Attached files
file | filename |
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EX-31.1 - China Energy Recovery, Inc. | v200723_ex31-1.htm |
EX-32.1 - China Energy Recovery, Inc. | v200723_ex32-1.htm |
EX-31.2 - China Energy Recovery, Inc. | v200723_ex31-2.htm |
EX-21.1 - China Energy Recovery, Inc. | v200723_ex21-1.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
DC 20549
FORM
10-K
(Mark
One)
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
fiscal year
ended December
31, 2009
or
¨
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
transition period from
to
Commission
file
number 000-53283
CHINA
ENERGY RECOVERY, INC.
(Exact
Name of Registrant as Specified in its Charter)
Delaware
|
90-0459730
|
|
(State
or Other Jurisdiction of
Incorporation
or Organization)
|
(I.R.S.
Employer
Identification
No.)
|
7F,
No. 267 Qu Yang Road
Hongkou
District, Shanghai
China
|
200081
|
|
(Address
of Principal Executive Offices)
|
(Zip
Code)
|
Registrant's
telephone number, including area
code +86 (0)21
5556-0020
Securities
registered pursuant to Section 12(b) of the Act:
Title
of Each Class
|
Name
of Each Exchange on Which Registered
|
|
NONE
|
Securities
registered pursuant to Section 12(g) of the Act:
Common
stock, par value $0.001
|
(Title
of Class)
|
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes ¨ No
x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes ¨ No
x
NOTE –
Checking the box above will not relieve any registrant required to file reports
pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under
those Sections.
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 ¨ No
x
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405) is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. x
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. (Check one):
Large
accelerated filer
|
¨
|
Accelerated
filer
|
||
Non-accelerated
filer
|
¨
|
Smaller
reporting company
|
x
|
|
(Do
not check if a smaller reporting company)
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes ¨ No x
The
aggregate market value of the voting and non-voting common equity held by
non-affiliates is $6,147,412 [as computed by reference to the price at which the
common equity was last sold, or the average bid and asked price of such common
equity, as of the last business day of the registrant's most recently completed
third fiscal quarter.]
Number of
shares outstanding of the registrant's common stock as of September 30,
2010:
30,934,203
shares of Common Stock, $0.001 par value per share
DOCUMENTS
INCORPORATED BY REFERENCE
None
Table
of Content
PART
I
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5
|
|
Item
1 Business
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5
|
|
Overview
of Our Business
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5
|
|
Our
History
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6
|
|
Organizational
Structure and Subsidiaries
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7
|
|
Industry
Overview
|
11
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|
Global
Market Overview
|
12
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Competitive
Markets and Competition
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13
|
|
Design
and Engineering
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14
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|
Manufacturing
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14
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|
Marketing
and Sales
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15
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|
Products
and Technology
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15
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|
Customers
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17
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|
Intellectual
Property and Other Proprietary Rights
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17
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|
Our
Business Strategy
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18
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|
Raw
Materials and Principal Suppliers
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18
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|
Employees
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19
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Governmental
Regulation
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19
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Compliance
with Environmental Laws
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19
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|
Item
1A Risk Factors
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19
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|
Risks
Related to Our Business
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20
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|
Risks
Related to Our Corporate Structure
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25
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|
Risks
Related to Doing Business in China
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26
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|
Risks
Related to our Common Stock
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28
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|
Risks
Related to Our Company
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30
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|
Item
1B Unresolved Staff Comments
|
32
|
|
Item
2 Properties
|
32
|
|
Item
3 Legal Proceedings
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32
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|
Item
4 [Reserved]
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32
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|
PART
II
|
33
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|
Item
5 Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
|
33
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|
Market
Information
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33
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|
Dividends
|
33
|
|
Recent
Sales of Unregistered Securities
|
34
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|
Securities
Authorized for Issuance under Equity Compensation Plans
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34
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|
Item
6 Selected Financial Data
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35
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2
Item
7 Management's Discussion and Analysis of Financial Condition and
Results of Operations
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35
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|
Overview
|
35
|
|
Critical
Accounting Policies and Estimates
|
39
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Results
of Operations
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44
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|
Liquidity
and Capital Resources
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47
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|
Table
Disclosure of Contractual Obligations
|
50
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Off-Balance
Sheet Arrangements
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52
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Item
7A Quantitative and Quantitative Disclosures about Market
Risk
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52
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Item
8 Financial Statements and Supplementary Data
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52
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Report
of Independent Registered Public Accounting Firm
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F-1
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Note
1 – Organization
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F-6
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Note 2
Restatement of Consolidated Financial Statements for Year ended December
31, 2008
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F-8
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Note
3 – Summary of Significant Accounting Policies
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F-11
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Note
4 – Accounts Receivable
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F-17
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Note
5– Inventories
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F-18
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|
Note
6 – Equipment, Net
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F-18
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Note
7 – Intangible Assets
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F-18
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Note
8 – Short-term Bank Loans
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F-19
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|
Note
9 – Convertible Notes
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F-19
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Note
10 – Taxation
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F-20
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Note
11 – Earnings/(Loss) per Share
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F-22
|
|
Note
12 – Convertible Preferred Stocks
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F-23
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|
Note
13 – Warrant and Derivative Liabilities
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F-24
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|
Note
14 - Stock-Based Compensation
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F-25
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|
Note
15 – Interest Expenses
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F-28
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|
Note
16 – Related Party Transactions
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F-28
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|
Note
17 – Retirement Benefits
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F-28
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|
Note
18 – Statutory Reserve
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F-28
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|
Note
19 – Commitments and Contingencies
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F-29
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|
Note
20 – Subsequent events
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F-30
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|
Note
21 – Restricted Net Assets
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F-31
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Item
9 Change
in and Disagreements with Accountants on Accounting and Financial
Disclosure
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53
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Item
9A (T) Controls and Procedures
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54
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Item
9B Other Information
|
57
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PART
III
|
57
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Item
10 Directors, Executive Officers and Corporate
Governance
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57
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Directors
and Executive Officers
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57
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Family
Relationships
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58
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Section
16(a) Beneficial Ownership Reporting Compliance
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58
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3
Audit
Committee
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59
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Item
11 Executive Compensation
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59
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Outstanding
Equity Awards at Fiscal Year-End
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59
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Option
Exercises
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59
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Item
12 Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
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61
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Item
13 Certain Relationships and Related Transactions, and Director
Independence
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62
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Transactions
with Related Persons
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62
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Director
Independence
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62
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Item
14 Principal Accountant Fees and Services
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62
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PART
IV
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63
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||
Item
15 Exhibits and Financial Statement Schedules
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63
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4
PART I CAUTIONARY NOTE
REGARDING FORWARD LOOKING STATEMENTS
This
Annual Report on Form 10-K and other materials we will file with the U.S.
Securities and Exchange Commission (the "SEC") contain, or will contain,
disclosures which are forward-looking statements. Forward-looking statements
include all statements that do not relate solely to historical or current facts,
such as, but not limited to, the discussion of economic conditions in market
areas and their effect on revenue growth, the discussion of our growth strategy,
the potential for and effect of future governmental regulation, fluctuations in
global energy costs, the effectiveness of our management information systems,
and the availability of financing and working capital to meet funding
requirements, and can generally be identified by the use of words such as "may,"
"believe," "will," "expect," "project," "estimate," "anticipate," "plan" or
"continue." These forward-looking statements are based on our management's
current plans and expectations and are subject to certain risks and
uncertainties that could cause actual results to differ materially from
historical results or those anticipated. These risks and uncertainties include,
but are not limited to: our limited operating history; our ability to
effectively market our products and services; the loss of key personnel; our
inability to attract and retain new qualified personnel; our capital needs and
the availability of and costs associated with potential sources of financing;
adverse effects of the current turmoil in the credit markets; adverse effects of
the current depressed global economic conditions; our inability to increase
manufacturing capacity to meet demand; economic conditions affecting
manufacturers of energy recovery systems and the industry segments they serve;
our dependence on certain customer segments; difficulties associated with
managing future growth; our failure to protect our intellectual property rights;
allegations of claims of infringements of intellectual property rights brought
against us; the loss of our ability to sell and install energy recovery systems
made by third parties or such systems manufactured by us under licenses from
third parties; fluctuations in currency exchange rates; our failure to comply
with applicable environmental regulations; increased competition in our
industry; our exposure to litigation from performing work on our customers'
properties; an increase in warranty claims; our liability for injuries caused by
our products; our inability to cover damages owed by insurance; fluctuations in
energy prices resulting in fluctuating demand for our products and services;
risks related to our corporate structure, such as our inability to control our
affiliated entities and conflicts of interest between our Chief Executive
Officer’s duties to us and to our affiliated entities; the uncertainties
associated with the environmental, economic, political and legal conditions in
China and changes thereof; the adverse effect of governmental regulation and
other matters affecting energy recovery system manufacturers; Chinese
restrictions on foreign currency exchange transactions; restrictions on foreign
investments in China; ineligibility for and expiration of current Chinese
governmental incentives; natural disasters and health related concerns; the
development of an active trading market for our common stock; the loss of
coverage of our common stock by securities analysts; the failure of our
complying with securities laws in private placements; our common stock being a
penny stock; a sudden increase in the number of shares of our common stock in
the market as a result of Rule 144 sales or conversion or exercise of derivative
securities, and our failure to maintain adequate internal controls over
financial reporting.
These
forward-looking statements speak only as of the date of this Annual Report on
Form 10-K. Except as required by law, we undertake no obligation to publicly
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise. You should also read, among other
things, the risks and uncertainties described in the section of this Annual
Report on Form 10-K entitled "Risk Factors."
