
Company does not expect the adoption of this ASU to have a material impact on
its consolidated financial statements.





In
February 2010, FASB issued ASU No. 2010-9 –Amendments to Certain Recognition and
Disclosure Requirements. This update addresses certain implementation issues
related to an entity’s requirement to perform and disclose subsequent-events
procedures, removes the requirement that public companies disclose the date of
their financial statements in both issued and revised financial statements.
According to the FASB, the revised statements include those that have been
changed to correct an error or conform to a retrospective application of U.S.
GAAP. The amendment is effective for interim and annual reporting periods in
fiscal year ending after June 15, 2010. The adoption of this ASU did not have a
material impact on the Company’s consolidated financial statements.





18





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





In March
2010, FASB issued ASU No. 2010-10 –Amendments for Certain Investment Funds. This
update defers the effective date of the amendments to the consolidation
requirements made by FASB Statement 167 to a reporting entity’s interest in
certain types of entities. The deferral will mainly impact the evaluation of
reporting enterprises’ interests in mutual funds, private equity funds, hedge
funds, real estate investment entities that measure their investment at fair
value, real estate investment trusts, and venture capital funds. The ASU also
clarifies guidance in Statement 167 that addresses whether fee arrangements
represent a variable interest for all service providers and decision makers. The
ASU is effective for interim and annual reporting periods in fiscal year
beginning after November 15, 2009. The adoption of this ASU did not have a
material impact on the Company’s consolidated financial statements.





In March
2010, FASB issued ASU No. 2010-11 –Scope Exception Related to Embedded Credit
Derivatives. Embedded credit-derivative features related only to the transfer of
credit risk in the form of subordination of one financial instrument to another
are not subject to potential bifurcation and separate accounting as clarified by
recently issued FASB guidance. Other embedded credit-derivative features are
required to be analyzed to determine whether they must be accounted for
separately. This update provides guidance on whether embedded credit-derivative
features in financial instruments issued by structures such as collateralized
debt obligations (CDOs) and synthetic CDOs are subject to bifurcation and
separate accounting. The guidance is effective at the beginning of a company’s
first fiscal quarter beginning after June 15, 2010. The Company does not expect
the adoption of this ASU to have a material impact on the Company’s consolidated
financial statements.





In April
2010, the FASB issued Accounting Standards Update 2010-13, “Compensation—Stock
Compensation (Topic 718): Effect of Denominating the Exercise Price of a
Share-Based Payment Award in the Currency of the Market in Which the Underlying
Equity Security Trades,” or ASU 2010-13. This Update provides amendments to
Topic 718 to clarify that an employee share-based payment award with an exercise
price denominated in currency of a market in which a substantial porting of the
entity’s equity securities trades should not be considered to contain a
condition that is not a market, performance, or service condition. Therefore, an
entity would not classify such an award as a liability if it otherwise qualifies
as equity. The amendments in this Update are effective for fiscal years, and
interim periods within those fiscal years, beginning on or after December 15,
2010. The Company does not expect the adoption of ASU 2010-17 to have a
significant impact on its consolidated financial statements.





In April
2010, the FASB issued Accounting Standard Update 20-10-17, “Revenue
Recognition—Milestone Method (Topic 605): Milestone Method of Revenue
Recognition” or ASU 2010-17. This Update provides guidance on the recognition of
revenue under the milestone method, which allows a vendor to adopt an accounting
policy to recognize all of the arrangement consideration that is contingent on
the achievement of a substantive milestone (milestone consideration) in the
period the milestone is achieved. The pronouncement is effective on a
prospective basis for milestones achieved in fiscal years and interim periods
within those years, beginning on or after June 15, 2010. The adoption of
ASU 2010-17 does not have a significant impact on its consolidated financial
statements.





In July
2010, the FASB issued Accounting Standards Update 2010-20, Disclosure about the
Credit Quality of Financing Receivables and the Allowance for Credit losses.
This ASU will increase disclosure made about the credit quality of loans and the
allowances for credit losses. The disclosures will provide additional
information about the nature of credit risk inherent in First Financial loans,
how credit risk is analyzed and assessed, and the reasons for the change in the
allowance for loan losses. The requirements will be effective for first fiscal
year ended December 31, 2010. The Company is evaluating the potential impact to
its consolidated financial statements from the adoption of this
ASU.





Reclassifications





Certain
prior period amounts have been reclassified to conform to the current period
presentation. These reclassifications have no effect on net income or cash
flows.





Note
3 – ACCOUNTS RECEIVABLE





Accounts
receivable consisted of the following:





June 30,
                    
                    
                    December 31,2010
                    
                    
                    2009(Unaudited)Accounts
      receivable
                    
                    $
                    68,952,101
                    
                    
                    $
                    58,084,617Less:
      allowance for bad debts
                    
                    
                    (562,822
                    )
                    
                    
                    (273,446
                    )Accounts
      receivable, net
                    
                    $
                    68,389,279
                    
                    
                    $
                    57,811,171





19





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





The
following table consists of allowance for doubtful accounts:





Allowance
      for doubtful accounts at January 1, 2009
                    
                    $
                    -Additional
      reserves
                    
                    
                    205,687Accounts
      receivable write off
                    
                    
                    -Effect
      of foreign currency translation
                    
                    
                    (99
                    )Allowance
      for doubtful accounts at June 30, 2009 (Unaudited)
                    
                    
                    205,588Additional
      reserves
                    
                    
                    67,591Accounts
      receivable write off
                    
                    
                    -Effect
      of foreign currency translation
                    
                    
                    267Allowance
      for doubtful accounts at December 31, 2009
                    
                    
                    273,446Additional
      reserves
                    
                    
                    287,064Accounts
      receivable write off
                    
                    
                    -Effect
      of foreign currency translation
                    
                    
                    2,312Allowance
      for doubtful accounts at June 30, 2010 (Unaudited)
                    
                    $
                    562,822





NOTE
4 – COST AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED
CONTRACTS





Costs and
estimated earnings in excess of billings on uncompleted contracts represent
revenues recognized in excess of amounts billed pursuant to the
percentage-of-completion method used to recognize contract revenue including the
construction of the BOT projects.  As of June 30, 2010 and December
31, 2009, the Company had $38,902,971 and $3,258,806 of cost and estimated
earnings in excess of billings, respectively. The cost and estimated earnings
incurred for the BOT contracts are amounted to $13,214,022 for 6 month period
ended June 30, 2010.




Costs and
estimated earnings in excess of billings consist of the following:




June30,
                      2010
                    
                    December31,
                      2009(Unaudited)Cost
      incurred on uncompleted contracts
                    
                    $
                    48,023,266
                    
                    
                    $
                    3,173,870Estimated
      earnings
                    
                    
                    22,625,831
                    
                    
                    
                    2,090,778Contract
      costs incurred plus estimated earnings to date
                    
                    
                    70,649,097
                    
                    
                    
                    5,264,648Less:
      progress billings
                    
                    
                    (31,746,126
                    )
                    
                    
                    (2,005,842
                    )Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
                    
                    $
                    38,902,971
                    
                    
                    $
                    3,258,806





NOTE
5 – INVENTORIES





Inventories
consisted of the following raw material, work-in-process and
supplies:





June30,
                    2010
                  
                  
                  December31,
                    2009(Unaudited)Raw
      material
                  
                  $
                  247,401
                  
                  
                  $
                  246,798Work-in-process
                  
                  
                  4,096,186
                  
                  
                  
                  5,101,685Low
      cost consumption supplies
                  
                  
                  57,641
                  
                  
                  
                  57,383Total
                  
                  $
                  4,401,228
                  
                  
                  $
                  5,405,866





20





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





For the
three and six months ended June 30, 2010 and 2009, no provision for
obsolete inventories was recorded by the Company.





NOTE
6 – ADVANCES FOR INVENTORY PURCHASES





The
Company makes advances to certain suppliers for inventory purchases and
subcontracting fees. Most of the Company’s vendors require advances to them
as a guarantee that the Company will receive their purchase on a timely
basis. The advances on inventory purchases amounted to $64,425,996 and
$34,056,231 as of June 30, 2010 and December 31, 2009,
respectively.





NOTE 7 –
PLANT AND EQUIPMENT





The
following is a summary of plant and equipment at June 30, 2010 and December
31, 2009:





June30,
                    2010
                  
                  
                  December31,
                    2009(Unaudited)Buildings
                  
                  $
                  3,952,876
                  
                  
                  $
                  3,936,775Equipment
      and machinery
                  
                  
                  9,584,898
                  
                  
                  
                  9,508,465Motor
      vehicles
                  
                  
                  1,838,763
                  
                  
                  
                  1,647,515Furniture
      and office equipment
                  
                  
                  457,176
                  
                  
                  
                  447,229Construction
      in progress
                  
                  
                  950,664
                  
                  
                  
                  6,768Total
                  
                  
                  16,784,377
                  
                  
                  
                  15,546,752Less:
      accumulated depreciation
                  
                  
                  (3,763,541
                  )
                  
                  
                  (3,281,363
                  )Plant
      and equipment, net
                  
                  $
                  13,020,836
                  
                  
                  $
                  12,265,389




Depreciation
expense for the three months ended June 30, 2010 and 2009 was $240,069 and
$221,917, respectively. Depreciation expense for the six months ended June 30,
2010 and 2009 was $466,837 and $478,251, respectively. For the six months ended
June 30, 2010 and 2009, no interest was capitalized into construction in
progress.





NOTE
8 – INVESTMENT IN UNCONSOLIDATED AFFILIATE




On March
9, 2010, the Company invested $441,900 (RMB 3,000,000) for 30% noncontrolling
interests in DEEC, for which the Company neither has substantive control over
the ventures nor is the primary beneficiary. Therefore, the Company does not
consolidate the results of operations and financial position of these entities,
but rather accounts for its noncontrolling ownership interest as equity method
investments.




The
following tables represent summarized combined financial information of the
Company’s unconsolidated affiliates accounted for under the equity
method:





ThreeandSixMonthsEndedJune30,2010
                  
                  
                  2009(Unaudited)
                  
                  
                  (Unaudited)Net
      revenue
                  
                  $
                  -
                  
                  
                  $
                  n/aIncome
      from operations
                  
                  $
                  -
                  
                  
                  $
                  n/aNet
      income
                  
                  $
                  -
                  
                  
                  $
                  n/a





June
      30,
                  
                  
                  December
      31,2010
                  
                  
                  2009(Unaudited)
                  
                  
                  (Unaudited)Current
      assets
                  
                  $
                  1,055,013
                  
                  
                  $
                  n/aLong-term
      assets
                  
                  $
                  424,459
                  
                  
                  $
                  n/aCurrent
      liabilities
                  
                  $
                  6,471
                  
                  
                  $
                  n/aLong-term
      liabilities
                  
                  $
                  -
                  
                  
                  $
                  n/a








21





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





NOTE
9 – ADVANCES ON NON CURRENT ASSETS





Advances to
Suppliers





The
Company makes advances to certain suppliers for construction
projects.  The advances on equipment and construction were
$8,851,355 and $5,550,966 as of June 30, 2010 and December 31, 2009,
respectively.




Prepayment for Land Use
Right





As of
June 30, 2010 and December 31, 2009, the Company prepaid $460,166 and
$799,965, respectively, for purchase of land use rights, but had not
obtained the title to the land use right. Therefore, as of June 30, 2010 and
December 31, 2009, the amount has been recorded as a prepayment for land use
right in other assets.





Long term prepaid
expenses





As of
June 30, 2010 and December 31, 2009, the Company prepaid $181,010 and
$219,447 for more than one year expenses. The Company amortizes the
prepayment based on the terms, for the three months ended June 30, 2010 and
2009, amortization expense for long term prepayment amounted to $19,609 and
$3,666, respectively. For the six months ended June 30, 2010 and 2009,
amortization expense for long term prepayment amounted to $39,166 and $7,329,
respectively.





For the
period ended June 30, amortization schedule for the following period amounted
to:


2011
                    
                    
                    78,3382012
                    
                    
                    78,3382013
                    
                    
                    24,3342014
                    
                    
                    -Thereafter
                    
                    
                    -Total
                    
                    
                    181,010





NOTE
10 – INTANGIBLE ASSETS





The
following is a summary of intangible assets:





June 30,
                  
                  
                  December 31,2010
                  
                  
                  2009(Unaudited)Land
      use rights
                  
                  $
                  8,617,066
                  
                  
                  $
                  651,136Patents
      and licenses
                  
                  
                  736,500
                  
                  
                  
                  733,500Total
      intangible assets
                  
                  
                  9,353,566
                  
                  
                  
                  1,384,636Less:
      accumulated amortization
                  
                  
                  (327,452
                  )
                  
                  
                  (239,840
                  )Total
      intangible assets, net
                  
                  $
                  9,026,114
                  
                  
                  $
                  1,144,796





Amortization
expense for the three months ended June 30, 2010 and 2009, amounted to
$73,240 and $16,695, respectively.


Amortization
expense for the six months ended June 30, 2010 and 2009, amounted to
$86,273 and $33,377, respectively.





NOTE
11 – BILLINGS IN EXCESS OF COST AND ESTIMATED EARNINGS ON UNCOMPLETED
CONTRACTS





Billings
in excess of costs and estimated earnings on uncompleted contracts represent
amounts billed in excess of revenues recognized pursuant to the
percentage-of-completion method used to recognize contract
revenue.  As of June 30, 2010 and December 31, 2009, the Company had
$3,385,163 and $0 of cost and estimated earnings in excess of billings,
respectively.