Item
1 Business
Overview
of Our Business
China
Energy Recovery, Inc. (the "Company," "we," "us," or "our") is headquartered in
Shanghai, China, and, through its subsidiaries and affiliates, is in the
business of designing, fabricating, implementing and servicing industrial energy
recovery systems. The Company's energy recovery systems capture industrial waste
energy for reuse in industrial processes or to produce electricity and thermal
power, thereby allowing industrial manufacturers to reduce their energy costs,
shrink their emissions and generate sellable emissions credits. A majority of
the manufacturing takes place at the Company's leased manufacturing facilities
in Shanghai, China. The Company transports the manufactured systems in parts via
truck, train or ship to the customers' facilities where the system is assembled
and installed. The Company has primarily sold energy recovery systems to
chemical manufacturing plants to reduce their energy costs by increasing the
efficiency of their manufacturing equipment. The Company has installed over 120
energy recovery systems both in China and internationally. The Company mainly
sells its energy recovery systems and services directly to
customers.
5
Our
History
Unless
otherwise noted, the disclosures about our history reflect the Company's capital
structure as of the time of the occurrences described and do not take into
account subsequent stock splits or other adjustments to the Company's capital
structure.
We
incorporated in the State of Maryland in May 1998 under the name Majestic
Financial, Ltd. We changed our name to Commerce Development Corporation, Ltd. in
April 2002. Effective June 5, 2007, we changed our name to MMA Media
Inc.
On
January 24, 2008, we entered into a Share Exchange Agreement (the "Share
Exchange Agreement") with Poise Profit International, Ltd., a private British
Virgin Islands corporation ("Poise Profit"), and Poise Profit's shareholders
pursuant to which we agreed to acquire all of the issued and outstanding shares
of Poise Profit's common stock in exchange for the issuance of 41,514,179 shares
of our common stock (on a post-1-for-9 stock split basis approved by our board
of directors in connection with entering into the Share Exchange Agreement) to
Poise Profit's shareholders (the "Share Exchange").
On
January 25, 2008, we entered into and closed an Asset Purchase Agreement with
MMA Acquisition Company, a Delaware corporation, pursuant to which we sold
substantially all of our assets to MMA Acquisition Company in exchange for MMA
Acquisition Company's assuming a substantial majority of our outstanding
liabilities. The transferred assets consisted of letters of intent for the
proposed acquisitions of MMAWeekly.com, dated June 9, 2007, and Blackbelt TV,
Inc., dated July 16, 2007, and all shares of common stock in Blackbelt TV, Inc.
we owned, among other things. The total book value of the assets acquired was
approximately $317,000. The assumed liabilities consist of accounts payable,
convertible debt, accrued expenses and shareholder advances of approximately
$360,000.
Effective
February 5, 2008, we changed our name to China Energy Recovery, Inc. and
conducted a 1-for-9 reverse stock split of our issued and outstanding capital
stock pursuant to which each nine shares of our common stock issued and
outstanding on the record date of February 4, 2008 was converted into one share
of our common stock. We had 84,922,000 shares of common stock issued and
outstanding immediately prior to the reverse stock split and 9,435,780 shares
thereafter.
On April
15, 2008, we closed the Share Exchange pursuant to which we acquired all of the
issued and outstanding shares of Poise Profit's common stock in exchange for the
issuance of 41,514,179 shares of our common stock to Poise Profit's
stockholders. Upon the closing of the Share Exchange, Poise Profit became our
wholly-owned subsidiary and our business operations consisted of those of Poise
Profit's wholly-owned subsidiary, HAIE Hi-tech Engineering (Hong Kong) Company,
Limited ("Hi-tech"), incorporated in the Hong Kong Special Administration
Region, China.
Also on
April 15, 2008 and as a condition to closing of the Share Exchange, we entered
into Securities Purchase Agreements (the "Securities Purchase Agreement") with
25 accredited investors pursuant to which we issued and sold an aggregate of
7,874,241 units at a price per unit of $1.08 with each unit consisting of one
share of our Series A Convertible Preferred Stock, par value $0.001 per share,
and one warrant to purchase one-half of one share of our common stock at an
exercise price of $1.29 per share (the "Financing"). Thus, at the closing of the
Financing, we issued 7,874,241 shares of our Series A Convertible Preferred
Stock to the investors and we also issued warrants to the investors for the
purchase of an aggregate of 3,937,121 shares of our common stock for an
aggregate purchase price of $8,504,181. After the April 16, 2008 1-for-2 reverse
stock split described below, the warrants are exercisable into 1,968,561 shares
of common stock at an exercise price of $2.58.
On April
16, 2008, we conducted a 1-for-2 reverse stock split of our issued and
outstanding capital stock pursuant to which each two shares of our common stock
issued and outstanding on the record date of April 15, 2008 was converted into
one share of our common stock. We had 50,949,959 shares of common stock issued
and outstanding immediately prior to the reverse stock split and 25,474,980
shares thereafter.
6
On May 6,
2008, we filed a registration statement on Form S-1 to register for resale
certain shares of our common stock held by selling stockholders. The
registration statement became effective on September 8, 2009.
On June
17, 2008, we filed a registration statement on Form 8-A to register our common
stock under Section 12(g) of the Securities Exchange Act of 1934, as amended
(the "Exchange Act").
Starting
in the summer of 2008, we began a reorganization of our corporate structure as
further described under the caption "Organizational Structure and Subsidiaries"
below.
As a
result of the closing of the Share Exchange on April 15, 2008, our new business
operations consist of those of Poise Profit's Chinese subsidiary, Hi-tech, which
were subsequently transferred to CER (Hong Kong) Holdings Limited (“CER Hong
Kong”) as described in Item 1 Business - Organizational Structure and
Subsidiaries. CER Hong Kong is principally engaged in designing, marketing,
licensing, fabricating, implementing and servicing industrial energy recovery
systems capable of capturing industrial waste energy for reuse in industrial
processes or to produce electricity and thermal power.
Organizational
Structure and Subsidiaries
After
closing of the Share Exchange, our organizational structure reflected Chinese
limitations on foreign investments and ownership in Chinese businesses.
Generally, these limitations prevent a U.S. corporation from owning directly
certain types of Chinese businesses. Instead, a U.S. corporation can obtain the
benefits and risk of equity ownership of a Chinese business either by being a
part-owner of a Chinese joint venture or by entering into fairly extensive and
complicated contractual relationships with Chinese companies wholly-owned by
Chinese owners. At that time, and still to a significant extent, our business
relied on contractual relationships. However, we began a corporate
reorganization process in the summer of 2008 to gradually move our assets and
operations from affiliated entities with which we have only contractual
relationships into wholly-owned subsidiaries. Until our reorganization is
complete, our corporate structure will reflect a combination of control via
direct ownership and contractual arrangements.
Poise
Profit, a wholly-owned subsidiary of the Company, was incorporated on November
23, 2007 under the laws of the British Virgin Islands. Poise Profit, in turn,
owns 100% of the issued and outstanding equity interests in Hi-tech and CER
(Hong Kong) Holdings Limited ("CER Hong Kong"). Historically, all of our
operations were conducted through Hi-tech via contractual arrangements with
affiliated Chinese entities, but we are in the process of transferring our
assets and operations from Hi-tech to CER Hong Kong and its wholly-owned
subsidiary CER Energy Recovery (Shanghai) Co., Ltd. ("CER Shanghai"). As part of
our reorganization, CER Hong Kong was incorporated on August 13, 2008 under the
laws of the Hong Kong Special Administrative Region, China and was originally
jointly owned by Mr. Qinghuan Wu, one of our directors and our Chairman of the
Board and Chief Executive Officer, and his spouse, Mrs. Jialing Zhou, who is one
of our directors. On December 3, 2008, Mr. Qinghuan Wu and Mrs. Zhou transferred
ownership of CER Hong Kong to Poise Profit. CER Shanghai was incorporated on
November 11, 2008 as a wholly foreign-owned enterprise in Shanghai, China. After
our reorganization is complete, CER Shanghai will be our primary operating
entity in China and CER Hong Kong will be our primary holding entity holding all
equity interests in our Chinese subsidiaries, including CER Shanghai. While we
are gradually transferring our current assets and operations to CER Shanghai, we
plan that CER Shanghai will enter into the majority of all new business
contracts.
At the
time of the closing of the Share Exchange, Hi-tech owned 90% of a joint venture
called Shanghai Haie Investment Consultation Co., Ltd. ("JV Entity"), a company
organized in Shanghai, China, providing investment consultancy services,
enterprise management consultancy services and marketing policy planning
services to third-party customers as well as affiliates. The remaining 10% was
owned by Shanghai Engineering. In compliance with the new Chinese regulation
effective January 2008, on June 16, 2008, JV Entity's board of directors
approved a plan to dissolve JV Entity. The application for dissolution was
approved by the Chinese governmental authority in July 2008. We dissolved JV
Entity on September 1, 2008 and its assets, in the form of an initial capital
contribution from Hi-tech, were returned to Hi-tech on September 18,
2008.
7
Before
December 3, 2008, all of our operations were conducted through Hi-tech and its
affiliated companies. Hi-Tech was engaged in the marketing and sale of energy
recovery systems which were designed, manufactured and installed by affiliated
companies. Hi-tech had entered into contractual relationships with two entities
incorporated in Shanghai, China: Shanghai Hai Lu Kun Lun Hi-tech Engineering
Co., Ltd. ("Shanghai Engineering") and Shanghai Xin Ye Environmental Protection
Engineering Technology Co., Ltd. ("Shanghai Environmental"). Each of Shanghai
Engineering and Shanghai Environmental was considered a "variable interest
entity" and its financial information was consolidated with Hi-tech's pursuant
to the Accounting Standard Codification (“ASC”) 810-10. Hi-tech entered into
contractual relationships with Shanghai Engineering and Shanghai Environmental
to comply with Chinese laws regulating foreign-ownership of Chinese companies.
Shanghai Engineering is engaged in the business of designing, manufacturing and
installing energy recovery systems. All manufacturing is done by Vessel Works
Division pursuant to a cooperative manufacturing agreement between Shanghai
Engineering and Vessel Works Division's parent, Shanghai Si Fang Boiler Factory
("Shanghai Si Fang"), as further described below. Vessel Works Division holds
important permits for the manufacturing and installation of boilers used in our
energy recovery systems. Shanghai Environmental is not an operating company but
it served in the past as a vehicle for arranging sales and maximizing tax
benefits. We did not use Shanghai Environmental for these purposes during our
2009 fiscal year and do not intend to do so in the future. We intend to start
the process to dissolve Shanghai Environmental in 2010. Shanghai Engineering is
owned jointly by Mr. Qinghuan Wu, our Chairman of the Board and Chief Executive
Officer, and his spouse, Mrs. Jialing Zhou, who is one of our directors.
Shanghai Environmental is wholly-owned by Mr. Qinghuan Wu.
The
material contractual relationships between Hi-tech and each of Shanghai
Engineering and Shanghai Environmental consisted of:
|
·
|
Consulting
Services Agreements - These agreements allow Hi-tech to manage and operate
Shanghai Engineering and Shanghai Environmental, and collect the
respective net profits of each company. Under the terms of the agreements,
Hi-tech is the exclusive provider of advice and consultancy services to
Shanghai Engineering and Shanghai Environmental, respectively, related to
the companies' general business operations, human resources needs and
research and development, among other things. In exchange for such
services, each of Shanghai Engineering and Shanghai Environmental must pay
to Hi-tech such company's respective net profits. Hi-tech will own all
intellectual property rights developed or discovered through research and
development in the course of providing services under the agreements but
will grant a license to use such intellectual property back to the
respective company if necessary to conduct the business. Each of Shanghai
Engineering and Shanghai Environmental are required to cause their
respective shareholders to pledge such shareholders' equity interests in
the respective companies to secure the fee payable by Shanghai Engineering
and Shanghai Environmental, respectively, under the agreements. The
agreements contain affirmative covenants requiring each of Shanghai
Engineering and Shanghai Environmental to take certain actions, such as
(but not limited to) delivering periodic financial reports to Hi-tech. The
agreements also contain negative covenants preventing each of Shanghai
Engineering and Shanghai Environmental from taking certain actions such as
(but not limited to) issuing equity, incurring indebtedness and changing
its business. The agreements are effective until terminated and they may
be terminated by Hi-tech for any or no reason and by either party for
reasons explicitly set forth in the agreements, including (but not limited
to) a breach by the other party or the other party's becoming bankrupt or
insolvent. The parties may not assign or transfer their rights or
obligations under the respective agreements without the prior written
consent of the other party, except that Hi-tech may assign its rights or
obligations under the agreements to an
affiliate.
|
|
·
|
Operating
Agreements - The parties to each of these agreements are Hi-tech, Shanghai
Engineering, Shanghai Environmental, respectively, and all of the
shareholders of each of Shanghai Engineering and Shanghai Environmental,
respectively. Under the agreements, Hi-tech guarantees the contractual
performance by each company under any agreements with third parties, in
exchange for a pledge by each of Shanghai Engineering and Shanghai
Environmental of all of its respective assets, including accounts
receivable. Hi-tech has the right to approve any transactions that may
materially affect the assets, liabilities, rights or operations of each
company and provide, binding advice regarding each company's daily
operations, financial management and employment matters, including the
dismissal of employees. In addition, Hi-tech has the right to recommend
director candidates and appoint the senior executives of each company. The
agreements expire 10 years from execution unless renewed. Hi-tech has the
right to terminate each of the agreements upon 30 days' written notice but
Shanghai Engineering and Shanghai Environmental do not have the right to
terminate their respective agreement during its term. Hi-tech may freely
assign its rights and obligations under the agreements upon written notice
to Shanghai Engineering and Shanghai Environmental, respectively. Shanghai
Engineering and Shanghai Environmental may not assign their rights or
obligations under the respective agreements without the prior written
consent of Hi-tech.
|
8
|
·
|
Proxy
Agreements - Hi-tech has entered into proxy agreements with all of the
shareholders of each of Shanghai Engineering and Shanghai Environmental
under which the shareholders have vested their voting power of the
companies in Hi-tech and agreed to not transfer the shareholders'
respective equity interests in the two companies to anyone but Hi-tech or
its designee(s). The agreements do not have an expiration date. Hi-tech
has the right to terminate each of the agreements upon 30 days' written
notice but the shareholders may not terminate the agreements without
Hi-tech's consent.
|
|
·
|
Option
Agreements - The parties to each of these agreements are Hi-tech, Shanghai
Engineering, Shanghai Environmental, respectively, and all of the
shareholders of each of Shanghai Engineering and Shanghai Environmental,
respectively. The shareholders of each of Shanghai Engineering and
Shanghai Environmental have granted Hi-tech or its designee(s) the
irrevocable right and option to acquire all or a portion of such
shareholders' equity interests in the two companies. The shareholders have
also agreed not to grant such an option to anyone else. The purchase price
for a shareholder's equity interests will be equal to such shareholder's
original paid-in price for such equity interest. Pursuant to the terms of
the agreements, the shareholders and each of Shanghai Engineering and
Shanghai Environmental have agreed to certain restrictive covenants to
safeguard Hi-tech's rights under the respective agreement. The agreements
expire 10 years from execution unless renewed. Hi-tech may freely assign
its rights and obligations under the agreements upon written notice to
Shanghai Engineering, Shanghai Environmental and the shareholders,
respectively. Shanghai Engineering, Shanghai Environmental and the
shareholders, respectively, may not assign their rights or obligations
under the respective agreements without the prior written consent of
Hi-tech.
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·
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Equity
Pledge Agreements - The parties to each of these agreements are Hi-tech,
Shanghai Engineering, Shanghai Environmental, respectively, and all of the
shareholders of each of Shanghai Engineering and Shanghai Environmental,
respectively. The shareholders of each of Shanghai Engineering and
Shanghai Environmental have pledged all of their respective equity
interests in the two companies to Hi-tech to guarantee each of Shanghai
Engineering and Shanghai Environmental performance of these companies'
respective obligations under the Consulting Services Agreements. The
pledge expires two years after the obligations under the Consulting
Services Agreements described above are fulfilled. Hi-tech has the right
to collect any and all dividends paid on the pledged equity interests.
Pursuant to the terms of the agreements, the shareholders and each of
Shanghai Engineering and Shanghai Environmental have agreed to certain
restrictive covenants to safeguard Hi-tech's rights under the respective
agreement. Upon an event of default under the agreements, Hi-tech may
vote, control, sell or dispose of the pledged equity interests and may
require the shareholders to pay all outstanding and unpaid amounts due
under the Consulting Services Agreement. Pursuant to the terms of the
agreements, the shareholders have agreed to certain restrictive covenants
to safeguard Hi-tech's rights under the respective agreement. Hi-tech may
freely assign its rights and obligations under the agreements upon written
notice to the shareholders. The shareholders may not assign their rights
or obligations under the respective agreements without the prior written
consent of Hi-tech.
|
On
December 3, 2008, as a part of our reorganization, all of the above-referenced
contracts between Hi-tech and Shanghai Engineering and between Hi-tech and
Shanghai Environmental were transferred to CER Hong Kong. Since that date, CER
Hong Kong has been engaged in the marketing and sale of energy recovery systems
which are designed, manufactured and installed by its subsidiaries and
affiliated companies.
All of
Shanghai Engineering’s manufacturing activities are conducted through a Leasing
and Operation Agreement, a form of cooperative manufacturing agreement,
originally effective as of May 1, 2003 and subsequently renewed and amended with
a state-owned enterprise, Shanghai Si Fang. Pursuant to the
agreement, Shanghai Si Fang leases certain land use right, buildings and fixed
assets (lease elements) in one of its subsidiaries, Vessel Works Division, and
provides management services and licenses the “Si Fang” brand and manufacturing
license (non-lease elements) of Vessel Works Division to Shanghai
Engineering. Because the arrangement contains both the lease and
non-lease elements, the amount of quarterly payment is allocated between the
lease and non-lease deliverables. The lease elements are classified
and accounted for as operating leases and the lease expense is recorded on a
straight-line basis. The non-lease elements are accounted for as
prepayment for management and licensing fees and the payment is amortized on a
straight-line basis over each contractual period.
9
Shanghai
Engineering does not have a variable interest in Vessel Works Division through
this agreement as the arrangement is established between Shanghai Engineering
and Shanghai Si Fang. Shanghai Engineering does not have any
contractual or ownership interest in Vessel Works Division, and therefore,
Shanghai Engineering does not have variable interests in Vessel Works
Division.
The
arrangement, however, may result in Shanghai Engineering having variable
interests in Shanghai Si Fang, but as Shanghai Si Fang is a state-owned
enterprise that has substantive operations other than this lease and operation
arrangement, Shanghai Engineering is not the primary beneficiary of Shanghai Si
Fang.
In August
2009, CER Hong Kong entered into a series of contracts with Yangzhou (Yizheng)
Automobile Industrial Park Administration Committee, a government entity of the
City of Yangzhou, Jiangsu Province, China, to acquire a tract of land on which
CER Hong Kong plans to build a new manufacturing facility. The plant is
currently under construction, and is expected to be completed by December 2010.
Once the plant is operational, we intend to transfer the production function of
Vessel Works Division to CER Yangzhou.
The
following is an organizational chart setting forth the current status of the
Company's subsidiaries and affiliated companies as of December 31
2009:
10
Industry
Overview
Global
demand is increasing for innovative environmental protection and renewable
energy solutions for sustainable economic growth. Modern industrial nations and
emerging markets today are faced with the growing challenge of reducing and
controlling air pollution emissions that present serious health risks to
national populations, cross international borders, and damage the environment.
Increased energy consumption has forced governments and industries to invest in
improving energy efficiency and alternative forms of power generation and
conservation. As the global power generation industry and manufacturing
industries increase their focus on improving efficiency and mitigating the
environmental impact of their processes, we believe that energy recovery systems
will play a major role in improving the output that can be obtained from current
supplies.