22





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Billings
in excess of costs and estimated earnings consist of the following:




June30,
                    2010
                  
                  December31,
                    2009(Unaudited)Progress
      billings
                  
                  $
                  17,093,152
                  
                  
                  $
                  -Less:
      cost incurred on uncompleted contracts
                  
                  
                  (9,633,506
                  )
                  
                  
                  -Less:
      estimated earnings
                  
                  
                  (4,074,483
                  )
                  
                  
                  -Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
                  
                  $
                  3,385,163
                  
                  
                  $
                  -





NOTE
12 –DEFERRED REVENUE





Construction
portion of BOT arrangements are accounted for under cost recovery method.
Deferred revenue represent estimated earnings related to the BOT contracts, and
are deferred to until collected the cost of the revenue, or until such time that
the company considers the collections to be probable and estimable. As of June
30, 2010 the company had $1,333,127 of deferred revenue.





NOTE
13 –BANK LOANS





Short
term bank loans consisted of the following:





June 30,
                  
                  
                  December 31,2010
                  
                  
                  2009(Unaudited)Due
      to Shanghai Pudong Development Bank,  interest at 5.31%, due in
      November 2010, secured by certain equipments
                  
                  $
                  1,473,000
                  
                  
                  $
                  1,467,000Due
      to Shanghai Pudong Development Bank  interest at 5.841%, due in
      February 2011, secured by certain equipments and guaranteed by
      shareholder
                  
                  
                  2,209,500
                  
                  
                  
                  -Total
      short term bank loans
                  
                  $
                  3,682,500
                  
                  
                  $
                  1,467,000





Long term
bank loans consisted of the following:





June 30,
                  
                  
                  December 31,2010
                  
                  
                  2009(Unaudited)Due
      to Shanghai Pudong Development Bank,  interest at 6.912%, due in
      installments from March 2012 to March 2014, secured by manufacturing
      plants and office buildings
                  
                  $
                  8,101,500
                  
                  
                  $
                  -Total
      long term bank loans
                  
                  $
                  8,101,500
                  
                  
                  $
                  -





Total
interest expense on the bank loans for the three months ended June 30, 2010 and
2009, amounted to $187,362 and $253,729, respectively. Total interest
expense on the bank loans for the six months ended June 30, 2010 and 2009,
amounted to $206,830 and $369,146, respectively.





The above
loans are secured by the Company's equipment, buildings and land use rights
located within PRC, with carrying net value as follows:




June30,
                    2010
                  
                  
                  December31,
                    2009(Unaudited)Equipment
      & Machinery in Dalian, China
                  
                  $
                  8,373,413
                  
                  
                  $
                  6,965,057Buildings
      in Dalian, China
                  
                  
                  3,390,031
                  
                  
                  
                  -Land
      use rights in Dalian, China
                  
                  
                  563,297
                  
                  
                  
                  -Total
      assets pledged as collateral for bank loans
                  
                  $
                  12,326,741
                  
                  
                  $
                  6,965,057





23





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





NOTE
14 –TAXES PAYABLE




Taxes
Payable consisted of the following at:




June 30,
                      
                      
                      December 31,2010
                      
                      
                      2009(Unaudited)Income
      taxes payable
                      
                      $
                      2,862,036
                      
                      
                      $
                      716,795VAT
      payable
                      
                      
                      191,823
                      
                      
                      
                      3,260,613Other
      miscellaneous taxes
                      
                      
                      207,940
                      
                      
                      
                      26,301Total
      taxes payable
                      
                      $
                      3,261,799
                      
                      
                      $
                      4,003,709





NOTE
15 – RELATED PARTY TRANSACTIONS





Loan toshareholders





On
December 7, 2009, the Company provided a loan to the major shareholders in the
amount of $3.5 million. The loan is short term and due on May 10, 2010, which
has an annual interest rate of 5.25%. Principal and interest are due in
full on maturity date. On May 7, 2010, the Company received principal of
$3,200,000 from the shareholders for the payment of the loan, on May 10, 2010,
the Company received the remaining principle and interest amounted to
$377,527.





As of
June 30, 2010 and December 31, 2009, the Company’s major shareholder advanced
$535,895 and $494,614, respectively, to the Company for operational purposes.
These advances are unsecured, noninterest bearing and payable on
demand.





NOTE
16 – REDEEMABLE COMMON STOCK





On
October 5, 2007, the Company received $24,480,319 (or $21,253,722 net proceeds
after deducting the offering expenses) from a group of accredited investors and
issued 5,464,357 shares of restricted common stock at $4.48 per share. The
Securities Purchase Agreement contained a transferrable provision such that if
any governmental agency in the PRC takes action that adversely affects the
Restructuring Agreements or the Share Exchange Agreement entered into in
connection with the Securities Purchase Agreement and the Company doesn’t
mitigate the adverse effect to the investors’ reasonable satisfaction within 60
days of the PRC action, then the Company is required to pay liquidated damages
in an amount equal to the initial investment without interest and the
shareholder must return the shares acquired under the Securities Purchase
Agreement. Consequently, the total amount of the gross proceeds has been
excluded from permanent equity and recorded as redeemable common stock in
accordance with Rule 5-02.28 of Regulation S-X and Section 211 of the
Codification of Financial Reporting Policies. Although there is no fixed
redemption requirement in any of the next five years, the entire amount of
$24,480,319 could become redeemable in any of the next five years. These shares
are included as outstanding common stock for purposes of earnings per
share.




NOTE
17 – COMMON STOCK AND OTHER SHAREHOLDERS’ EQUITY





Statutory
Reserves





The
Company is required to make appropriations to the statutory surplus reserve
based on the after-tax net income determined in accordance with the laws and
regulations of the PRC.  Prior to January 1, 2006 the appropriation to
the statutory surplus reserve should be at least 10% of the after tax net income
determined in accordance with the laws and regulations of the PRC until the
reserve is equal to 50% of the entities’ registered
capital.  Appropriations to the statutory public welfare fund are at
5% to 10% of the after tax net income determined by the Board of
Directors.  Effective January 1, 2006, the Company is only required to
contribute to one statutory reserve fund at 10 % of net income after
tax per annum, such contributions not to exceed 50% of the respective company’s
registered capital.  As of June 30, 2010 and December 31, 2009, the
remaining reserve needed to fulfill the 50% registered capital requirement
totaled $84.9 million and $84.5 million, respectively.





24





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





The
statutory reserve funds are restricted for use to offset against prior period
losses, expansion of production and operation, or for the increase in the
registered capital of the Company. These reserves are not transferable to the
Company in the form of cash dividends, loans or advances. These reserves are
therefore not available for distribution except in liquidation.




Common Stock and
Warrants





Issuance of Common
Stock





On June
21, 2010, the Company issued 2,000 shares of common stock to the chairman of the
Audit Committee for his services provided based upon the agreement dated April
4, 2008.  The shares were valued at $13.27, yielding an aggregate fair
value of total $26,540.  This expense was recorded as stock based
compensation expense.





On
December 7, 2009, the Company closed sales of 3,252,032 shares of its common
stock; Series A Common Stock Warrants, which are exercisable within six months
of the closing date; to purchase up to an aggregate of 1,138,211 shares of
Common Stock at an exercise price of $34.50 per Warrant (the “2009 Series A
Warrants”); and Series B Common Stock Warrants, which are exercisable beginning
on the six month one day anniversary of the closing date until the one year one
day anniversary of the closing date, to purchase up to an aggregate of 1,138,211
shares of Common Stock at an exercise price of $34.50 per Warrant (the “2009
Series B Warrants”).  These warrants were treated as a derivative
liability because the strike price of the warrants is denominated in the
U.S. dollar, a currency other than the Company’s functional currency, the
Chinese Renminbi.  As a result, the warrants are not considered
indexed to the Company’s own stock, and as such, all future changes in the fair
value of these warrants will be recognized currently in earnings until such time
as the warrants are exercised or expired. The purchase price for each common
share together with Series A Warrants exercisable into 0.35 of a common share
and Series B Warrants exercisable into 0.35 of a common share is $30.75, and the
gross proceeds of the sale were $99,999,984.  The following table
represents the allocation of the fair value of warrants and also common stock on
issuance date:





Total
      Proceeds
                        
                        $
                        9
      9,999,984Direct
      expenses
                        
                        
                        (5,144,531
                        )Fair
      value of warrants
                        
                        
                        (18,743,862
                        )Allocation
      to common stock and APIC
                        
                        $
                        7
      6,111,591





On
October 5, 2007, in connection with the Private Financing and pursuant to the
Engagement Agreement Providing for Investment Banking Services, by and between
the Company and a placement agent for the Private Financing, as amended, the
placement agent received the following compensation: (i) $80,000 cash as an
engagement and documentation fee; (ii) $1,750,000 as a placement
commission; (iii) 875,000 shares of Common Stock, and (iv) warrants to purchase
382,500 shares of Common Stock at an exercise price of $5.376 per share,
exercisable within 6 years of the date of issuance. The exercise price of the
warrants is subject to adjustment under certain circumstances and the warrants
permit cashless exercise by the holders. This expense is recorded as additional
paid-in capital in the accompanying financial statements.





The
warrants issued to the placement agent, initially qualify as permanent equity,
the value of such warrants has created offsetting debit and credit entries to
additional paid-in capital.





Effective
January 1, 2009, 382,500 warrants previously treated as equity pursuant to
the derivative treatment exemption are no longer afforded equity treatment
because the strike price of the warrants is denominated in the U.S. dollar, a
currency other than the Company’s functional currency, the Chinese
Renminbi.  As a result, the warrants are not considered indexed to the
Company’s own stock, and as such, all future changes in the fair value of these
warrants will be recognized currently in earnings until such time as the
warrants are exercised or expired.





In
connection with the Private Financing, 250,000 shares of the Company’s common
stock were issued to a consultant for advisory services. This expense is
recorded as additional paid-in capital in the accompanying financial
statements.





A
discussion of the valuation techniques used to measure fair value for the
warrant liabilities listed above and activity for these liabilities for the
three months ended March 31, 2010 is provided elsewhere in this footnote and in
Note 2.





25





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Warrants





Following
is a summary of the warrant activity:





Numberof
                    SharesOutstanding
      as of January 1, 2009
                  
                  
                  382,500Granted
                  
                  
                  -Forfeited
                  
                  
                  -Exercised
                  
                  
                  -Outstanding
      as of June 30, 2009 (Unaudited)
                  
                  
                  382,500Granted
                  
                  
                  2,276,422Forfeited
                  
                  
                  -Exercised
                  
                  
                  (382,500
                  )Outstanding
      as of December 31, 2009
                  
                  
                  2,276,422Granted
                  
                  
                  -Forfeited/Expired
                  
                  
                  (1,138,211
                  )Exercised
                  
                  
                  -Outstanding
      as of June 30, 2010 (Unaudited)
                  
                  
                  1,138,211





Following
is a summary of the status of warrants outstanding at June 30, 2010
(Unaudited):





Outstanding Warrants
                                            
                                            Exercisable WarrantsExercise
                                              Price
                                            
                                            
                                            Number of
                                              Shares
                                            
                                            
                                            Average
                                              Remaining
                                              Contractual
                                              Life
                                            
                                            Average
                                              Exercise
                                              Price
                                            
                                            
                                            Number of
                                              Shares
                                            
                                            
                                            Average
                                              Remaining
                                              Contractual
                                              Life$
                                            34.50
                                            
                                            
                                            
                                            
                                            1,138,211
                                            
                                            
                                            0.44
      years
                                            
                                            
                                            $
                                            34.50
                                            
                                            
                                            
                                            
                                            1,138,211
                                            
                                            
                                            0.44
      yearsTotal
                                            
                                            
                                            
                                            
                                            1,138,211
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            1,138,211





Stock Options





On June
30, 2009, pursuant to an Employment Agreement, the Company granted to the
former Chief Financial Officer, a non-qualified stock option to purchase 50,000
shares of its Common Stock at an exercise price of $6.15 per share, vesting in 3
equal annual installments beginning on June 30, 2010, with a term life of
five years.





The fair
values of stock options granted to the executive were estimated at the date of
grant using the Black-Scholes option-pricing model with the following
assumptions:




Expected
                          
                          Expected
                          
                          
                          Dividend
                          
                          
                          Risk Free
                          
                          
                          Grant DateLife
                          
                          Volatility
                          
                          
                          Yield
                          
                          
                          Interest Rate
                          
                          
                          Fair ValueExecutives
                          
                          3.3
      yrs
                          
                          
                          121.7
                          %
                          
                          
                          0
                          %
                          
                          
                          1.64
                          %
                          
                          $
                          9.80





Volatility:
In light of the Company’s thin stock trading history, expected volatility is
based on historical stock pricing data (adjusting for stock splits and
dividends) of six publicly traded peer companies and the Company’s own
data.  The Company-specific volatility is computed annually by taking
the base-10 logarithm of each daily stock closing price divided by the previous
stock closing price (adjusted for stock splits and dividends).  The
logarithm smoothes the daily results so that percentage differences are computed
and tailed.  Each annual volatility calculation is weighted along with
the other (non-excluded) annual volatility result to produce the average
historical volatility for the selected period.    The
Company believes this method produces an estimate that is representative of the
Company’s expectations of future volatility over the expected term of these
warrants.