Energy
recovery systems can salvage the majority of the wasted energy from excess heat
that industrial manufacturing facilities and power plants release into the
atmosphere in the form of hot exhaust gases or high pressure steam by converting
the heat into electricity (often through steam driven generator turbines) which
can be used in industrial processes, thereby lowering energy costs. In addition,
energy recovery systems can also capture harmful pollutants that would otherwise
be released into the environment from certain industrial processes. These
reduced emissions can also help companies meet environmental regulations. Energy
recovery systems may also be used in heat recovery applications whereby excess
heat may be used to heat buildings and water. Examples of end-users of this type
of energy recovery system include hospitals and schools that may heat their
buildings and water with excess heat generated by their own large electrical
equipment. This type of energy recovery system is less complicated and requires
significantly less technical qualifications to build than the industrial energy
recovery systems described above as it is essentially redirecting the heat
generated by one system into other on-site systems. As a result, this type of
energy recovery system is cheaper to build and the barriers to entry into this
market are lower than in the market for industrial energy recovery systems. Our
business focuses on energy recovery systems for industrial
applications.
We
believe that energy recovery systems represent a large-scale, environmentally
friendly and economically feasible form of power generation and tool for
improving energy efficiency. Compared with other alternative forms of power,
such as solar, wind or biomass, we believe that energy recovery systems are
dramatically more affordable for technology capable of delivering power on the
scale necessary for industrial clients. In our opinion, energy recovery systems
are cost competitive even with large-scale, traditional power sources such as
coal, fossil fuels and nuclear power, but have the added benefit of reducing
pollution and greenhouse gas emissions.
According
to recent studies from the U.S. Department of Energy and the U.S. Environmental
Protection Agency, energy recovery systems could generate nearly 200 gigawatt
("GW") new power, equivalent to approximately 20% of current U.S. power
generation capacity. The European Union is a significant user of energy recovery
systems, with 104 GW installed power generating capacity. Germany and Italy have
the most installed capacity at 16 GW and 13 GW, respectively.
We have
developed and commercialized our proprietary customized energy recovery
technologies and solutions to cost-effectively reduce pollution and capture the
waste heat released by our customer's industrial processes. Our energy recovery
systems can help our customers improve their energy use efficiency. For example,
our energy recovery systems applied in sulfuric acid manufacturing processes can
produce as much as three times the useable energy from the same fuel by
recovering otherwise lost energy and reusing it in the manufacturing processes
directly or to further generate electrical power, which may allow customers to
slash energy expenditures by up to two-thirds. Additionally, these systems can
reduce harmful emissions resulting from certain types of sulfuric acid
manufacturing processes that otherwise would have been released into the
atmosphere. Other benefits include our customers' ability to sell carbon
credits, reduction of flue gas and equipment sizes of all flue gas handling
equipment such as fans, stacks, ducts, and burners, and a reduction in auxiliary
energy consumption.
The most
notable target customers for our energy recovery systems are major types of
industrial manufacturing facilities, such as chemical plants, petrochemical
plants, paper manufacturing plants, oil refineries, cement plants, steel mills,
etc. These types of customers generally operate manufacturing equipment that
release waste heat into which our energy recovery systems can be implemented and
integrated to capture such waste heat for direct reuse or, if connected with
steam-driven turbines, to produce electricity.
11
In March
2010, the Chinese People's Political Consultative Conference (“CPPCC”) and
National People's Congress (“NPC”) convened, during which the No 1 proposal on
low carbon: Suggestion On Promotion of Low Carbon Life and Improve Social
Sustainable Development, proposed by Jiu San Society, was highly received by the
NPC and CPPCC; over 10% proposals of CPPCC and NPC were related to low carbon
issues. The Government Work Report of 2009, issued by Premier Wen Jiabao,
addressed that Energy Saving and Environmental Protection is one of the ninth
Key jobs of the government in 2010, which means low carbon will be a State
Strategy in the near future. The issues mentioned above implied that the energy
saving industry should experience significant growth over the next few years.
Furthermore, at the Copenhagen Climate Conference, Premier Wen Jiabao announced
that China would decrease carbon emission by 40%-45% in 2020, as compared with
2005, which is further evidence that the Energy Saving industry should
experience significant growth in the near future in China, which should benefit
CER to grow its business in the domestic Chinese market.
Global
Market Overview
The world
currently faces fundamental problems with its energy supply, which are due
primarily to the reliance on fossil fuels. The economic prosperity of the
wealthiest nations in the twentieth century was built on a ready supply of
inexpensive fossil fuel and developing nations have continued in the
twenty-first century to consume fossil fuel reserves at an ever increasing rate.
This has led to worldwide reserve depletions, indicating that both oil and gas
are likely to be effectively exhausted before the end of this century. Only coal
reserves are expected to last into the next century. Yet even if fossil fuel
supplies were unconstrained, their continued use poses its own problems. All
fossil fuel combustion produces carbon dioxide, which appears to result in the
warming of the earth's atmosphere with profound environmental implications
across the globe.
These
problems have resulted in the realization that the world must both increase the
efficiency of its utilization of fossil fuels and decrease its reliance upon
them. Environmental issues related to fossil fuel combustion arose first during
the 1980s with the advent of acid rain, a product of the sulfur and nitrogen
emissions from fossil fuel combustion. Power plants were forced by legislation
and economic measures to control these emissions. However it is the recognition
of global warming that presents the most serious challenge because carbon
dioxide exists at much higher levels in the flue gases of power plants and major
types of industrial manufacturing facilities than sulfur dioxide and nitrogen
oxides.
Although
renewable energy capacity offers a hedge against major price rises because most
renewable technologies exploit a source of energy that is freely available, many
renewable technologies today still rely on government subsidies to make them
competitive. Governments may also impose penalties upon companies, such as
carbon trading schemes, which discourage the use of fossil fuels or increase its
costs by imposing stringent emissions limits.
Given the
international concerns regarding global warming and pollution and the need to
more efficiently utilize fossil fuels, we believe that there exists substantial
worldwide demand and a growing market for technologies that can enable companies
to generate greater amounts of energy from the same supply of fossil fuels and
that also reduce the amount of harmful emissions that would otherwise be
released from the combustion of those fossil fuels. These technologies,
including energy recovery systems, could benefit companies by both reducing
energy costs and mitigating possible emissions penalties.
China
Market Overview
Booming
economic growth and rapid industrialization has spurred demand for electric
power in China over the previous few years. For example, by the end of 2009,
China's total installed generating capacity reached 874 GW, an increase of more
than 10% over the capacity at the end of 2008. Due to the expansion of energy
intensive industrial sectors such as steel, cement, and chemicals, China's
energy consumption has been growing faster than the country's gross domestic
product ("GDP") and thus causing a shortage of electricity and coal and
blackouts in over 20 of the country's 32 provinces, autonomous regions and
municipalities. With the rapid modernization and industrialization of the
country's economy, China is the world's second largest consumer of energy after
the United States with its demand now accounting for over 17% of the world's
energy consumption. According to the International Energy Agency, China needs to
add 1,300 GW to its electricity-generating capacity, more than the total
installed capacity currently in the United States, to meet its demands over the
next several years. We predict that the result of this massive increase in
electric generation capacity will be a rapid rise in harmful emissions. China
has already surpassed the United States to become the world's largest emitter of
greenhouse gases, and the country faces enormous challenges from the pollution
brought about by its energy needs. Only 1% of China's 560 million city dwellers
breathe air considered safe by EU standards, environmental problems have led to
industrial cities where people rarely see the sun, and birth defects in infants
have soared nearly 40% since 2001. In addition, sulfur dioxide and nitrogen
oxides released by coal-fired power plants in China fall as acid rain on Seoul,
South Korea and Tokyo, Japan. A 2005 report by Chinese environmental experts,
quoted in a New York Times article ("As China Roars, Pollution Reaches Deadly
Extremes," August 26, 2007), estimates that annual premature deaths attributable
to outdoor air pollution in China were likely to reach 380,000 in 2010 and
550,000 in 2020.
12
In
November 2009, the Chinese government announced a "voluntary action" before the
Copenhagen Conference to reduce the intensity of carbon dioxide emissions per
unit of GDP in 2020 by 40 to 45 percent compared with 2005 levels, in order to
address global climate change.
On March
1, 2010, the National Development and Reform Commission also confirmed that the
government would take concrete actions to develop a low-carbon
economy.
China
would include the low-carbon targets in the 12th five-year plan for national
economic development (2011-2015) to build an energy-saving, ecologically
friendly society, the commission said.
It would
launch a series of technological and fiscal support policies to promote the use
of non-fossil, renewable energies including wind, solar, biomass, geothermal and
nuclear power, aiming to increase its proportion of primary energy consumption
to about 15 percent by 2020 from 9.9 percent at year-end 2009.
Use of
alternative and renewable energy is expanding rapidly in China and currently
contributes more than 23% to total electricity generation and 9.9% to total
primary energy supply. In China the generation capacity of electricity from
renewable energy is dominated by hydropower, which accounted for more than 95%
of the total electricity from renewable energy in 2009 to reduce the country's
current reliance on coal-fired generation, the Chinese government is stepping up
efforts to accelerate the development of renewable energy. The Renewable Energy
Law, which came into effect on January 1, 2006, along with a number of incentive
policies ranging from tax incentives to subsidies, have been introduced to
stimulate investment in renewable energy technologies. This includes development
of 300 GW of hydropower, 30 GW of wind power, 30 GW of biomass power, 1.8 GW of
solar photovoltaic systems, and smaller amounts of solar thermal and geothermal
power. Business Insights, a company involved in providing strategic market and
company analyses, estimates that realizing this target would require
approximately 130 GW of new renewable energy capacity with an investment of up
to $184 billion.
Competitive
Markets and Competition
Competition
in the energy recovery system industry generally is divided by segment following
the differentiation between low-grade energy recovery systems used for heat
recovery applications (lower power extraction/generation capacity) and
high-grade energy recovery systems used in industrial applications (higher power
extraction/generation capacity).
Most of
the players in the market are engineering firms that produce low-grade energy
recovery systems for heat recovery applications mainly used by schools,
hospitals and similar facilities. These products are generally undifferentiated
and require lower levels of capital to develop. This type of energy recovery
system is less complicated and requires significantly less technical
qualifications to build than high-grade industrial energy recovery systems. As a
result, this type of energy recovery system is cheaper to build and the barriers
to entry into this market are lower than in the market for industrial energy
recovery systems.
High-grade
energy recovery systems for industrial applications, like ours, require large
amounts of capital investment and high levels of expertise resulting in barriers
to entry to most prospective market entrants. Because energy recovery systems of
this type are highly customized based on the particular customer's need,
manufacturers mainly compete based on their respective engineering capabilities.
The manufacturers of industrial energy recovery systems generally fall into one
of the following classifications:
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1
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Companies
that specialize exclusively in energy recovery systems and account for the
majority of the larger and more advanced production of energy recovery
systems; and
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13
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2
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Major
equipment manufacturers for which energy recovery systems are not a key
focus but which have the necessary resources to build effective
systems.
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Barriers
to entry for the production of high grade energy recovery systems have resulted
in a majority of the global sales for energy recovery systems being generated by
a few large players. These industry participants focus on large scale projects
leaving many intermediate opportunities for companies such as ours. The largest
of these players globally include Babcock-Hitachi (Japan), Foster Wheeler (USA),
and Mitsubishi Heavy Industries (Japan). The major players in China include Dong
Fang Boiler Group, Wuhan Boiler, Hangzhou Boiler Group, and Anshan
Boiler.
We are
principally engaged in designing, manufacturing, installing and servicing
fully-customized energy recovery systems. While most of our competitors only
offer one or two off-the-rack models, we develop products across varying
specifications to best suit each customer's needs and objectives. Our products
can recycle as much as 70% of the energy that would otherwise have been
lost.
We
believe that our products enable our customers to achieve substantial gains in
energy efficiency and we continue to carry out research and development
activities along with the design and engineering activities for customers’
projects to enhance efficiencies and decrease environmental impact. We employ
approximately 90 highly trained engineers in our engineering team and are
planning to hire more.
We have
targeted our products at industrial sectors with significant amounts of waste
heat. These sectors include:
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Chemical
and Petrochemical Industries;
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Paper
Manufacturing;
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Refining
Industry; and
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Metallurgical
Industry.
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We
differentiate ourselves from our competitors by specializing in energy recovery
systems and being one of the few players in the market capable of providing
engineering, procurement and construction ("EPC") services for waste heat
recovery (as further described below under the caption "Products and
Technology"). Although we have the capacity and ability to provide EPC services,
it was relatively rare in the past that a customer requests such services. For
example, we did not enter into any EPC contracts in 2006 but entered into three
EPC contracts upon customers' request in 2007 and 2008. The number of EPC
contracts increased to four in 2009, and the revenue generated from EPC
contracts increased to 43.6% of the total revenue. We believe that we are
currently a dominant player in energy recovery systems to sulfuric acid
manufacturers in China. We believe that energy recovery systems for sulfuric
manufacturing are the most difficult to design and engineer due to the strong
corrosive character of the sulfuric acid.
Design
and Engineering
Our
primary design and engineering facility is located in Shanghai, China. The
facility employs approximately 100 engineers. Approximately 70 of the engineers
engage in project design, customizing the energy recovery systems to meet the
individual needs of various industries. The others manage our production
processes at the facility. We believe that our engineering team is highly
experienced and accomplished in its field.
Manufacturing
We
operate a manufacturing facility, owned by Shanghai Si Fang through Shanghai
Engineering as further described above, in Shanghai, China. The facility
occupies approximately 10 acres (4 hectares) of land with approximately 191,300
square feet of manufacturing space and storage. We employ a team of 230 skilled
workers, technicians and quality assurance personnel at the manufacturing
facility. Our employees utilize a vast array of equipment including lathes,
drills, metal cutting machines, forging equipment, handling equipment (cranes),
welding machines, and testing equipment. A majority of the equipment is leased
from Shanghai Si Fang pursuant to the cooperative manufacturing agreement
described above. This equipment will remain the property of Shanghai Si Fang
when the agreement expires. Shanghai engineering does not own the facility but
leases it from Shanghai Si Fang.
14
In August
2009, we started to build our new manufacturing base in Yangzhou Auto Industry
Park, Jiangsu Province. The new factory will be about 300,000 square meters,
with a total investment is about USD 60 million. Total registered capital is USD
20 million. One special railway is planned from Yizheng railway station leading
directly to the plant. Meanwhile, there are three ports adjoining the Park:
Yangzhou Port, Yizheng Liquid Dock of Nanjing Port Inc. and Yihua Port. Our
objective is to construct a facility for the manufacturing of energy-saving and
highly effective waste heat boilers, and also for the manufacturing of Pressure
Vessels and other equipment, forming the capability of manufacturing Level-A
boilers and Class I, II and III pressure vessels. Our plan is to establish CER
(Yangzhou) as an international manufacturing base of waste heat equipment,
leading in both products and technology. More specifically, we plan to make
energy-saving and highly effective products, make advanced manufacturing process
and equipment, for this manufacturing facility to embody a completely new look
of a modern factory, and make the Company more competitive; while promoting the
development of the local economy and further exploiting the manufacturing
advantages in renewable energy equipment and waste heat recovery core equipment.
We estimate that the production capability will reach an annual capability of 10
sets of biomass boilers, 4 sets of alkali recovery boilers, 20 sets of waste
heat recovery boilers, 1500t coal chemical vessel synthesizing towers and 2000t
stainless steel vessel, etc, with an annual metal production amount of
32500t.
Marketing
and Sales
We market
and sell our products worldwide through our direct sales force, which is based
in Shanghai, China. Our marketing programs include industrial conferences, trade
fairs, sales training, and trade publication advertising. Our sales and
marketing groups work closely with our design and engineering, and manufacturing
groups to coordinate our product development activities, product launches and
ongoing demand and supply planning. Primarily we sell our products directly to
the end users of our energy recovery systems, but we also sell energy recovery
systems to leading engineering firms who in turn sell them to their end
users.
We are
also planning on entering into marketing partnerships and licensing deals that
will enable us to reach a boarder segment of the market. We believe that there
is significant opportunity in international markets such as the Middle East, the
United States, Europe and Latin America, and we intend to enter these markets
through partnerships. Additionally, we will look to expand into new industrial
sectors through partnerships with leading engineering firms that specialize in
specific industry groups.
Products
and Technology
We have
four main service offerings available to our customers, of which the first three
generate the majority of our revenue stream:
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Fabrication.
We have highly-trained manufacturing teams capable of building high
quality energy recovery systems in a timely fashion. All of our energy
recovery systems are of modular design with a high degree of factory
assembly. With modular construction, site welds on heat exchanger pressure
parts are kept to a minimum. We design all energy recovery systems we
manufacture to protect our brand. We collect a one-time fee for the
fabrication of each of our units. Of the over 100 unique customers who
have purchased energy recovery systems from us, more than 25% of them have
also purchased some of the other three major services that we offer which
are auxiliary to our fabrication services, or have returned to us for new
projects.
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Design.
Our primary product line of energy recovery systems can be designed to
meet the specific needs of our customers. We typically focus on heavy
industrial applications. In addition to the designing of energy recovery
systems for our own customers, we occasionally are approached by and
contract with third party manufacturers or engineering firms to design
systems for their customers. This offers a peripheral revenue stream to
supplement our core operations. We employ a flexible pricing scheme when
designing for third parties that depends upon the size, application and
deadline of the proposed energy recovery
system.
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15
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Implementation
and EPC Projects. Similar to the revenue model employed for our design
services, we either package the implementation (installation) of our
energy recovery system with the design and fabrication of our units, or
outsource this function to third party manufacturers for a service charge;
this allows smaller third party manufacturers to convert fixed costs to
variable costs, while offering us an ancillary revenue stream. We do not
perform implementation services on a stand-alone basis. We also possess the
resources, expertise and capabilities to act as the lead engineering
procurement and construction contractor, overseeing the implementation of
energy recovery systems for our customers. EPC services involve the whole
process of the construction of projects from design, development,
engineering, manufacturing up to
installation.
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Maintenance.
Our team is responsible for the overall maintenance of the energy recovery
systems we install. In the event that major repairs are needed, the
maintenance team is capable of rebuilding the equipment in order to repair
or replace any necessary components. The maintenance team is contracted to
service our own as well as other manufacturers' energy recovery systems.
Our maintenance team charges an hourly fee for its
services.
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Our
energy recovery systems represent a fully-customizable technology capable of
meeting the varying needs of a diversified customer base. The systems are
capable of recycling up to 70% of the energy that would otherwise be lost in
customers' industrial processes, in many cases allowing our customers to recover
their costs of the energy recovery system in energy savings within one to three
years. The energy recovery systems can also capture and eliminate harmful
particles, carbon dioxide, sulfur dioxide and other pollutants where the main
industrial facilities release such harmful emissions.
Our
energy recovery systems are suitable for use in a wide range of industries,
including chemical processing, papermaking, and oil and ethanol refining. The
core technology is easily adaptable to meet a variety of different size
facilities and types of plant design. Below is an illustration of our technology
as it is implemented in the sulfuric acid production industry.
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Traditional
Sulfuric Acid Production Process. The production of sulfuric acid involves
highly exothermic chemical reactions. Most of the heat is released into
the atmosphere through cooling towers without capturing any of the energy
contained therein. Some of the heat from the production process is
captured as steam, which the manufacturer can use to, for example,
generate electricity. Without the use of an energy recovery system, the
production of one ton of sulfuric acid will produce approximately one ton
of steam.