Dividend
Yield: The expected dividend yield is zero. The Company has not paid a cash
dividend and does not anticipate paying cash dividends in the foreseeable
future.





Risk Free
Rate: Risk-free interest rate of 1.64% was used. The risk-free interest rate was
based on U.S. Treasury yields with a remaining term that corresponded to the
expected term of the option calculated on the granted date.





26





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Expected
Life: Because the Company has no historical share option exercise experience to
estimate future exercise patterns, the expected life was determined using the
simplified method as these awards meet the definition of "plain-vanilla" options
under the rules prescribed by GAAP.





Stock
compensation expense is recognized based on awards expected to vest. There were
no estimated forfeitures as the Company has a short history of issuing options.
GAAP requires forfeitures to be estimated at the time of grant and revised in
subsequent periods, if necessary, if actual forfeitures differ from those
estimates.





On August
12, 2010, pursuant to an Separation Agreement with former CFO, the options to
purchase 10,000 shares of the Employer’s common stock (the “Shares”) at the
exercise price $6.15 per share granted to Employee shall vest immediately upon
the execution of this Agreement. And the options to purchase 20,000 shares that
were to vest on June 30, 2011 and the options to purchase 20,000 shares which
were to vest on June 30, 2012 shall be cancelled and be of no further force or
effect. Once vested, the foregoing options to purchase 10,000 shares of the
Employer’s common stock which may be exercised until August 12, 2013, the
third anniversary of the Separation Date.





The
10,000 options vested had fair value of approximately $77,417. The Company
recognized $38,992 compensation expense in general and administrative expenses
for the six months ended June 30, 2010. The Company recognized $19,496
compensation expense in general and administrative expenses for the three months
ended June 30, 2010.





The
following is a summary of the stock options activity:




Number of
                    Options
                    Outstanding
                  
                  
                  Weighted-
                    Average
                    Exercise
                    Price
                  
                  
                  Aggregate
                    Intrinsic
                    ValueBalance, January
      1, 2009
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -Granted
                  
                  
                  50,000
                  
                  
                  
                  6.15
                  
                  
                  
                  182,500Forfeited
                  
                  
                  -Exercised
                  
                  
                  -Balance, June
      30, 2009 (Unaudited)
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -Granted
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  -Exercised
                  
                  
                  -Balance,
      December 31, 2009
                  
                  
                  50,000
                  
                  
                  $
                  6.15
                  
                  
                  $
                  1,075,000Granted
                  
                  
                  -Forfeited/Cancelled
                  
                  
                  (40,000
                  )Exercised
                  
                  
                  -Balance,
      June 30, 2010 (Unaudited)
                  
                  
                  10,000
                  
                  
                  $
                  6.15
                  
                  
                  $
                  63,600





Following
is a summary of the status of options outstanding at June 30, 2010
(Unaudited):




Outstanding Options
                                            
                                            Exercisable OptionsExercise
                                              Price
                                            
                                            
                                            Number
                                            
                                            Average
                                              Remaining
                                              Contractual Life
                                            
                                            Average
                                              Exercise
                                              Price
                                            
                                            
                                            Number
                                            
                                            
                                            Average
                                              Remaining
                                              ContractualLife$
                                            6.15
                                            
                                            
                                            
                                            10,000
                                            
                                            3.12 yrs
                                            
                                            
                                            6.15
                                            
                                            
                                            
                                            10,000
                                            
                                            
                                            
                                            3.12Total
                                            
                                            
                                            
                                            10,000
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            10,000





27





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





NOTE
18 - EARNINGS PER SHARE





The
following sets forth the calculation of earnings per share for three months
ended June 30, 2010 and 2009 (Unaudited):





2010
                  
                  
                  2009Net
      income
                  
                  $
                  20,436,248
                  
                  
                  $
                  9,855,284Adjustments
      for diluted EPS calculation
                  
                  
                  -
                  
                  
                  
                  -Adjusted
      net income for calculating EPS-diluted
                  
                  $
                  20,436,248
                  
                  
                  $
                  9,855,284Weighted
      average number of common stock – Basic
                  
                  
                  28,603,517
                  
                  
                  
                  25,070,356Effect
      of dilutive securities:Warrants
                  
                  
                  5,935
                  
                  
                  
                  -Weighted
      average number of common stock – Diluted
                  
                  
                  28,609,452
                  
                  
                  
                  25,070,940Earnings
      per share:Basic
                  
                  $
                  0.71
                  
                  
                  $
                  0.39Diluted
                  
                  $
                  0.71
                  
                  
                  $
                  0.39





The
following sets forth the calculation of earnings per share for six months ended
June 30, 2010 and 2009 (Unaudited):




2010
                  
                  
                  2009Net
      income
                  
                  $
                  39,092,754
                  
                  
                  $
                  22,330,200Adjustments
      for diluted EPS calculation
                  
                  
                  -
                  
                  
                  
                  -Adjusted
      net income for calculating EPS-diluted
                  
                  $
                  39,092,754
                  
                  
                  $
                  22,330,200Weighted
      average number of common stock – Basic
                  
                  
                  28,603,431
                  
                  
                  
                  25,055,668Effect
      of dilutive securities:Warrants
      & options
                  
                  
                  6,814
                  
                  
                  
                  -Weighted
      average number of common stock – Diluted
                  
                  
                  28,610,245
                  
                  
                  
                  25,055,668Earnings
      per share:Basic
                  
                  $
                  1.37
                  
                  
                  $
                  0.89Diluted
                  
                  $
                  1.37
                  
                  
                  $
                  0.89





All stock
options and warrants have been included in the diluted earnings per share
calculation for the three and six months ended June 30, 2010 and 2009. All of
the outstanding shares of redeemable common stock are included as outstanding
common stock for purposes of earnings per share.





NOTE
19 – COMMITMENTS AND CONTINGENCIES





Employee
Benefits





The full
time employees of the Company are entitled to employee benefits including
medical care, welfare subsidies, unemployment insurance and pension benefits
through a Chinese government mandated multi-employer defined contribution plan.
The Company is required to accrue for those benefits based on certain
percentages of the employees’ salaries and make contributions to the plans out
of the amounts accrued for medical and pension benefits.  The total
provisions and contributions made for such employee benefits were $50,225 and
$30,436for the six months ended June 30, 2010 and 2009, respectively, and
$90,172 and $57,057 for the three months ended June 30, 2010 and 2009,
respectively. The Chinese government is responsible for the medical
benefits and the pension liability to be paid to these employees.





28





RINO
INTERNATIONAL CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Lease
Commitments





The
Company recognizes lease expense on a straight-line basis over the term of the
lease in accordance to FASB’s accounting standard regarding leases. The Company
entered into vehicle leases and property leases. The minimum future payment for
leases is as follows:





Year
      ending June 30, 2011
                    
                    $
                    23,310Year
      ending June 30, 2012
                    
                    
                    6,660Year
      ending June 30, 2013
                    
                    
                    6,660Year
      ending June 30, 2014
                    
                    
                    2,220Thereafter
                    
                    
                    -Total
                    
                    $
                    38,850





Purchase Commitments





As of
June 30, 2010 and December 31, 2009, the Company had firm purchase commitments
for capital projects in progress of $93 million and $101 million,
respectively.





Register Capital
Commitments





In
December 2009, RINO increased its investment to Dalian Innomind from
$20 million to $80 million, Dalian Innomind received $20 million
on December 18, 2009, and the remaining $40 million is to be paid by RINO
in two years from December 18, 2009.





In
November 2009, RINO founded Dalian Investment with registered capital of
$98 million. As of June 30, 2010, Dalian Investment received $70 million;
the remaining $ 28 million is to be paid by RINO in two years from November
2009.





NOTE 20–SUBSEQUENT EVENT





In August
2010, the Company received the letter of a loan application approval of $44.2
million (RMB 300 million) from Agricultural Bank of China. The Company will be
able to use this amount for Changxing Island Project when there is a
need.





The
Company has performed an evaluation of subsequent events through the date these
consolidated financial statements were issued to determine whether the
circumstances warranted recognition and disclosure of those events or
transactions.





29





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





Disclaimer
Regarding Forward-looking Statements





Certain
statements made in this report, and other written or oral statements made by or
on behalf of RINO International Corporation and its direct and indirect
subsidiaries and controlled affiliates (collectively, the “Company”), may
constitute “forward-looking statements” under the Private Securities Litigation
Reform Act of 1995, which represent the expectations or beliefs of the
Company. Such “forward-looking statements” include, but are not limited to,
statements concerning the operations, performance, financial condition and
growth of the Company. For this purpose, any statements contained in this report
that are not statements of historical fact may be deemed forward-looking
statements. Without limiting the generality of the foregoing, when used in this
report, the word “believes,” “expects,” “estimates,” “intends,” “will,” “may,”
“anticipate,” “could,” “should,” “can,” or “continue” or the negative or other
variations thereof or comparable terminology are intended to identify
forward-looking statements. Examples of such statements in this report include
descriptions of our plans and strategies with respect to developing certain
market opportunities, our overall business plan, our plans to develop additional
strategic partnerships, our intention to develop our products and platform
technologies, our continuing growth and our ability to contain our operating
expenses. All forward-looking statements are subject to certain risks and
uncertainties that could cause actual events to differ materially from those
projected, including those described under Item 1.A. of Part I of our Annual
Report on Form 10-K for the fiscal year ended December 31, 2009, and matters
described in this report generally. In light of these risks and uncertainties,
there can be no assurance that the forward-looking statements contained in this
filing will in fact occur. You should not place undue reliance on these
forward-looking statements.





The
following is management’s discussion and analysis of certain significant factors
that have affected aspects of our financial position and results of operations
during the periods included in the accompanying unaudited financial statements.
You should read this in conjunction with discussion under “Management’s
Discussion and Analysis of Financial Conditions and Results of Operations” and
the audited consolidated financial statements and accompanying notes for
the year ended December 31, 2009 included in our Annual Report on Form 10-K for
the fiscal year ended December 31, 2009 and the unaudited consolidated financial
statements and accompanying notes and the other financial information appearing
in Item 1 of this report and elsewhere in this report.





Except
as otherwise specifically stated or unless the context otherwise requires, the
"Company", "we," "us," "our," and the "Registrant" refer to, collectively, (i)
RINO International Corporation (formerly Jade Mountain Corporation); (ii)
Innomind Group Limited (“Innomind”), a wholly-owned subsidiary of RINO
International Corporation organized under the laws of the British Virgin
Islands; (iii) Rino Investment Co., Ltd., a wholly-owned subsidiary of RINO
International Corporation under the laws of the People’s Republic of China (the
“PRC”); (iv) Dalian Innomind Environment Engineering Co., Ltd. (“Dalian
Innomind”), a wholly-owned subsidiary of Innomind organized under the laws of
PRC; (v) Dalian RINO Heavy Industries Co., Ltd. (“RINO Heavy Industries”), a
wholly-owned subsidiary of RINO Investment, organized under the PRC laws; (vi)
Dalian RINO Environment Engineering Science and Technology Co., Ltd., a
contractually controlled affiliate of Dalian Innomind organized under the laws
of the PRC (“Dalian Rino”); (vii) Dalian Rino’s wholly owned subsidiaries,
Dalian Rino Environmental Engineering Project Design Co., Ltd., organized under
the PRC laws (“Dalian Rino Design”); (viii) Dalian Rino Environmental
Construction & Installation Project Co., Ltd., organized under the PRC laws
(“Dalian Rino Installation”) and (ix) Rino Technology Corporation, a
wholly-owned subsidiary of Dalian Rino organized under the laws of the state of
Nevada (“Rino Technology”).





30





Company
Overview





We are
engaged in designing, developing, manufacturing, installing and servicing
proprietary and patented environmental protection and energy saving equipment
for large, state-owned iron and steel industry manufacturers in the People’s
Republic of China. Our business operations are conducted throughout China and we
do not rely on any particular region for revenues.





On July
13, 2009, our common stock, par value of $0.0001 per share (“Common Stock”),
started trading under the symbol "RINO" on the Nasdaq Global
Market.





Following
the expansion of China’s economy and growth in the size of its manufacturing
sectors such as its iron and steel industry, the total volumes of waterborne and
airborne industrial waste and pollution have grown, and consequently, China’s
industries face increasingly stringent governmental mandates to reduce or
eliminate sulphur dioxide emissions and untreated wastewater discharges. Failure
to meet mandated emission and discharge standards can result in financial
penalties. On July 31, 2009, the Chinese Ministry of Industry and
Information Technology published a formal plan for the implementation of Flue
Gas Desulphurization systems in the sintering plants of Chinese steel companies,
which is a specific roadmap to accelerate the number of desulphurization
projects completed throughout the PRC. During the three months ended June 30,
2010, our revenues reached $65.4 million, representing an increase of 60.6%
from the total revenues of $40.7 million for the same period ended June 30,
2009. Our gross profit increased from $14.2 million for the three months ended
June 30, 2009 to $23.1 million for the same period in 2010, representing an
increase of 63.0%. Our income from operations increased to $18.1 million for the
three months ended June 30, 2010 from $10.0 million for the same period ended
June 30, 2009, representing an increase of 80.5%. Our net income for the three
months period ended June 30, 2010 grew to $20.4 million from $9.9 million for
the same period ended June 30, 2009, representing an increase of
107.4%.





Principal
Products





We have
three principal products and product lines: the “Lamella Inclined Tube Settler
Waste Water Treatment System,” the “Flue Gas Desulphurization System,” and the
“High Temperature Dynamic Anti-Oxidation System for Hot Rolled Steel.” In
addition, we also provide machining services for industrial
enterprises.





1) Lamella Inclined Tube
Settler Waste Water Treatment System





Our core
product for waste water treatment, the Lamella Inclined Tube Settler Waste Water
Treatment System (the “Waste Water System”), is a highly efficient wastewater
treatment system that incorporates our proprietary and patented “Lamella
Inclined Tube Settler” technology. We believe that our Waste Water System is
among the most technologically advanced wastewater treatment systems presently
in use in China’s iron and steel industry. It includes an industrial wastewater
treatment system, highly efficient solid and liquid abstraction dewatering
equipment and coal gas dust removal and cleaning equipment. The technology
has received numerous regional and national design awards, and has been
successfully installed and used at some of the largest steel mills in China,
including Jinan Iron & Steel Group Co., Ltd., Benxi Iron & Steel (Group)
Co., Ltd., Handan Iron & Steel Group Co., Ltd., Tianjin Tiangang Group Co.,
Ltd., Shijiazhuang Iron & Steel Group Co., Ltd., Panzhihua Iron & Steel
Group Co., Ltd., Anyang Iron & Steel Group Co., Ltd., Nanchang Changli Steel
Co., Ltd., Shaogang Steel Co., Ltd., Linggang Steel Co., Ltd. Weifang Steel
Group Co.,Ltd and Puyang Steel Co., Ltd.





31





Our
combination of proprietary system design and patented technology allows
wastewater to flow through the system in layers while at the same time settling
particulate matter without disturbing the water flow. Operating results of the
above Lamella Wastewater System installations show that our technology improves
the stability of the settling sedimentation, increases the available settling
area, shortens the settling distance for particles, reduces the settling time,
and results in particle removal efficiency rates of up to 99%. After treatment
with our technology and system, coal gas wastewater and wastewater containing
iron mineral powder can be reused and returned to the production process without
further treatment. This reduces the industrial water usage for the enterprises
utilizing our technology, reduces the output of solid industrial waste and
improves the efficient use of resources.





Compared
with alternative inclined plate technology, the Lamella Wastewater Treatment
System has several important advantages as shown in the following
table:





NormalInclinedPlateSettlingPool
            
            LamellaInclinedTubeSettlerWater
      power staying time 30 minutes, surface load 3m 3/m
      2·h, small hydraulic coefficient, short waterpower process (with
      short current in winter).
            
            Water
      power staying time 45 minutes with surface load 8m 3/m
      2·h, large hydraulic coefficient, long water power
      process.One-time
      precipitation, is not fit for a wide range wave of floats, affected by the
      stability and effect of the water outlet.
            
            Three-time
      precipitation (with sludge abstraction collection system in every layer),
      anti-pump load, no interference between water inlet and sludge outlet,
      water outlet stable.Water
      inlet float content: SS3,000 ~ 5,000mg/L, water outlet float content:
      SS100 ~ 200 mg/L, low treatment efficiency.
            
            Water
      inlet float content: SS3,000 ~ 16,000mg/L water outlet float content: SS50
      ~ 80 mg/L, high treatment efficiency.Inclined
      plate, inclining angle 60 degree, small settling sedimentation
      area.
            
            Inclined
      plate, inclined tube inclining angle 45 degree, under the same volume
      condition, largely enlarge the settling sedimentation
  area.Small
      sludge abstraction area, low sludge water abstraction efficiency, short
      life cycle of the sludge outlet, high and unstable water content of
      sludge, adds difficulty to the next sludge treatment
    process.
            
            With
      sludge water abstraction area and dust collection transmission device,
      long sludge outlet circle, special sludge disposal equipment sludge
      outlet, lower water content of sludge, convenient for new process to
      recycle.The
      low carbon steel structures - such as pool surface frame - exposed to
      humidity and high temperature, easily corrode, which greatly reduces the
      life of equipment.
            
            Lamella
      Inclined Tube Settler system is enclosed, the high humidity of the tank
      will not cause corrosion of the equipment.Occupies
      large area - large footprint, strict requirement for
      placement.
            
            Occupying
      small area - small footprint - equipment can save over 30% area to treat
      same amount of water and is flexible for installation.Complicated
      system technique, complicated equipment configuration, high maintenance,
      inconvenient for use with automated control, often creates secondary
      pollution.
            
            Short
      technical process, simple equipment, low failure rate - high MTBF, easy
      maintenance, highly automated, low operational cost, closed-end
      circulating treatment, without secondary
  pollution.





32





2) Flue Gas Desulphurization
Systems





In China,
sulphur dioxide emitted from the sintering process of manufacturing iron and
steel is a major component of environmental pollution as a result of China’s
industrial expansion. Sintering is part of steel-making process; removing
sulphur dioxide from a steel mill’s hot flue gas emissions is, therefore, a
principal way of controlling acid rain. During this process, the sulphur content
is separated and emitted with flue gas while being heated.





We have
two principal desulphurization technologies: Circulating-Fluidized Bed-Flue Gas
Desulphurization System (“CFB-FGD System”) and Ammonia-based Desulphurization
system (the "DXT-FGD System").





CFB-FGD
System





The
CFB-FGD System is a highly effective system that removes sulphur dioxide from
flue gas emissions generated by the sintering process in the production of iron
and steel (a process in which sulphur and other impurities are removed from iron
ore by heating, without melting, pulverized iron ore), so that the discharge
will meet all relevant air pollution standards in China. Without such treatment,
flue gas emitted from sintering with high sulphur dioxide content will react
with atmospheric water and oxygen and therefore produce sulphuric acid that
precipitates as “acid rain.” As illustrated below, the CFB-FGD System is
comprised of a desulphurization agent inlet system, a circulating fluidized bed
desulphurization reactor, a dust removal system, a desulphurization dust removal
treatment system, a desulphurization wind pump system, a monitoring system, an
electrical control system and a smoke flue system.





The
CFB-FGD System utilizes proprietary technology jointly developed by Dalian RINO
and the Chinese Academy of Sciences. We have the right to acquire certain
related technology from the Chinese Academy of Sciences for RMB 1 million
pursuant to a technology transfer agreement dated May 18, 2007.





Compared
with other semi-dry desulphurization technologies, our proprietary technology
has the following advantages:


1.
            Our equipment has a smaller
      footprint;


2.
            Shorter circulation process and
      lower calcium sulphur ratio;


3.
            Lower cost of operating the
      system; and


4.
            Higher desulphurization
      rates.





In
addition, our desulphurization process does not generate wastewater. After the
treatment, sulphur and dust content in flue gas satisfy the national standard in
China. In addition, the costs for the manufacturing and installation of the
equipment are relatively affordable to the targeted iron and steel
mills.





33





DXT-FGD
System





The DXT
System or the DXT Flue Gas Desulphurization process uses ammonia (which is
extracted from the onsite coke oven gas process and stored in tanks) as
desulphurization agent to reacts with SO2 and form
an "ammonium sulfate" solution without lowering the flue gas temperature, After
removing heavy metals and other harmful substances, the ammonium sulfate can be
used to produce agricultural fertilizers, whose quality meets the Chinese
national quality standards. In early September 2009, we commenced installation
of our new proprietary DXT System on a 280 m2sinter
system at Hunan Lianyuan Iron and Steel Company. The total contract value is
approximately $10.3 million, with the installation and testing completed during
the second quarter of 2010.





To
effectively utilize this synthetic ammonia extracted from coke oven gas, which
is later introduced to the flue gas via an injection grid, the DXT System
utilizes a component technology, the ammonia scrubbing technology, licensed from
Baosteel Group Co., Ltd. (“Baosteel”). Baosteel is China's largest steel
producer, which has been successfully applying this technology to its
manufacturing process for 10 years. The ammonia scrubbing technology was
initiated in the 1960s at the TVA fertilizer center in the U.S., and was later
commercialized by German, U.S. and Japanese companies in the 1970’s. However,
until now, technical issues have limited the wide-scale adoption of ammonia
scrubbing within the flue gas desulphurization process. Those technical issues
include, among other things, the safe and proper transportation and storage of
ammonia; the effective filtration of heavy metals from the ammonium
sulfate by-product; and the release of unreacted ammonia during the
process, so called "ammonia slip".





After
four years of research and development, we have solved those technical problems
by introducing the DXT System, which to our knowledge, is the only truly
effective ammonia scrubbing desulphurization system in China's iron and steel
industry. We believe, that in addition to our commitment to remove up to 99% of
the harmful SO2, the DXT
System also utilizes less energy, decreases operating and maintenance costs, and
creates a sustainable revenue stream through the production of high quality
ammonia sulfate fertilizers for agricultural use. The Chinese government
strongly supports technologies which are both environmentally friendly and
economical.





Economically,
The key reason is the attractive price of ammonium sulfate fertilizer.
Converting coke oven gas to fertilizer is obviously made more economical by the
available free ammonia. Presently, the purchase price of ammonia is less than
25% of that of ammonium sulfate. Sinter plants, especially those located close
to Chinese fertilizer market, could very profitably produce ammonium sulfate
fertilizer.





3) High Temperature Dynamic
Anti-Oxidation System for Hot Rolled Steel





Our High
Temperature Anti-Oxidation System for Hot Rolled Steel (the “Anti-Oxidation
System”) is a set of products and a mechanized system that substantially reduces
oxidation-related output losses in the production process of continuous casting
and hot steel rolling. In the process of continuous casting and hot steel
rolling, oxidation-related output loss ranges from 2% to 5% on average, while
our Anti-Oxidation System reduces such loss by over 60%. In addition, oxidation
process in high-temperature steel production not only causes waste of water and
energy but also generates pollutants. In the United States, Japan and Europe,
technology has been developed to solve this problem, but the cost of the coating
used in such technology and the inability of the equipment to be utilized in
high-temperature environments limit its application to the manufacturing of
specialty steel products such as stainless steel, silicon and carbide steel
products.





Our
Anti-Oxidation System is specifically designed to work effectively with hot
rolled steel products in a high-temperature environment. As illustrated below,
our system operates at significantly higher product temperatures than its
competitors, thereby increasing its general utility and its range of steel
product applications. We believe that in design and technology, our
Anti-Oxidation System is the only anti-oxidation process available for the iron
and steel industry (both in the PRC and internationally) that can be applied in
a high-temperature environment, and is a unique solution to the loss of steel
production output due to high-temperature oxidation, which has been a
long-standing problem in the world-wide iron and steel industry.





34





The
technology utilized in the Anti-Oxidation System is jointly developed by Dalian
RINO and the Chinese Academy of Sciences. In March 2006, Dalian Rino acquired
the technology from the Chinese Academy of Sciences under an agreement that
provides for the co-ownership of the intellectual property rights to the formula
for the anti-oxidizing paint used in the system and to the spray system for
applying the paint, co-ownership of any patents granted, and the transfer to
Dalian Rino of all commercialization rights.





Contract Machining
Services





In
addition to the environmental remediation and protection systems that described
above, since late 2005 we have also being using our slight capacity surplus of
mainframe equipment processing to perform contract machining services for
third-party industrial enterprises and this is reported as “Service
Revenue”.





The
specialized heavy machinery and equipment that we use to produce our Lamella
Wastewater System, Flue Gas Desulphurization Systems and Anti-Oxidation System
also provide us with a substantial capacity to undertake large, specialized and
high-precision parts machining. To this end, Dalian Rino establishes and
maintains strategic cooperation relationships with companies such as China First
Heavy Industries, with which we contracted to provide access to our heavy
machine tools, and Dongfang Electric Machinery, for which we provide hydropower
equipment parts.





We expect
that as sales of our own products increase, we will reduce or eliminate
contracting the use of our machines and equipment to third parties.





Customers





Our
customers are mainly large iron and steel companies in China. Generally, our
projects involve manufacturing, installation and testing of the equipment we
sell, and the contract prices vary with products and technical conditions. Due
to the size of our projects, we generally work on a limited number of projects
with a limited number of customers at any given period of time. Due to the size
of our projects and the length of time (on average in 6 - 8 months) to complete,
it appears that our revenues are generated from a limited number of customers at
any given period of time. However, we do not rely on a limited number of
customers for revenue generation over time, as our customers constantly change.
There are approximately 34 iron and steel companies in China of a size and with
annual production levels that make our products feasible for sale and
installation. In order to expand our sales, we plan to capture increasing
numbers of these potential customers for primary product sales and aggressively
cross-sell our products to each customer. During the years ended December 31,
2009 and 2008, no customer accounted for more than 10% of the Company’s total
sales. For the quarter ended June 30, 2010, no customer accounted for more than
10% of the Company’s total sales also. Our biggest contract with Baotou
Iron and Steel Group accounted for 9.1% of our total revenue. Sales to the
other three major customers, Zhongtian Iron and Steel Co., Ltd., Jiangsu
Yonggang Group Co., Ltd., Chengde Iron and Steel Group contributed approximately
8.7%, 7.3% and 6.1% of our revenue, respectively, in the second quarter of
2010.