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Sulfuric
Acid Production Process with Energy Recovery System. The incorporation of
an energy recovery system increases the manufacturer's ability to extract
energy from the production process such that the production of one ton of
sulfuric acid can produce between 1.3 and 1.65 tons of steam. In so doing,
94% of the heat that would have otherwise been released to the atmosphere
is utilized to provide a larger quantity of steam that can be used in
industrial applications. The harnessed steam can be used for various
applications, most commonly to drive generator turbines to produce
electricity. Doing so decreases the manufacturer's demand for externally
produced energy as the manufacturer instead can use internally produced
energy resulting from the energy recovery system's increased production
and utilization of steam.
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16
Customers
We have
provided over 100 unique customers with energy recovery systems, and more than
25% of these customers have purchased multiple other products and services from
us such as design and implementation services. Our customers are mainly
industrial manufacturers, such as chemical plants, paper manufacturers and
industrial engineering firms. Our energy recovery systems are currently deployed
and being deployed in a variety of international markets, including Egypt,
Pakistan, Korea, Vietnam and Malaysia, as well as in 20 of China's 32 provinces,
including Yunnan, Jiangsu, Shandong, Sichuan, Hunan and Hubei.
Because
of the nature and long life of our energy recovery systems, a majority of our
sales are from new customers when comparing our customer base from year to year.
However, we do receive repeat business from previous customers, especially those
in China, when they are expanding their capacities or building new plants. For
the years ended December 31, 2008 and 2009, our five largest customers accounted
for 50% and 69% of our sales, respectively. Receivables from these five
customers were 47% and 66% of total accounts receivable at December 31, 2008 and
2009, respectively. There were two and one customers with balances greater than
10% at December 31, 2008 and 2009, respectively. The two customers with balances
greater than 10% at December 31, 2008 were ShuangShi (Zhangjiaguang) Chemical
Co., Ltd. and Jilin Chemical Industrial Co., Ltd.. The customer with balance
greater than 10% at December 31, 2009 was Zhenjiang Sopo Chemical New
Development Co., Ltd. (“Sopo”). Our large customers may not be the same from
year to year. Therefore, we do not believe that we are dependent upon any
specific major customers to continue our current level of sales.
Intellectual
Property and Other Proprietary Rights
The
Chinese State IPR Office has authorized and granted the following patents to
Shanghai Engineering on various components of our energy recovery
systems:
Patent
Type
|
Patent
Name
|
Expiration
Date
|
||
Utility
model
|
Drum-type
sectional ache fire tube boiler made by sulphur
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5/6/2013
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||
Utility
model
|
Double
drum-type fire tube exhaust-heat boiler which shares one steam
dome
|
11/6/2013
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Utility
model
|
Improvement
of tube compensator breed which makes ache fume
|
11/6/2013
|
||
Utility
model
|
Improvement
of protective casing tube
|
11/6/2013
|
||
Utility
model
|
Triple
drum-type fire tube exhaust-heat boiler which shares one steam
dome
|
1/30/2015
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Utility
model
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|
Cement
kiln forced-circulated waste heat recovery boiler
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4/2/2019
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Shanghai
Engineering has, together with an unrelated company, Zhejiang Jia Hua Group
Joint Stock Co., Ltd., submitted the following patent applications to the
Chinese State IPR Office, which are currently pending
authorization:
Patent
Type
|
Patent
Name
|
Application
Date
|
||
Utility
model
|
Spray
pump synthesizing tower
|
8/31/2007
|
||
Invention
|
Chlorosulfonic
acid preparation new craftwork and equipment
|
8/31/2007
|
||
Utility
model
|
The
center pipe smoke double disc regulator
|
4/17/2009
|
||
Utility
model
|
|
Steam
air reactor
|
|
3/29/2010
|
The
patent application for “chlorosulfonic acid preparation new craftwork and
equipment” passed the publication period and entered into the examination period
in March 2009. If our application is successful, we expect that it will take
between two to three years until we are granted a patent for this invention, if
at all.
17
Research
and Development
We are
focused on a strategy of utilizing our research and development capabilities to
continuously improve the waste heat and emissions capture technology of our
energy recovery systems. Our research and development efforts focus specifically
on maximizing efficiency and reliability while minimizing the cost to customers.
We have currently been focusing our efforts on new products with immediate
demand in the markets such as capturing and reducing emissions released in
various industrial processes, such as sulfur dioxide (a byproduct in sulfuric
acid processes) and alkali (a byproduct in paper-making processes). We maintain
strong relationships with many professional engineering firms in China that can
provide technical support in the development process.
We employ
approximately 100 specialized engineers at our Shanghai, China facilities who
are engaged in refining the core technology for our energy recovery systems,
developing our intellectual property rights, enhancing energy efficiencies and
decreasing environmental impact for our customers. Our engineers carry out
development activities alongside with the design work for our customers’
projects and the expenses associated with our research and development
activities are passed along to our customers as part of the price paid for our
products and services. However, since expenses incurred in research and
development are immaterial, we do not record research and development expenses
as a separate line item in our financial statements. Shanghai Engineering has a
portfolio of core Chinese patents on various components of our energy recovery
systems as described above.
Our
Business Strategy
We have
established a three-phase growth strategy:
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Phase
One. During the first phase of our growth strategy, we will continue to
fulfill our current orders while growing our domestic Chinese business.
During this time, we intend to establish long-term strategic purchasing
agreements with suppliers that provide key raw
materials.
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Phase
Two. The second phase of our growth strategy involves increased
expenditures that will support our growth. We intend to complete the first
phase of the construction of our first owned manufacturing facility, which
we believe will increase our profit margins and efficiency. We also intend
to invest in specialized equipment to further increase the efficiency of
our manufacturing process. While these capital expenditures are underway,
we expect to incur separate (unrelated to any particular customer project)
research and development expenditures to support an expansion into new
sectors, such as coke refining and cement, including adding more
specialized talents to our engineering and design team. We also anticipate
recruiting an international sales and marketing team to assist in
international market expansion.
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Phase
Three. In the third phase of our growth strategy, we plan to complete the
second phase of the construction of our first owned manufacturing facility
to meet future demand. We also anticipate expanding our EPC business by
continuing to increase the size of our engineering and design team.
Finally, we intend to increase our international marketing efforts in the
Middle East, Europe and the United States during this
phase.
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Raw
Materials and Principal Suppliers
We do not
currently have any long-term supply agreements. We do not believe that we are
reliant on our current suppliers. We believe that we could substitute other
suppliers if needed. Our five largest suppliers (by value) supplied
approximately 62% of our raw materials in 2009.
18
Employees
As of
December 31, 2009, we had approximately 390 employees, all of who are full time
employees. Of these, approximately 100 are engineering and technical personnel.
We expect to continue to add additional personnel, especially engineers, in 2010
and beyond to support our anticipated growth.
None of
our employees is covered by a collective bargaining agreement. Each of our
managerial, sales and administrative employees has entered into a standard form
of employment agreement. All of our personnel who have access to our
confidential information and technical know-how have entered into a separate
agreement that contains covenants not to compete for 24 months following
termination of employment and to maintain the confidentiality of certain
proprietary information. We believe that our employee relations are
good.
Governmental
Regulation
The
manufacture of boilers and pressure vessels used in our energy recovery systems
is subject to licensing requirements imposed by the Chinese national government,
as well as regional and local governments, depending on the type of license
needed. Shanghai Si Fang conducts all our manufacturing operations and has
obtained all required licenses. Boilers and pressure vessels manufactured
without such licenses are not allowed to be sold in China. To qualify for a
license, a manufacturer must (a) be a legal entity registered with the local
government; (b) have a production facility, equipment, technical expertise, and
inspection and testing capabilities suitable for producing boilers and pressure
vessels; (c) establish and maintain an effective quality assurance system; and
(d) manufacture the boilers and pressure vessels in accordance with the
requirements of the applicable safety and technical standards.
Our
operations are also subject to governmental regulations applicable to any
business such as general permitting, licensing and registration. For example,
the installation of energy recovery systems at our clients' locations requires a
construction project building permit from the applicable regional
government.
Compliance
with Environmental Laws
We belong
to what is known as the "machinery manufacturing industry" in China which
industry is considered not to generate exhaust gas, waste liquor or waste
residue during manufacturing. Therefore, generally, our manufacturing operations
are not subject to any material environmental regulations.
The
installation and construction of our energy recovery systems at our clients'
locations are subject to environmental laws applicable to construction projects
generally. As part of the procedure for obtaining a construction project
building permit, we must submit an environmental impact statement for each
construction project which assesses the pollution the projects is likely to
produce, its impact on the environment, and stipulates preventive and curative
measures. The issuance of a building permit is conditioned on the approval of
the environmental impact statement.
There are
emissions standards applicable to the operation of coal-burning, oil-burning or
gas-fired boilers (China National General Standard GWPB 3-1999). We do not
believe that these emission standards are applicable to the boilers included
within our energy recovery systems because our boilers are not independently
emitting any emissions as they are being heated by industrial processes as
opposed to by coal, oil or gas.
Item
1A Risk Factors
There are
numerous and varied risks that may prevent us from achieving our goals,
including those described below. You should carefully consider the risks
described below and the other information included in this Annual Report on Form
10-K, including our financial statements and related notes. Our business,
financial condition and results of operations could be harmed by any of the
following risks. If any of the events or circumstances described below were to
occur, our business, financial condition and results of operations could be
materially adversely affected. As a result, the trading price of our common
stock could decline, and investors could lose part or all of their
investment.
19
Risks
Related to Our Business
Our
limited operating history may not serve as an adequate basis to judge our future
prospects and results of operations.
Our
limited operating history and the unpredictability of our industry make it
difficult for investors to evaluate our business and future operating results.
An investor in our securities must consider the risks, uncertainties and
difficulties frequently encountered by companies in new and rapidly evolving
markets. The risks and difficulties we face include challenges in accurate
financial planning as a result of limited historical data and the uncertainties
resulting from having had a relatively limited time period in which to implement
and evaluate our business strategies as compared to companies with longer
operating histories.