35





All of
our products are customized to our customers’ specific requirements. We enter
into fixed-price equipment sales contracts with our customers that are performed
in engineering, manufacturing, construction and installation phases. Generally,
we fulfill our contractual obligations within twelve months.





Our
project-based revenue is affected directly by our customers’ capital budgets and
their needs to build new plants. Because most of our customers are
state-owned-enterprises, their budgeting decisions are influenced by the Chinese
central government’s environmental protection and pollution control policies,
which presently are favorable to our business and products. We believe that such
policy emphasis will continue in the foreseeable future. The cost of revenues
for our products includes direct materials, direct labor, outsourcing costs and
manufacturing overhead.





Competition





Lamella Wastewater
System





Prior to
Dalian Rino’s introduction of its Lamella Wastewater technology, the typical
industrial wastewater treatment technology used in China relied on an inclined
“plate settling pool” process which is still generally available in China. Our
advanced technology results in the following competitive advantages: large
hydraulic coefficient, long water power process, high treatment efficiency, etc.
We know of no comparable technology presently available in China.





Desulphurization
System





Presently
in China, major domestic companies engaged in the desulphurization equipment
market include: Beijing Guodian Longyuan Environmental Company, Zhejiang Feida
Company, Fujian Longjing Environmental Company, Wuhan Kaidi Electric Power
Company, Jiulong Electric Power Company, Qinghua Tongfang, University of Science
& Technology, Beijing ZHTD Technology, Talroad Company, Yonker Environmental
Protection Group, and China City Environment Protection Engineering. To the best
of our knowledge, among them, University of Science & Technology, Beijing
ZHTD Technology Co., Talroad Company, Yonker Environmental Protection Group,
China City Environment Protection Engineering Ltd. Co. and Fujian Longjing
Co., Ltd have entered into the desulphurization market of the iron and steel
industry; and the rest are mainly servicing the desulphurization market of
China’s power industry. We consider Fujian Longjing as our major potential
competitor in the desulphurization market, but it is more focused on power
industry.





Major
international companies in the desulphurization market include: Voestalpine AG
and Mitsubishi, each of which has won one business contract in Taiyuan and Anhui
in China, respectively. We believe we have strong competitive advantages over
these international players in terms of project investments and operating costs.
We don’t believe they will become our strong competitors in the near
future.





36





Anti-Oxidation
System





We
believe our High Temperature Anti-Oxidation System is unique and virtually
no competition in China. We know of no other entity that is engaged in
developing or supplying anti-oxidation technology that can operate on-line at
the high temperatures (600 – 1000 °C) involved in hot rolled steel production,
which represents 90% of China’s steel output. A number of anti-oxidation
technologies are available internationally, suppliers of those include: Advanced
Technical Products Company, ATP Metallurgical Coatings, Duffy Company, Condursal
and Berktekt. However, the high costs of the anti-oxidizing coatings these
technologies rely on, and especially their ineffectiveness at high temperatures,
have limited their market to specialty steels. We believe that in design and
technology our Anti-Oxidation System is the only anti-oxidation process
available for the iron and steel industry (both in the PRC and internationally)
that can be applied in high temperature environments, and is a unique solution
to the loss of production output due to high-temperature oxidation, which
is a long-standing problem in the world-wide iron and steel
industry.





Recent
Developments





BOT
Projects





Build-Operate-Transfer
(“BOT”) projects are highly encouraged by the Chinese government in
environmental protection industry. For example, Ministry of Industry and
Information (MII) promotes the BOT projects in metallurgy industry by
alleviating the financing burden of such enterprises, so that they can make the
best use of funds from society. This will incur a higher entry barrier for
smaller players which do not have advanced technology and solid capital support.
Also, commercial banks are highly encouraged by the Chinese government to
provide loans to BOT projects in metallurgy industry. Several major banks in
China have expressed their willingness of providing loans to our BOT projects.
Usually, BOT projects require investments during the initial 4 years and start
generating profits thereafter.





On March
1, 2010, we secured an $8.1 million project loan for the construction phase
of our BOT project with Shougang Jingtang Iron & Steel Co., Ltd., which
covers the design, construction and installation of two Semi-Dry Flue Gas
Desulphurization ("FGD") units. The project loan, provided by Pudong Development
Bank of Shanghai, has a four-year term which commenced on March 1, 2010.
Interest on the outstanding principal of the loan is payable quarterly starting
from June 1, 2010. The interest rate, initially set at 6.9%, is based upon
the Chinese Central Bank Rate plus a fixed margin, and can be adjusted only once
annually to reflect changes in the underlying Chinese Central Bank Rate.
Additionally, the loan carries no prepayment penalties. Upon construction
completion and final customer approval, we will commence the 10-year operating
contract of this BOT project. The commencement date of operating stage is
expected to be in the fourth quarter of 2010.





Sludge Treatment
System





In
November 2008, Dalian University of Technology (“DUT”) successfully developed a
new sludge treatment system with our cooperation. This can be used to treat
sludge generated by the municipal wastewater, industrial sludge generated by
chemical and oil industry. Based on our estimation, this market is approximately
$30 billion in China. To treat the sludge, the first and most critical step is
to remove water from the sludge through a dehydration process, which will reduce
the quantity of the sludge and make it easier to be incinerated and vaporized.
Depending on the heavy metal content of the desiccated sludge, the final product
can be used as agricultural fertilizer if the heavy metal content is low, or,
after further processing, as a component in various construction materials if
the heavy metal content is high.





37





We
believe the current best sludge treatment technology available in the PRC market
(provided by third parties) can make the sludge moisture content reach 70%,
whereas our technology, using superheated steam to dehydrate sludge, can make
the moisture content at a 50 – 60% level. In addition, our system costs
approximately 30% less than imported ones and the costs of daily operation are
approximately 45% less. The Chinese government recently promulgated a new
regulation requiring at least 60% of municipal wastewater be treated by 2010,
the implementation of which is expected to significantly increase the amount of
sludge generated by the wastewater treatment process in China in the next
several years. We estimate the profits to process one ton of sludge generated by
municipal wastewater treatment process vary between $12 and $19, depending on
different steam sources. Currently, approximately 40 million tons of sludge is
being generated by the wastewater treatment process annually with a water
content of approximately 80%.





We
believe Northeastern China, where Dalian Rino is located, is the oil industry
center and this region generates approximately 2 million tons of oil sludge
annually. Although our new sludge treatment system has not yet generated any
revenue, we estimate the profit to process one ton of oil sludge averages $30.
DUT has made a patent application for this technology in China. Pursuant to our
agreement with DUT, we will pay an ongoing royalty of approximately 5% of sales
to DUT.





Our BOT
project with Dalian Development Zone is our first sludge treatment project. The
start time delayed several months because:


1.
            The
      district divisions of Dalian City has been through changes and
      modifications


2.
            the
      selected site for sludge treatment plant wasn’t approved by local
      land-planning bureau and it was settled only till
  recently


3.
            The
      environmental assessment from government officials caused some
      delay





We expect
the commencement of the operating stage to be in the fourth quarter of
2010.





CFO Employment and
Compensatory
Arrangements





Effective
April 27, 2010, the Board of Directors appointed Mr. Ben Wang to serve as the
Chief Financial Officer of the Company.  On August 12, 2010, the Company
and Mr. Wang entered into an Employment Agreement (the “Employment Agreement”),
pursuant to which Mr. Wang shall serve as the Company’s CFO for a term of 3
years, which commenced on April 27, 2010. Mr. Wang’s base salary is RMB
1,000,000 per annum after tax, or RMB 83,333 per month, payable monthly in
arrears on the 10th day of
each month. Pursuant to the Employment Agreement, the Company also entered into
a Non-Qualified Stock Option Agreement with Mr. Wang, where Mr. Wang was granted
150,000 options to purchase the Common Stock at an exercise price of $20 per
share, vesting in 3 equal annual installments beginning on April 19, 2011. Each
installment of options, once vested, will expire on the fifth anniversary of its
vesting date.




On August
12, 2010, the Company entered into a Separation Agreement with Yi (Jenny) Liu
(the “Separation Agreement”), who resigned as the Company’s former CFO on April
27, 2010. The Separation Agreement, which amended Section 5(B) of her original
employment agreement with the Company dated June 30, 2009, provided that Ms. Liu
shall receive option to purchase 10,000 shares of the Common Stock at the
exercise price of $6.15 per share, vesting immediately upon the execution of the
Separation Agreement. Such option to purchase 10,000 shares of Common Stock will
expire in three years from the vesting date.





Changxing
Island Project





On March
2, 2010, Rino Heavy Industry entered into a Purchase Agreement for Land Use
Right of State-Owned Construction Site (the “Agreement”) with Dalian City Land
Resources and Housing Bureau of Liaoning Province of PRC (the “Seller”) for the
land located at Enterprise District, Lingang Industrial District, Changxing
Island, Dalian (the “Changxing Island Land”). The purchase price for the land
use right is in an aggregate amount of RMB 51,239,320 (or approximately
$7,516,808) (the “Purchase Price”). For more details of the Agreement, please
refer to our Annual Report on Form 10-K for the fiscal year ended December 31,
2009.





38





The
Changxing Island Industrial Project is intended for plant expansion purpose to
meet the Company’s expanding client base and service scope. The estimated total
investment amount is around $107 million. Aside from using $50 million of the
proceeds that we raised from the financing in December 2009, the remaining $57
million will be funded by Chinese local commercial banks.





By the
end of June 30, 2010, we had already invested $12.3 million in the Changxin
Island Project, which includes infrastructure construction, land acquisition,
equipment prepayment, taxes and other miscellaneous costs. We started the
construction of the Changxing Island Project on April 20, 2010, and we
anticipated it to be finished by July 2011 which is around two months later than
expected earlier due to the authorities’ delay and weather conditions. Once
it launched, our capacity and profit margin will be greatly enhanced, as
currently we have to outsource some of our products to outside constructors
since we have reached the maximum production capacity. Recently, the State
Council of China named Changxin Island Industrial Zone as “National Level
Development Zone”, which may attract more investments and then drive up the land
value thereafter.





New Approval of bank
loan





In August
2010, we received the letter of approval from Agricultural Bank of China for a
loan of the principal amount of $ 44.2 million (RMB 300 million) for fixed
assets purpose. We will be able to use this amount for our Changxing Island
Project when we see there is a need.





Backlog





Backlog,
defined as unfinished projects including not started projects, as of June
30, 2010 was $104.7 million and the breakdown associated with the backlog is set
forth in the following table. The Company expects that approximately 50% of this
backlog amount will turn into revenue by the end of the third quarter of
2010.





ProductSegment
                  
                  Amount($millions)1.  Desulphurization
      Systems
                  
                  
                  70.82. 
      Wastewater Treatment
                  
                  
                  14.63. 
      Anti-oxidation Systems
                  
                  
                  0.44. 
      Municipal Sludge Treatment
                  
                  
                  18.9Total
                  
                  
                  104.7





Results
of Operations





Three
Months Ended June 30, 2010 and June 30, 2009.





39





Revenue





Total
revenue increased by approximately $24.7 million to $65.4 million or an increase
of 60.6% for the three months ended June 30, 2010, as compared to the total
revenue $40.7 million for the three months ended June 30, 2009. Revenue
growth was driven by demand for RINO’s three major product lines as the Company
continued to execute on new and existing project installations. The breakdown of
the revenue growth is as follows:





ForthethreemonthsendedJune30,2010
                    
                    
                    2009Revenue(inthousands)
                    
                    
                    Asa%oftotalrevenue
                    
                    
                    Revenue(inthousands)
                    
                    
                    Asa%oftotalrevenue
                    
                    
                    %ofIncreaseFlue
      gas desulphurization
                    
                    $
                    42,426
                    
                    
                    
                    64.8
                    %
                    
                    
                    30,083
                    
                    
                    
                    73.9
                    %
                    
                    
                    41.0
                    %Wastewater treatment equipment
                    
                    
                    14,968
                    
                    
                    
                    22.9
                    %
                    
                    
                    9,258
                    
                    
                    
                    22.7
                    %
                    
                    
                    61.7
                    %Anti-oxidation
      equipment and coatings
                    
                    
                    7,102
                    
                    
                    
                    10.9
                    %
                    
                    
                    1,128
                    
                    
                    
                    2.8
                    %
                    
                    
                    529.6
                    %Machining
      services
                    
                    
                    888
                    
                    
                    
                    1.4
                    %
                    
                    
                    253
                    
                    
                    
                    0.6
                    %
                    
                    
                    250.8
                    %Total
      revenue
                    
                    $
                    65,384
                    
                    
                    
                    100
                    %
                    
                    
                    40,722
                    
                    
                    
                    100.0
                    %
                    
                    
                    60.6
                    %





For the
three months ended June 30, 2010, we have been working on 13 desulphurization
projects, 5 waste water projects, and 3 anti-oxidation projects.





Our
Desulphurization System, which we introduced in late 2006, utilizes proprietary
technology we jointly developed with the Research Institute of the Chinese
Academy of Sciences, and can reduce flue gas sulphur dioxide levels by 90-99%.
Our increase in the flue gas desulphurization sales were mainly due to the
increased demand from the iron and steel industry for this solution.. For the
three months ended June 30, 2010, we recorded revenues of $42.4 million, as
compared to revenues of $30.1 million for the three months ended June 30, 2009,
representing an increase of 41.0%.





Demand
for our Lamella Wastewater System, increased 61.7% to $15.0 million for the
three months ended June 30, 2010, as compared with $9.3 million for the three
months ended June 30, 2009. Our increase in the waste water system sales was
mainly due to the increased demand from the iron and steel industry for our
solutions.





Our
Anti-Oxidation System, which we introduced in January 2007, reduces oxidation
loss in the production of hot rolled steel plates. For the three months ended
June 30, 2010, we recorded revenues of $7.1 million anti-oxidation equipment and
related coatings sales, as compared to revenues of $1.1 million for the
three months ended June 30, 2009, representing an increase of $6.0 million or
529.6%. The increase in revenues largely reflects our increased demand as the
value of our anti-oxidation technology has been proven in commercial
practice. However, going forward, we decide to gradually reduce the
production and sales of our Anti-Oxidation System and withdraw from the
Anti-Oxidation market. The turnaround time of completing Anti-Oxidation system
projects in general is much longer than our other projects because
Anti-Oxidation projects can only commence when the customer steelmakers conduct
inspection and repair. It is therefore more time consuming to realize any
revenues from Anti-Oxidation projects.





40





In
addition to the foregoing, we provide machining services to third parties,
utilizing our heavy machine tools’ idle time to generate contract manufacturing
revenue. The revenue generated from our machining services fluctuates based on
the level of our using our heavy machining equipment to produce more of our own
products rather than for third-party contract work. For the three months ended
June 30, 2010, revenues accounted for 1.4% of the total revenue as compared to
0.6 % for the corresponding period in 2009, reflecting a higher demand on
services provided to third parties. This machining service, as percentage of
total revenue within the range of 0.5% to 2%, will fluctuate from quarter to
quarter with no pattern as most of the services are of one time
nature.





Cost
of Sales





The cost
of sales for the three months ended June 30, 2010 increased by $15.7 million to
$42.3 million from $26.6 million for the three months ended June 30, 2009,
representing an increase of 59.3%. The increase in our cost of sales resulted
directly from the increased number of projects during the period.


We did
not experience a significant change in cost of revenue as a percentage of sales
for the second quarter in 2010 comparing to the same period last year. As a
percentage of sales, the cost of sales was 64.7% for the three months ended
June 30, 2010 compared to 65.2% for the same period in 2009. The breakdown of
the cost of sales is as follows:





ForthethreemonthsendedJune30,2010
                            
                            
                            2009Total
                              (inthousands)
                            
                            
                            %ofsales
                            
                            
                            Total
                              (inthousands)
                            
                            
                            %ofsalesRevenuesContracts
                            
                            $
                            64,496
                            
                            
                            
                            
                            
                            $
                            40,469Machining
      Services
                            
                            
                            888
                            
                            
                            
                            
                            
                            
                            253Cost
      of SalesContracts
                            
                            $
                            41,809
                            
                            
                            
                            64.8
                            %
                            
                            $
                            26,286
                            
                            
                            
                            65.0
                            %Machining
      Services
                            
                            
                            495
                            
                            
                            
                            55.7
                            %
                            
                            
                            269
                            
                            
                            
                            106.3
                            %Gross
      Profit
                            
                            $
                            23,080
                            
                            
                            
                            35.3
                            %
                            
                            $
                            14,167
                            
                            
                            
                            34.8
                            %





Our cost
of sales primarily consists of costs for raw materials, direct labor,
outsourcing and overhead allocation. As a result of the growth in our business,
our capacity has directly impacted how we operate and how much we can charge
from period to period, depending on demand level, production efficiency and
location of the contracts. Initially, we had to try to fully utilize our own
manpower on the contracted projects. However, when we reached our maximum
production capacity, we have to outsource some of our products to outside
constructors.




Our gross
profit for the three months ended June 30, 2010 grew by $ 8.9 million or 63.0 %,
to $23.1 million from $14.2 million for the same period in 2009. The increase in
gross profit was in line with our growth in revenue as we received and completed
more projects in 2010, due to the high demand of our products and the Chinese
government regulations on environmental protection, such as Ministry of
information and Industry’s policy on flue gas desulphurization on iron and
steel industry in July 2009, which has significantly increased demand for our
products. Our gross margin of second quarter in 2010 is slightly
higher compared to the same period last year, this is mainly due
to the increased sales of our anti-oxidation products which had higher gross
margin.




41





Operating
Expense





Operating
expenses for the three months ended June 30, 2010 were $5.0 million, an increase
of $0.8 million or 20.4%, compared to operating expenses of $4.2 million
for the same period ended June 30, 2009. Our operating expenses were consistent
with growth in revenue and during this quarter, we experienced modest increase
in our operating expense as we paid more sales commission compared to the
same period in 2009, which is a major component of the operating
expenses. Our Company’s sales commission is usually determined based on the
execution of a signed contract. The Company agreed to pay 4-8% sales commission
upon the receipt of first payment from its customers.





Other
Income, Net





Other
income, for the three months ended June 30, 2010 increased $5.0 million to
$4.8 million from other expense, of $ 156,728 during same period of 2009. The
increase in other income, net, was mainly due to the $4.9 million decrease of
the fair value of the warrants. The expiration of 1.1 million shares of Series A
warrants on June 7, 2010 contributed to the decrease in the fair value of the
warrants mostly .




Total
interest expense on the bank loans for the three months ended June 30, 2010 and
2009, amounted to $187,362 and $253,729, respectively.





Six
Months Ended June 30, 2010 and June 30, 2009.





Revenue





The total
revenue increased by approximately $36.9 million to $113.2 million or an
increase of 48.4% for the six months ended June 30, 2010, as compared to the
total revenue $76.3 million for the six months ended June 30, 2009. The revenue
growth was driven by the demand for RINO’s three major product lines as the
Company continued to execute on new and existing project installations. The
breakdown of the revenue growth is as follows:





ForthesixmonthsendedJune30,2010
                      
                      
                      2009Revenue(inthousands)
                      
                      
                      Asa%oftotalrevenue
                      
                      
                      Revenue(inthousands)
                      
                      
                      Asa%oftotalrevenue
                      
                      
                      %ofIncreaseFlue
      gas desulphurization
                      
                      $
                      76,365
                      
                      
                      
                      67.4
                      %
                      
                      
                      55,787
                      
                      
                      
                      73.1
                      %
                      
                      
                      36.9
                      %Wastewater treatment equipment
                      
                      
                      25,760
                      
                      
                      
                      22.7
                      %
                      
                      
                      16,496
                      
                      
                      
                      21.6
                      %
                      
                      
                      56.2
                      %Anti-oxidation
      equipment and coatings
                      
                      
                      10,139
                      
                      
                      
                      9.0
                      %
                      
                      
                      3,552
                      
                      
                      
                      4.7
                      %
                      
                      
                      185.4
                      %Machining
      services
                      
                      
                      979
                      
                      
                      
                      0.9
                      %
                      
                      
                      495
                      
                      
                      
                      0.6
                      %
                      
                      
                      97.80
                      %Total
      revenue
                      
                      $
                      113,243
                      
                      
                      
                      100
                      %
                      
                      
                      76,330
                      
                      
                      
                      100.0
                      %
                      
                      
                      48.4
                      %





Our
Desulphurization System, which we introduced in late 2006, utilizes proprietary
technology we jointly developed with the Research Institute of the Chinese
Academy of Sciences, and can reduce flue gas sulphur dioxide levels by 90-99%.
Our increase in the flue gas desulphurization sales were mainly due to the
increased demand from the iron and steel industry for the
solutions.  For the six months ended June 30, 2010, we recorded
revenues of $76.4 million, as compared to revenues of $55.8 million for the six
months ended June 30, 2009, representing an increase of 36.9%.





42





The
demand for our Lamella Wastewater System, increased 56.2% to $25.8 million for
the six months ended June 30, 2010, as compared with $16.5 million for the six
months ended June 30, 2009. Our increase in the waste water system sales was
mainly due to the increased demand from the iron and steel industry for our
solutions.





Our
Anti-Oxidation System, which we introduced in January 2007, reduces oxidation
loss in the production of hot rolled steel plates. For the six months ended June
30, 2010, we recorded revenues of $10.1 million anti-oxidation equipment and
related coatings sales, as compared to revenues of $3.6 million for the six
months ended June 30, 2009, representing an increase of $6.6 million or 185.4%.
The increase in revenues largely reflects the fact that the value of our
anti-oxidation technology has been proven in commercial practice.





In
addition to the foregoing, we provide machining services to third parties,
utilizing our heavy machine tools’ idle time to generate contract manufacturing
revenue. The revenue generated from our machining services fluctuates based on
the level of our using our heavy machining equipment to produce more of our own
products rather than for third-party contract work. For the six months ended
June 30, 2010, revenues accounted for 0.9% of the total revenue as compared to
0.6 % for the corresponding period in 2009, reflecting a higher demand on
services provided to third parties. This service, as percentage of total revenue
within the range of 0.5% to 2%, will fluctuate from quarter to quarter with no
pattern as most of the services are of one time nature.





Cost
of Sales





The cost
of sales for the six months ended June 30, 2010 increased by $27.3 million to
$73.5 million from $46.2 million for the six months ended June 30, 2009,
representing an increase of 59.0%. The increase in our cost of sales resulted
directly from the increased number of projects during the period.


As a
percentage of sales, the cost of sales was 64.9% for the six months ended June
30, 2010 compared to 60.5% for the same period in 2009. The breakdown of the
cost of sales is as follows:





ForthesixmonthsendedJune30,2010
                            
                            
                            2009Total
                              (inthousands)
                            
                            
                            %ofsales
                            
                            
                            Total
                              (inthousands)
                            
                            
                            %ofsalesRevenuesContracts
                            
                            $
                            112,263
                            
                            
                            
                            
                            
                            $
                            75,835Machining
      Services
                            
                            
                            979
                            
                            
                            
                            
                            
                            
                            495Cost
      of SalesContracts
                            
                            $
                            72,968
                            
                            
                            
                            65.0
                            %
                            
                            $
                            45,619
                            
                            
                            
                            60.2
                            %Machining
      Services
                            
                            
                            494
                            
                            
                            
                            50.5
                            %
                            
                            
                            592
                            
                            
                            
                            119.8
                            %Gross
      Profit
                            
                            $
                            39,780
                            
                            
                            
                            35.1
                            %
                            
                            $
                            30,118
                            
                            
                            
                            39.5
                            %





43





Our cost
of sales primarily consists of costs for raw materials, direct labor,
outsourcing and overhead allocation. As a result of the growth in our business,
our capacity has directly impacted how we operate and how much we can charge
from period to period, depending on demand level, production efficiency and
location of the contracts. Initially, we had to try to fully utilize our own
manpower on the contracted projects. However, when we reached our maximum
production capacity, we have to outsource some of our products to outside
constructors, and consequently resulted in higher cost and lower profit margin.
During the six months ended June 30, 2010, the outsourcing was the main cause
for 4.8% increase in cost of contract sales as percentage of total contract
sales.





Our gross
profit for the six months ended June 30, 2010 grew by $ 9.7 million or 32.1 %,
to $39.8 million from $30.1 million for the same period in 2009. The increase in
gross profit was in line with the increase in revenue for the six months of
2010, and was mainly because we received and completed more projects in 2010,
due to the high demand for our products and the Chinese government regulation on
environmental protection, such as Ministry of Information and Industry’s policy
on flue gas desulfuration on iron and steel industry in July 2009, which has
significantly increased the demand for our products.





Operating
Expense





Operating
expenses for the six months ended June 30, 2010 were $11.8 million, an increase
of $4.3 million or 57.3%, compared to operating expenses of $7.5 million
for the same period ended June 30, 2009. The increase was mainly resulted
from the increase of sales commission from $4.7 million in 2009 to $7.1
million in 2010, which is consistent with the growth in revenue. Our Company’s
sales commission is usually determined based on the execution of a signed
contract. The Company agreed to pay 4-8% sales commission upon the receipt of
first payment from its customers.





Other
Income, Net





Other
income, net, for six months ended June 30, 2010 increased $15.4 million to
$ 15.1 million from other expense, net, of $261,726 during same period of
2009. The increase in other income, net, was mainly due to the decrease of
fair value on warrants we issued in the amount of $15.1 million, which is a
direct result of stock price drop.





Liquidity
and Capital Resources





Cash
and Cash Equivalents





As of
June 30, 2010, we have cash and cash equivalents of $88.0 million. Our liquidity
position remains strong. We have historically funded our working capital
needs from operations, advance payments from customers, bank borrowings, and
capital from shareholders. Our working capital requirements are influenced by
the level of our operations, the numerical and dollar volume of our project
contracts, the progress of our contract execution, and the timing of accounts
receivable collections.


We
believe that our cash position is adequate to meet future short-term and
mid-term liquidity requirements, as well as our obligation to satisfy the PRC’s
statutory reserves requirement.





44





The
following tables present our net cash flows for the six months ended June 30,
2010 and for the same period ended June 30, 2009.