Our
dependence on a limited number of customer segments may cause significant
fluctuations or declines in our revenues.
We
currently sell a substantial portion of our energy recovery systems to companies
in either the chemical or paper manufacturing sectors. We anticipate that our
dependence on a limited number of customer sectors will continue for the
foreseeable future. Consequently, any one of the following events may cause
material fluctuations or declines in our revenues and have a material adverse
effect on our results of operations:
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Decreased
demand for the products of these manufacturing
sectors;
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Advances
in the manufacturing processes of these sectors that could eliminate the
economic feasibility of our technology;
and
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Failure
to successfully implement our systems for one or more customers within a
particular sector could adversely affect the reputation of our products
and services have as a viable option for other companies within that
sector.
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We
face risks associated with the marketing, distribution and sale of our energy
recovery systems, and if we are unable to effectively manage these risks, they
could impair our ability to expand our business.
The
marketing, distribution and sale of our products expose us to a number of risks,
including, but not limited to:
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Increased
costs associated with maintaining marketing efforts in various parts of
China and various countries;
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Marketing
campaigns that are either ineffective or negatively perceived in one or
more countries and/or across one or more industry
sectors;
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Difficulty
and cost relating to compliance with the different commercial and legal
requirements of the overseas markets in which we offer our
products;
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Inability
to obtain, maintain or enforce intellectual property rights;
and
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Trade
barriers such as export requirements, tariffs, taxes and other
restrictions and expenses, which could increase the prices of our products
and make us less competitive in some
countries.
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If we are
unable to manage these risks, we may be unable to expand our business into new
countries or industries, or expansion may become costlier than
expected.
20
The
success of our business depends on our ability to attract highly qualified
personnel without whom we would be unable to maintain the quality of our
services, and our ability to retain them, including senior management and other
key personnel who may terminate their employment with us at any time causing us
to lose experienced personnel and to expend resources in securing qualified
replacements.
We depend
substantially on the current and continued services and performance of our
senior management and other key personnel. Loss of the services of any of such
individuals would adversely impact our operations. In addition, we believe that
our technical personnel represent a significant asset and provide us with a
competitive advantage over many of our competitors and that our future success
will depend upon our ability to hire and retain these key employees and our
ability to attract and retain other skilled financial, engineering, technical
and managerial personnel. As our industry continues to grow, we expect increased
competition for qualified personnel. In the event that we are unable to retain
or attract the same level of qualified personnel as in the past on the current
terms of employment, we may face higher labor costs or lower productivity. If
our productivity or the quality of the services we provide decrease, our
business may suffer negative consequences such as a reduction in our rate of
securing and completing customer engagements. Increased costs of labor and
reduced throughput would negatively affect our profitability.
None of
our key personnel, including our Chief Executive Officer, is party to any
employment agreements with us and management and other employees may voluntarily
terminate their employment at any time. There is no guarantee that we will be
able to retain the services of these, or other, individuals on reasonable terms
or at all. We do not currently maintain any "key man" life insurance with
respect to any of such individuals.
Our
inability to obtain capital, use internally generated cash, or use shares of our
capital stock or debt to finance future expansion efforts could impair the
growth and expansion of our business.
Reliance
on internally generated cash or debt to finance our operations or complete
business expansion efforts could substantially limit our operational and
financial flexibility. The extent to which we will be able or willing to use
shares of capital stock to consummate expansions will depend on the market value
of our capital stock from time to time and the willingness of potential
investors, sellers or business partners to accept it as full or partial payment.
Using shares of capital stock for this purpose also may result in significant
dilution to our then existing stockholders. To the extent that we are unable to
use capital stock to make future expansions, our ability to grow through
expansions may be limited by the extent to which we are able to raise capital
for this purpose through debt or equity financings. Raising external capital in
the form of debt could require periodic interest payments that could hinder our
financial flexibility in the future. No assurance can be given that we will be
able to obtain the necessary capital to finance a successful expansion program
or our other cash needs. If we are unable to obtain additional capital on
acceptable terms, we may be required to reduce the scope of any expansion. In
addition to requiring funding for expansions, we may need additional funds to
implement our internal growth and operating strategies or to finance other
aspects of our operations. Our failure to (a) obtain additional capital on
acceptable terms, (b) use internally generated cash, or (c) use shares of
capital stock to make future expansions may hinder our ability to actively
pursue any expansion program we may decide to implement. In addition, if we are
unable to obtain necessary capital going forward, our ability to continue as a
going concern would be negatively impacted.
Our
business has been and may continue to be adversely affected by disruptions in
the credit markets, including reduced access to credit and higher costs of
obtaining credit.
Widening
credit spreads, as well as significant declines in the availability of credit,
have adversely affected our ability to borrow on a secured and unsecured basis
and may continue to do so. Disruptions in the credit markets make it harder and
more expensive to obtain funding for our businesses. If our available funding is
limited or we are forced to fund our operations at a higher cost, these
conditions may require us to curtail our business activities and increase our
cost of funding, both of which could reduce our profitability and prevent or
hamper our growth through acquisitions.
Our
business has been and may continue to be adversely affected by conditions in the
global financial markets and economic conditions generally.
Our
business is materially affected by conditions in the global financial markets
and economic conditions generally. The ongoing financial crisis and the loss of
confidence in the stock market has increased our cost of funding and limited our
access to some of our traditional sources of liquidity, including both secured
and unsecured borrowings. Increases in funding costs and limitations on our
access to liquidity have negatively impacted our ability to grow our business.
In addition, the deteriorating general economic conditions globally have caused
a drop in corporate spending on non-essential capital improvements, such as our
energy recovery systems. This has caused a slowdown in our order volume and
delays in acceptance of international orders. Overall, the business environment
has started to become adverse for our business and there can be no assurance
that these conditions will improve in the near term. Until they do, we expect
our results of operations to be adversely affected.
21
Our
future success substantially depends on our ability to significantly increase
our manufacturing capacity. Our ability to achieve our capacity expansion goals
is subject to a number of risks and uncertainties.
Our
future success depends on our ability to significantly increase our
manufacturing capacity. If we are unable to do so, we may be unable to expand
our business, decrease our average cost per watt, maintain our competitive
position and improve our profitability. Our ability to establish additional
manufacturing capacity is subject to significant risks and uncertainties. We may
be unable to raise the necessary capital to initiate and complete the
construction of a new manufacturing facility, acquire the appropriate permits to
allow construction of a new manufacturing facility, or engage a company
qualified to construct our manufacturing facility at a reasonable price, or at
all.
We
may not be able to manage our expansion of operations effectively and if we are
unable to do so, our profits may decrease.
We are in
the process of significantly expanding our business in order to meet the
increasing demand for our products and services, as well as to capture new
market opportunities. As we continue to grow, we must continue to improve our
operational and financial systems, procedures and controls, increase
manufacturing capacity and output, and expand, train and manage our growing
employee base. In order to fund our on-going operations and our future growth,
we need to have sufficient internal sources of liquidity or access to additional
financing from external sources. Furthermore, our management will be required to
maintain and strengthen our relationships with our customers, suppliers and
other third parties. As a result, our continued expansion has placed, and will
continue to place, significant strains on our management personnel, systems and
resources. We will also need to further strengthen our internal control and
compliance functions to ensure that we will be able to comply with our legal and
contractual obligations and minimize our operational and compliance risks. Our
current and planned operations, personnel, systems, internal procedures and
controls may not be adequate to support our future growth. If we are unable to
manage our growth effectively, we may not be able to take advantage of market
opportunities, execute our business strategies or respond to competitive
pressures. As a result, our results from operations may decline.
Our
failure to protect our intellectual property rights may undermine our
competitive position, and litigation to protect our intellectual property rights
or defend against third-party allegations of infringement may be
costly.
We rely
primarily on patent, trademark, trade secret, copyright law and other
contractual restrictions to protect our intellectual property. For example,
Shanghai Engineering holds six patents in China. Nevertheless, these afford only
limited protection and the actions we take to protect our intellectual property
rights may not be adequate. In addition, implementation of China's intellectual
property-related laws has historically been lacking, primarily because of
ambiguities in China's laws and difficulties in enforcement. Accordingly,
intellectual property rights and confidentiality protections in China may not be
as effective as in the United States or other countries. As a result, third
parties may infringe or misappropriate our proprietary technologies or other
intellectual property rights, which could have a material adverse effect on our
business, financial condition or operating results. In addition, policing
unauthorized use of proprietary technology can be difficult and expensive.
Litigation may be necessary to enforce our intellectual property rights, protect
our trade secrets or determine the validity and scope of the proprietary rights
of others. We cannot assure you that the outcome of such potential litigation
will be in our favor. Such litigation may be costly and may divert management
attention as well as expend our other resources away from our business. An
adverse determination in any such litigation will impair our intellectual
property rights and may harm our business, prospects and reputation. In
addition, we have no insurance coverage against litigation costs and would have
to bear all costs arising from such litigation to the extent we are unable to
recover them from other parties. The occurrence of any of the foregoing could
have a material adverse effect on our business, results of operations and
financial condition.
We
may be exposed to infringement or misappropriation claims by third parties,
which, if determined adversely to us, could cause us to pay significant damage
awards.
Our
success also depends largely on our ability to use and develop our technology
and know-how without infringing the intellectual property rights of third
parties. The validity and scope of claims relating to our technology patents
involve complex scientific, legal and factual questions and analysis and,
therefore, may be highly uncertain. We may be subject to litigation involving
claims of patent infringement or violation of intellectual property rights of
third parties. The defense and prosecution of intellectual property suits,
patent opposition proceedings and related legal and administrative proceedings
can be both costly and time consuming and may significantly divert the efforts
and resources of our technical and management personnel. An adverse
determination in any such litigation or proceedings to which we may become a
party could subject us to significant liability to third parties, require us to
seek licenses from third parties, to pay ongoing royalties, or to redesign our
products or subject us to injunctions prohibiting the manufacture and sale of
our products or the use of our technologies. Protracted litigation could also
result in our customers or potential customers deferring or limiting their
purchase or use of our products until resolution of such
litigation.