Forthesixmonthsended
                      June30,US$ (in thousands)
                    
                    2010
                    
                    
                    2009Cash
      (used in) provided by operating activities
                    
                    $
                    (48,253
                    )
                    
                    $
                    9,740Cash
      used in investing activities
                    
                    $
                    (12,462
                    )
                    
                    $
                    (28
                    )Cash
      provided by financing activities
                    
                    $
                    13,809
                    
                    
                    $
                    22,333





Cash
flow from operating activities





Cash used
in operations totaled $48.2 million in the six months ended June 30, 2010,
representing a decrease of 595.4 % as compared to $9.7 million cash provided by
operations in the same period ended June 30, 2009. The major components of cash
used in operations were related to the increased operating net earnings and
offset by non-cash gain of the fair value of the warrants, increase in cost and
estimated earnings in excess of progress billing for uncompleted projects and
increase in advances for inventory purchases. Cash provided by operations
decreased by $58.0 million in the six months ended June 30, 2010 as compared to
the same period of 2009.





Accounts
Receivable





Our
accounts receivable at June 30, 2010 increased to $68.4 million from $57.8
million at December 31, 2009, representing an increase of 18.3%. The
increase in our accounts receivable was inline with our growth in
revenue. Days sales outstanding for the six months ended June 30, 2010
was 102 days compared with 124 days for same period 2009. Usually our
customers require 5-10% retainage for a 12-month period and our retainage
receivable is short term in nature based on the term of our
contract.





As the
billing cycle for our construction projects was relatively long, our accounts
receivable used a great deal of our cash as a result of the rapid growth of our
company.





Costs
and estimated earnings in excess of billings on uncompleted
contracts





Costs and
estimated earnings in excess of billings on uncompleted contracts increased to
$38.9 million from $3.3 million on December 31, 2009. The increase was mainly
due to the fact that there were only two contracts uncompleted as of December
31, 2009. However, as of June 30, 2010, fourteen contracts remained open, which
resulted in increase of unbilled projects.





Progress
billing may not be the same as construction stage under our
percentage-of-completion income recognition method, unbilled revenue which is
reported as costs and estimated earnings in excess of billings on uncompleted
contracts utilized another part of our cash.





Advances
for inventory purchase





Advances
for inventory purchases are required to ensure timely delivery of raw materials
needed to execute existing production contracts as well as to expand the
business. Our advances for inventory purchases increased to $64.4 million on
June 30, 2010, an increase of $30.3 million or 89.2%, from the $34.1 million
recorded on December 31, 2009. The increase was largely related to the increased
prepayment for raw materials in order to secure timely delivery, which is
consistent with our business expansion.





45





Cash
used in investing activities





For the
six months ended June 30, 2010, net cash used in investing activities increased
to $ 12.5 million as compared to $ 28,051 used for the same period ended June
30, 2009, representing an increase of $12.4 million. This increase in cash used
in investing activities primarily resulted from the $7.9 million increase in
purchase of intangible asset and $2.9 million in advances for non-current assets
for the six months ended June 30, 2010, as compared to none made in the same
period of 2009.





Cash
provided by financing activities





For the
six months ended June 30, 2010, net cash provided by financing activities was $
13.8 million as compared to cash provided by financing of $22.3 million for the
same period ended June 30, 2009, representing a decrease of 38.2%. The
decrease was primarily due to the decrease of $18.3 million in proceeds from
short term bank loans and partially offset by an increase of $8.1 million in
proceeds from long term bank loan. for the six months ended June 30, 2010
compared with same period of 2009.





Related
Party Transactions





The
Company owed $535,895 and $ 494,614 to Mr. Dejun Zou, our CEO and director, as
of June 30, 2010 and December 31, 2009, respectively, for advances made on an
unsecured basis, payable on demand and interest free. Imputed interest is
charged per annum on the amount with loan in nature due at 0% and 5.24 % for the
six months periods ended June 30, 2010 and 2009, respectively. Total imputed
interest recorded as additional paid-in capital amounted to $0 and
$13,557 for the six months ended June 30, 2010 and 2009,
respectively.





On December
7, 2009, the Company entered into a loan agreement with Mr. Dejun Zou and Ms.
Jianping Qiu evidencing the terms of a loan made to them in a principal sum of
$3.5 million at an annual interest rate of 5.25%. Pursuant to the Loan
Agreement, Mr. Zou and Ms. Qiu also issued a secured promissory note to the
Company due on May 10, 2010 (the “Secured Promissory Note”). Mr. Zou and
Ms. Qiu are directors and officers of the Company. The Loan, with principal and
accrued interest totaling approximately $3.577 million, was fully repaid on May
10, 2010.





Seasonality





Our sales
are not significantly affected by seasonality.





Off-Balance
Sheet Arrangements





The
Company does not have any off-balance sheet arrangements.





CRITICAL
ACCOUNTING POLICIES





We
believe that the application of the following accounting policies, which are
important to our financial position and results of operations, require
significant judgments and estimates on the part of management. Our critical
accounting policies and estimates present an analysis of the uncertainties
involved in applying a principle, while the accounting policies note to the
financial statements (Note 2) describe the method used to apply the accounting
principle.





46





Fair Value of Financial
Instruments





On
January 1, 2008, the Company began recording financial assets and liabilities
subject to recurring fair value measurement at the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction
between market participants. On January 1, 2009 the Company began recording
non-recurring financial as well as all non-financial assets and liabilities
subject to fair value measurement under the same principles. These fair value
principles prioritize valuation inputs across three broad levels. The three
levels are defined as follows:





·
            Level 1 inputs to the valuation
      methodology are quoted prices (unadjusted) for identical assets or
      liabilities in active
markets.





·
            Level 2 inputs to the valuation
      methodology include quoted prices for similar assets and liabilities in
      active markets,and
      inputs that are observable for the assets or liability, either directly or
      indirectly, for substantially the full term of the financial
      instruments.





·
            Level 3 inputs to the valuation
      methodology are unobservable and significant to the fair
      value.





Effective
January 1, 2009, warrants previously treated as equity pursuant to the
derivative treatment exemption are no longer afforded equity treatment because
the strike price of the warrants is denominated in the U.S. dollar, a currency
other than the Company’s functional currency, the Chinese Renminbi (RMB). As a
result, the warrants are not considered indexed to the Company’s own stock, and
as such, all future changes in the fair value of these warrants will be
recognized currently in earnings until such time as the warrants are exercised
or expired.





Revenue
Recognition





Contracts. The Company enters
into long-term fixed-price contracts with customers to manufacture and install
industrial equipment. Revenue on long-term fixed-price contracts is recognized
under the percentage-of-completion method. Under the
percentage-of-completion method, management estimates the
percentage-of-completion based upon costs incurred to date as a percentage of
the total estimated costs to the customer. When total cost estimates exceed
revenues, the Company accrues for the estimated losses immediately. The use of
the percentage-of-completion method requires significant judgment in estimating
total contract revenues and costs, including assumptions relative concerning the
length of time to complete the project, the nature and complexity of the work to
be performed, and anticipated changes in estimated costs. Estimates of total
contract revenues and costs are continuously monitored during the term of the
contract, and recorded revenues and costs are subject to revision as the
contract progresses. When revisions in estimated contract revenues and costs are
determined, such adjustments are recorded in the period in which they are first
identified.





Services.In addition to the
Company’s specialty equipment sales, the Company uses heavy machining equipment
to perform machining services for third parties. These engagements, numbering
several hundred per year, are essentially piecework and are completed in usually
less than one month. Each machining engagement is governed by a separate
contract, indicating existence of an arrangement. Revenue is recognized
when service is performed, which is usually concurrent with delivery to the
customer, the contract price is set by contract, and collectability is
reasonably assured.





47





The
Company also provides technical professional services to its customers based on
a fixed-price time contract. The Company recognizes services-based revenue from
all of its contracts when the services have been performed, the customers have
approved the completion of the services and invoices have been issued and
collectability is reasonably assured.





BOT Contracts. Starting from
2010, the Company started entering into long-term “build-operate-transfer”
contracts (the “BOT” contracts) with customers to manufacture and install,
operate and maintain the industrial equipments. The revenue and costs relating
to construction or upgrade services is recognized under the cost recovery method
as the collection of the receivable cannot be reasonably predicted. Under the
cost recovery method, no gross profit is recognized until the Company collected
the cost of the revenue, or until such time that the company considers the
collections to be probable and estimable and begins to recognize income based on
the accrual method. A BOT service contract has an indeterminable number of acts
to be performed over a specific period of time.  As such, revenue from a
BOT service contract is recognized on a straight-line basis unless it is
possible to estimate the stage of completion by some other method more reliably.
 When in a series of acts to be performed in rendering a service, a
specific act is much more significant than other acts, and then the recognition
of income is postponed until the significant acts are performed.





Recently Issued Accounting
Pronouncements and Adopted Accounting





In
January 2010, FASB issued ASU No. 2010-01- Accounting for Distributions to
Shareholders with Components of Stock and Cash. The amendments in this Update
clarify that the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a potential limitation on the total
amount of cash that all shareholders can elect to receive in the aggregate is
considered a share issuance that is reflected in EPS prospectively and is not a
stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings
Per Share). The amendments in this update are effective for interim and annual
periods ending on or after December 15, 2009, and should be applied on a
retrospective basis. The adoption of this ASU did not have impact on the
Company’s consolidated financial statements.





In
January 2010, FASB issued ASU No. 2010-02 – Accounting and Reporting for
Decreases in Ownership of a Subsidiary – a Scope Clarification. The amendments
in this Update affect accounting and reporting by an entity that experiences a
decrease in ownership in a subsidiary that is a business or nonprofit activity.
The amendments also affect accounting and reporting by an entity that exchanges
a group of assets that constitutes a business or nonprofit activity for an
equity interest in another entity. The amendments in this update are effective
beginning in the period that an entity adopts SFAS No. 160, “Non-controlling
Interests in Consolidated Financial Statements – An Amendment of ARB No. 51.” If
an entity has previously adopted SFAS No. 160 as of the date the amendments in
this update are included in the Accounting Standards Codification, the
amendments in this update are effective beginning in the first interim or annual
reporting period ending on or after December 15, 2009. The amendments in this
update should be applied retrospectively to the first period that an entity
adopted SFAS No. 160. The adoption of this ASU did not have a material impact on
the Company’s consolidated financial statements.





48





In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows: 1) Transfers in and out of Levels 1 and 2. A
reporting entity should disclose separately the amounts of significant transfers
in and out of Level 1 and Level 2 fair value measurements and describe the
reasons for the transfers. 2) Activity in Level 3 fair value measurements. In
the reconciliation for fair value measurements using significant unobservable
inputs (Level 3), a reporting entity should present separately information about
purchases, sales, issuances, and settlements (that is, on a gross basis rather
than as one net number). This update provides amendments to Subtopic 820-10 that
clarifies existing disclosures as follows: 1) Level of disaggregation. A
reporting entity should provide fair value measurement disclosures for each
class of assets and liabilities. A class is often a subset of assets or
liabilities within a line item in the statement of financial position. A
reporting entity needs to use judgment in determining the appropriate classes of
assets and liabilities. 2) Disclosures about inputs and valuation techniques. A
reporting entity should provide disclosures about the valuation techniques and
inputs used to measure fair value for both recurring and nonrecurring fair value
measurements. Those disclosures are required for fair value measurements that
fall in either Level 2 or Level 3. The new disclosures and clarifications of
existing disclosures are effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about
purchases, sales, issuances, and settlements in the roll forward of activity in
Level 3 fair value measurements. These disclosures are effective for fiscal
years beginning after December 15, 2010, and for interim periods within those
fiscal years. The Company is currently evaluating the impact of this ASU,
however, the Company does not expect the adoption of this ASU to have a material
impact on its consolidated financial statements.





In
February 2010, FASB issued ASU No. 2010-9 – Amendments to Certain Recognition
and Disclosure Requirements. This update addresses certain implementation issues
related to an entity’s requirement to perform and disclose subsequent-events
procedures, removes the requirement that public companies disclose the date of
their financial statements in both issued and revised financial statements.
According to the FASB, the revised statements include those that have been
changed to correct an error or conform to a retrospective application of U.S.
GAAP. The amendment is effective for interim and annual reporting periods in
fiscal year ending after June 15, 2010. The Company does not expect the adoption
of this ASU to have a material impact on the Company’s consolidated financial
statements.





In March
2010, FASB issued ASU No. 2010-10 – Amendments for Certain Investment Funds.
This update defers the effective date of the amendments to the consolidation
requirements made by FASB Statement 167 to a reporting entity’s interest in
certain types of entities. The deferral will mainly impact the evaluation of
reporting enterprises’ interests in mutual funds, private equity funds, hedge
funds, real estate investment entities that measure their investment at fair
value, real estate investment trusts, and venture capital funds. The ASU also
clarifies guidance in Statement 167 that addresses whether fee arrangements
represent a variable interest for all service providers and decision makers. The
ASU is effective for interim and annual reporting periods in fiscal year
beginning after November 15, 2009. The adoption of this ASU did not have a
material impact on the Company’s consolidated financial statements.





In March
2010, FASB issued ASU No. 2010-11 – Scope Exception Related to Embedded Credit
Derivatives. Embedded credit-derivative features related only to the transfer of
credit risk in the form of subordination of one financial instrument to another
are not subject to potential bifurcation and separate accounting as clarified by
recently issued FASB guidance. Other embedded credit-derivative features are
required to be analyzed to determine whether they must be accounted for
separately. This update provides guidance on whether embedded credit-derivative
features in financial instruments issued by structures such as collateralized
debt obligations (CDOs) and synthetic CDOs are subject to bifurcation and
separate accounting. The guidance is effective at the beginning of a company’s
first fiscal quarter beginning after June 15, 2010. The Company does not expect
the adoption of this ASU to have a material impact on the Company’s consolidated
financial statements.





In April
2010, the FASB issued Accounting Standards Update 2010-13, “Compensation—Stock
Compensation (Topic 718): Effect of Denominating the Exercise Price of a
Share-Based Payment Award in the Currency of the Market in Which the Underlying
Equity Security Trades,” or ASU 2010-13. This Update provides amendments to
Topic 718 to clarify that an employee share-based payment award with an exercise
price denominated in currency of a market in which a substantial porting of the
entity’s equity securities trades should not be considered to contain a
condition that is not a market, performance, or service condition. Therefore, an
entity would not classify such an award as a liability if it
otherwise qualifies as equity. The amendments in this Update are effective
for fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2010. The Company does not expect the adoption of ASU 2010-17
to have a significant impact on its consolidated financial
statements.





49





In April
2010, the FASB issued Accounting Standard Update 20-10-17, “Revenue
Recognition—Milestone Method (Topic 605): Milestone Method of Revenue
Recognition” or ASU 2010-17. This Update provides guidance on the recognition of
revenue under the milestone method, which allows a vendor to adopt an accounting
policy to recognize all of the arrangement consideration that is contingent on
the achievement of a substantive milestone (milestone consideration) in the
period the milestone is achieved. The pronouncement is effective on a
prospective basis for milestones achieved in fiscal years and interim periods
within those years, beginning on or after June 15, 2010. The Company does
not expect the adoption of ASU 2010-17 have a significant impact on its
consolidated financial statements.





In July
2010, the FASB issued Accounting Standards Update 2010-20, Disclosure about the
Credit Quality of Financing Receivables and the Allowance for Credit losses.
This ASU will increase disclosure made about the credit quality of loans and the
allowances for credit losses. The disclosures will provide additional
information about the nature of credit risk inherent in First Financial loans,
how credit risk is analyzed and assessed, and the reasons for the change in the
allowance for loan losses. The requirements will be effective for first fiscal
year ended December 31, 2010. The Company is evaluating the potential impact to
its consolidated financial statements from the adoption of this
ASU.





Item
3. Quantitative and Qualitative Disclosure About Market Risk




Interest
Rate Risk




The
Company deposits surplus funds with Chinese banks earning daily interest. The
Company does not invest in any instruments for trading purposes. All of the
Company’s outstanding debt instruments carry fixed rates of interest. The
Company’s operations generally are not directly sensitive to fluctuations in
interest rates. The amount of long-term debt outstanding as of June 30, 2010 and
December 31, 2009 was $8.1 million and $0.0 million, respectively. A
hypothetical 1.0% increase in the annual interest rates for all of our credit
facilities under which we had outstanding borrowings at June 30, 2010 would not
have any material impact on our net income before provision for income taxes for
the quarter. Management monitors the banks’ prime rates in conjunction with our
cash requirements to determine the appropriate level of debt balances relative
to other sources of funds. We have not entered into any hedging transactions in
an effort to reduce our exposure to interest rate risk.




Inflation




Inflationary
factors such as increases in the cost of our product and overhead costs may
adversely affect our operating results. Although we do not believe that
inflation has had a material impact on our financial position or results of
operations to date, a high rate of inflation in the future may have an adverse
effect on our ability to maintain current levels of gross margin and selling,
general and administrative expenses as a percentage of net revenues if the
selling prices of our products do not increase with these increased
costs.





50





Item
4. Controls and Procedures.





Disclosure
Controls and Procedures





The
Company’s management, with participation of the Company’s Chief Executive
Officer and Chief Financial Officer, has evaluated the effectiveness of the
Company’s disclosure controls and procedures (as such term is defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the “Exchange Act”)) as of the end of the period covered by this report. The
term “disclosure controls and procedures” as defined in Rules 13a-15(e) and
15d-15(e) means controls and other procedures of the Company that are designed
to ensure that information required to be disclosed by a company in
reports, such as this reports, that it files, or submits under the Exchange Act
is recorded, processed, summarized and reported, within the time periods
specified in the U.S. Securities and Exchange Commission’s (“SEC”) rules and
forms. Disclosure controls and procedures include, without limitation, controls
and procedures designed to ensure that information required to be disclosed by a
company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the company’s management, including its
principal executive and principal financial officers, as appropriate to allow
timely decisions regarding required disclosure. Management recognizes that any
controls and procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving their objectives and management
necessarily applies its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. Based on that evaluation, management concluded
that because of the material weakness in internal control over financial
reporting described below, our disclosure controls and procedures were not
effective as of June 30, 2010, to satisfy the objectives for which they are
intended.





1)
Insufficient controls over related party transactions and cash disbursement
management





During
the fiscal year ended December 31, 2009, the Company made a loan to certain
officers and directors (the “Loan”) which created a contingent liability for a
possible violation of Section 13(k) of the Exchange Act (Section 402(a) of the
Sarbanes-Oxley Act of 2002). Section 13(k) provides that it is unlawful for a
company, such as the Company, which has a class of securities registered under
Section 12 of the Exchange Act, to directly or indirectly, including
through any subsidiary, extend or maintain credit in the form of a personal loan
to or for any director or executive officer of the company.





The lack
of adequate cash disbursement management by the Company and lack of adequate
procedures and controls with respect to related party transactions which allowed
for the Loan to occur are material weaknesses in the Company’s internal
controls.





2)
Ineffective controls over accounting for revenues and billing
process





We did
not design and maintain effective controls over the accounting for assets.
Specifically, the controls over our billing system were not designed and
operating effectively to ensure the completeness and accuracy of related
revenues. As of June 30, 2010, management’s evaluation of internal controls
revealed that our accounting department was not timely notified about the
entry of certain subcontracted projects.





Further,
during its evaluation, management determined that a material weakness existed
with respect to our process of estimating the allowance for uncollectible
accounts at June 30, 2010. The Company’s process for determining its allowance
for uncollectible accounts focused primarily on evaluating the appropriate
percentage of gross revenues to record during a particular period. However, as
of June 30, 2010, the Company did not have processes or controls in place that
would enable management to appropriately evaluate, document and review the
adequacy of the allowance for uncollectible accounts as of a particular
period-end.





3)
Lack of controls over fixed assets management





We did
not maintain effective controls over recording of fixed assets. Specifically, we
mistakenly recorded the receipt of certain fixed assets, which resulted in
significant adjustment between the fixed assets and the advance to suppliers.
The lack of timely reconciliation procedures and deficient recordkeeping
controls result in material weakness in this area such that there is a
reasonable possibility that due to these control deficiencies a material
misstatement will not be prevented or detected on a timely basis.





51





4)
Lack of internal audit function





We lack
qualified resources to perform the internal audit functions properly, and the
scope and effectiveness of the internal audit function are yet to be developed.
Specifically, the reporting mechanism between the accounting department and the
Board of Directors and the CFO was not effective, therefore resulting in the
delay of recording, reporting and the failure to comply with the Company’s Code
of Ethics.





Changes
in Internal Control over Financial Reporting





As a
result of the foregoing material weaknesses, as of June 30, 2010, the Company’s
audit committee of its Board of Directors has undertaken to further review
internal controls along with management and in cooperation with outside
consultants in order to remediate all existing material weaknesses and internal
control deficiencies.





Effective
April 27, 2010, the Company’s Board of Directors approved the appointment of Ben
Wang as its Chief Financial Officer.





In
addition, the Company hired a new Internal Audit Manager in July 2010 to help
the Company develop and perform the internal audit functions more properly and
effectively. Specifically, the reporting mechanism between the accounting
department and the Board of Directors and the CFO has been established,
therefore we expect that the risk of failure to comply with the Company’s Code
of Ethics is minimized.





Except as
described above, there were no other changes in our internal control over
financial reporting during the fiscal quarter ended June 30, 2010 that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.





Management
also intends to take the following further specific actions to address the
deficiencies that are identified and strengthen our internal control over
financial reporting:





•
            to implement proper procedures of
      cash disbursement approval-control management under the supervision of the
      Audit Committee of the Board of Directors





•
            to create positions in our
      accounting department to segregate duties of recording, authorizing and
      testing





•
            to increase our accounting and
      financing personnel resources, by retaining more U.S. GAAP knowledgeable
      financial professionals




52







•
            to allocate sufficient resources to
      achieve an effective internal audit
  function





•
            to establish direct reporting
      procedures from the Chief Accounting Officer to the Chief Financial
      Officer to ensure a better overview of the Company’s financial reporting
      system by the
      CFO





•
            to reemphasize to all the
      officers and employees of the Company the Code of Ethics and to ensure all
      officers and employees’full compliance of the Code of
      Ethics





•
            to adopt policies and procedures
      regarding related party transactions and to ensure Audit
      Committee’s review of all interested
      transactions





Our
management, including our Chief Executive Officer and our Chief Financial
Officer, does not expect that our disclosure controls and procedures or our
internal controls will prevent or detect 100% of all errors and fraud that may
occur. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Further, the design of a control system must reflect the fact
that there are resource constraints and the benefits of controls must be
considered relative to their costs. Due to the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within our company have been
detected. And management believes that the steps we are taking are necessary for
remediation of the material weaknesses identified above, and we will continue to
monitor the effectiveness of these steps and to make any changes that our
management deems appropriate.




53






PART
II - OTHER INFORMATION




Item
2. Unregistered Sales of Equity Securities and Use of Proceeds





On
June 21, 2010, Mr. Kennith Johnson received 2,000 shares of Common Stock as the
compensation for his service as the Chairman of Company’s Audit Committee in
year 2009.





Such
issuance of the Company’s securities described herein were effectuated pursuant
to the exemption from the registration requirements of the Securities Act of
1933 (the “Act”), as amended, provided by Section 4(2) of the Act.




Item
5. Other Information.
 
 Effective
April 27, 2010, the Board of Directors appointed Mr. Ben Wang to serve as the
Chief Financial Officer of the Company.  On August 12, 2010, the Company
and Mr. Wang entered into an Employment Agreement (the “Employment Agreement”),
pursuant to which Mr. Wang shall serve as the Company’s CFO for a term of 3
years, which commenced on April 27, 2010. Mr. Wang’s base salary is RMB
1,000,000 per annum after tax, or RMB 83,333 per month, payable monthly in
arrears on the 10th day of
each month. Pursuant to the Employment Agreement, the Company also entered into
a Non-Qualified Stock Option Agreement with Mr. Wang, where Mr. Wang was granted
150,000 options to purchase the Common Stock at an exercise price of $20 per
share, vesting in 3 equal annual installments beginning on April 19, 2011. Each
installment of options, once vested, will expire on the fifth anniversary of its
vesting date.  Copies of the Employment Agreement and the
Non-Qualified Stock Option Agreement with Mr. Wang are filed herewith as Exhibit
10.1 and Exhibit 10.2.
  On August
12, 2010, the Company entered into a Separation Agreement with Yi (Jenny) Liu
(the “Separation Agreement”), who resigned as the Company’s former CFO on April
27, 2010. The Separation Agreement, which amended Section 5(B) of her original
employment agreement with the Company dated June 30, 2009, provided that Ms. Liu
shall receive option to purchase 10,000 shares of the Common Stock at the
exercise price of $6.15 per share, vesting immediately upon the execution of the
Separation Agreement. Such option to purchase 10,000 shares of Common Stock will
expire in three years from the vesting date. Copies of the Separation
Agreement and the Non-Qualified Stock Option Agreement with Ms. Liu are filed
herewith as Exhibit 10.3 and Exhibit 10.4.
 Item
6. Exhibits





(a)
            Exhibits





10.1 –
Employment Agreement, dated August 12, 2010, between the Company and Ben
Wang.





10.2 –
Non-Qualified Option Agreement, dated August 12, 2010, between the Company and
Ben Wang.





10.3 –
Separation Agreement, dated August 12, 2010, between the Company and Yi (Jenny)
Liu.





10.4 –
Non-Qualified Option Agreement, dated August 12, 2010, between the Company and
Yi (Jenny) Liu.





31.1 -
Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.





31.2 -
Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.





32.1 -
Certification of Chief Executive Officer and Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.




54





SIGNATURES





Pursuant
to the requirements of the Securities Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned there unto duly
authorized.




RINO
      INTERNATIONAL CORPORATIONDate:
      August 16, 2010
              By:
              /s/ Zou
      DejunZou
      DejunChief
      Executive Officer






55






INDEX TO
EXHIBITS




EXHIBIT
              NUMBER
            
            DESCRIPTION10.1
            
            Employment
      Agreement, dated August 12, 2010, between the Company and Ben
      Wang.10.2
            
            Non-Qualified
      Option Agreement, dated August 12, 2010, between the Company and Ben
      Wang.10.3
            
            Separation
      Agreement, dated August 12, 2010, between the Company and Yi (Jenny)
      Liu.10.4
            
            Non-Qualified
      Option Agreement, dated August 12, 2010, between the Company and Yi
      (Jenny) Liu.31.1
            
            Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
            
            Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.32.1
            
            Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to Section
      906 of the Sarbanes-Oxley Act of
2002.





56