22
Although
we sell a substantial portion of our products outside of China through the local
contractors, the patents protecting parts of our energy recovery systems are
issued in China. Our business, results of operations and financial condition
could be materially and adversely affected if our sales outside China were to be
restricted by intellectual property claims by third parties.
As of
today, Shanghai Engineering held a total of six issued patents in China. We do
not have, and have not applied for, any patent for our proprietary technologies
outside of China although we have sold, and expect to continue to sell, a
substantial portion of our products outside of China through the local
contractors. Because the protection afforded by our patents is effective only in
China, others may independently develop substantially equivalent technologies,
or otherwise gain access to our proprietary technologies, and obtain patents for
such intellectual properties in other jurisdictions, including the countries to
which we sell our products. If any third parties are successful in obtaining
patents for technologies that are substantially equivalent or the same as the
technologies we use in our products in any of our markets before we do and
enforce their intellectual property rights against us, our ability to sell
products containing the allegedly infringing intellectual property in those
markets will be materially and adversely affected. If we are required to stop
selling such allegedly infringing products, obtain a license and pay royalties
for the relevant intellectual properties, or redesign such products with
non-infringing technologies, our business, results of operations and financial
condition may be materially and adversely affected.
We
also sell or install other types of energy recovery systems manufactured by
a third party and our inability to continue to do so may make us less
competitive in the market and decrease our revenues.
We do not
manufacture all types of the energy recovery systems that we sell or install. In
the sulfuric acid industry, our proprietary energy recovery systems are used for
high and middle temperature applications. We also sell or install low
temperature energy recovery systems manufactured by a third party specifically
for sulfuric acid manufacturing facilities. Also, in the future, we may sell or
install energy recovery systems that we manufacture under licenses from third
parties owning the proprietary rights to such energy recovery systems. These
energy recovery systems allow us to serve the low temperature market segment in
the sulfuric acid manufacturing sector that we are unable to serve with our own
proprietary energy recovery systems. Our current arrangement with this third
party is on a project-by-project basis. If we are unable to continue offering
these energy recovery systems to our customers, we may be unable to serve the
low temperature market segment in the sulfuric acid manufacturing sector,
thereby harming our competitive position and likely decreasing our
revenues.
Fluctuations
in exchange rates could adversely affect our business and your
investment.
A portion
of our sales is currently denominated in U.S. dollars, with the remainder in
Renminbi, while our costs and expenses are denominated in U.S. dollars and
Renminbi. Therefore, fluctuations in currency exchange rates could have a
material adverse effect on our financial condition and results of operations.
Fluctuations in exchange rates, particularly among the U.S. dollar and Renminbi,
affect our gross and net profit margins and could result in foreign exchange and
operating losses.
Our
financial statements are expressed in U.S. dollars but our functional currency
is Renminbi. The value of your investment in our stock will be affected by the
foreign exchange rate between U.S. dollars and Renminbi. To the extent we hold
assets denominated in U.S. dollars, any appreciation of the Renminbi against the
U.S. dollar could result in a change to our income statement. On the other hand,
a decline in the value of Renminbi against the U.S. dollar could reduce the U.S.
dollar equivalent amounts of our financial results, the value of your investment
in our company and the dividends we may pay in the future, if any, all of which
may have a material adverse effect on the prices of our stock.
23
The
change in value of the Renminbi against the U.S. dollar and other currencies is
affected by, among other things, changes in China's political and economic
conditions. On July 21, 2005, the Chinese government changed its policy of
pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the
Renminbi is permitted to fluctuate within a narrow and managed band against a
basket of certain foreign currencies. This change in policy has resulted in
approximately 21% appreciation of the Renminbi against the U.S. dollar as of
December 31, 2009 since the change in policy. While the international reaction
to the Renminbi revaluation has generally been positive, there remains
significant international pressure on the Chinese government to adopt an even
more flexible currency policy, which could result in a further and more
significant appreciation of the Renminbi against the U.S. dollar. As we rely
entirely on dividends paid to us by our operating subsidiaries, any significant
revaluation of the Renminbi may have a material adverse effect on our revenues
and financial condition, and the value of, and any of our dividends payable on
our ordinary shares in foreign currency terms. For example, to the extent that
we need to convert U.S. dollars we received in a financing into Renminbi for our
operations, appreciation of the Renminbi against the U.S. dollar would have an
adverse effect on the Renminbi amount we receive from the conversion.
Conversely, if we decide to convert our Renminbi into U.S. dollars for the
purpose of making payments for dividends on our ordinary shares or for other
business purposes, appreciation of the U.S. dollar against the Renminbi would
have a negative effect on the U.S. dollar amount available to us.
We
do not believe that our energy recovery systems are subject to emission
standards applicable to fuel-burning boilers but if they were to be subject to
such emission standards, we may incur additional costs in complying with them
which may negatively impact our profitability.
There are
emissions standards applicable to the operation of coal-burning, oil-burning or
gas-fired boilers (China National General Standard GWPB 3-1999). We do not
believe that these emission standards are applicable to the boilers included
within our energy recovery systems because our boilers are not independently
emitting any emissions as they are being heated by industrial processes as
opposed to by coal, oil or gas. If our energy recover systems were to become
subject to these emission standards, we may need to change the design of our
energy recovery systems to bring them into compliance with the emission
standards which may increase our costs and negatively impact our
profitability.
We
operate in a competitive industry with several established and more horizontally
integrated companies. It may be difficult to sustain our market share in the
event of a decline in market conditions.
Our
industry is competitive and rapidly changing. Future competitors may include
international engineering companies and large domestic engineering companies.
These competitors may have a material advantage in their financial, technical
and marketing resources. Competition in the energy recovery industry may
increase in the future, which could result in reduced pricing power and
declining margins. We may be unable to successfully compete against future
competitors, which would adversely affect our business and
operations.
In
our course of business, we expose ourselves to possible litigation associated
with performing services on our customers' properties.
We
perform installation services on our customers' properties and doing so can
result in claims of property damage, breach of contract, harassment, theft, and
other such claims. These claims may become time consuming and expensive, which
would adversely affect our financial condition and the reputation of our
business.
We
are subject to risks related to warranty claims whereby we may not be able to
collect the full purchase price of sold products or which are greater than
anticipated due to the unenforceability of liability limitations.
We
warrant the majority of our products for periods of one or two years. Defects
may not become apparent until after the products have been sold and installed.
As a normal practice in the industry, we allow our customers to retain 5% to 10%
of the contract prices as retainage during the warranty period for any future
warranty claims. When a warranty claim occurs and we determine that the product
in question is defective, we repair the product at our expenses, which could
increase our costs and adversely affect our business. Also, if we are unable to
repair the product to the customer's satisfaction or for other reasons, we may
not have the right or be able to collect the whole or part of the retainage at
the end of the warranty period. Further, our standard warranties contain limits
on damages and exclusions of liability for consequential damages and for misuse,
alteration, accident or mishandling after the sale and installation. If these
limitations are ineffective or found to be unenforceable, we may be subject to
greater than anticipated warranty claims.
24
We have limited insurance coverage
and may incur losses resulting from product liability claims or business
interruptions.
While we
historically have not been subject to any product liability claims, we are
exposed to risks associated with such claims in the event that the use of the
products we sell results in injury. We do not have any product liability
insurance and may not have adequate resources to satisfy a judgment in the event
of a successful claim against us. The successful assertion of product liability
claims against us could result in potentially significant monetary damages and
require us to make significant payments. In addition, because the insurance
industry in China is still in its early stages of development, business
interruption insurance available in China offers limited coverage compared to
that offered in many other countries. We do not have any business interruption
insurance. Any business disruption or natural disaster could result in
substantial costs and diversion of resources.
A
drop in the price of conventional energy sources may decrease the demand for our
energy recovery systems and may negatively impact our sales and
profitability.
Our
energy recovery systems capture industrial waste energy which then can be reused
in industrial processes or used to produce electricity and thermal power. An
energy recovery system is expensive to purchase and install. We believe that our
customers make purchasing decisions based on the economic feasibility of
installing one of our energy recovery systems relative to using conventional
energy and other alternative energy sources. Decreases in the prices of oil and
other fossil fuels, utility electric rates, and other alternative energy sources
could cause the demand for energy recovery systems to substantially decline,
which would negatively impact our profitability. A significant decrease in
energy prices globally could cause a slowdown in our order volume and delays in
acceptance of international orders.
If
we do not generate the anticipated demand for our energy recovery systems, we
may not continue to realize the necessary sales levels needed to reach or
maintain profitability.
The
market for energy recovery systems is relatively new and still evolving. The
success of our products and services will depend on the cost effectiveness and
the relative performance of our systems relative to conventional and other
alternative energy technologies. If our products and services do not capture the
necessary industry market share, we may not be able to generate sufficient
revenue or sustain profitability.
Risks
Related to Our Corporate Structure
In
order to comply with Chinese laws limiting foreign ownership of Chinese
companies, we currently conduct our business by means of contractual
arrangements with Chinese companies that we do not own. If the Chinese
government determines that these contractual arrangements do not comply with
applicable regulations, our business could be adversely affected.
The
Chinese government restricts foreign investment in the manufacturing business in
China. Accordingly, we operate our business in China through our indirect
wholly-owned Chinese subsidiary, CER Hong Kong, which in turn has entered into
contractual arrangements with Shanghai Engineering and Shanghai Environmental
for the design, manufacturing and installation of energy recovery systems.
Shanghai Engineering, in turn, has entered into contractual agreements with
Shanghai Si Fang, an entity owned and controlled by the Chinese government,
pursuant to which Shanghai Engineering leases Vessel Works Division, a
subsidiary of Shanghai Si Fang, which manufactures our energy recovery systems.
Vessel Works Division holds the licenses and approvals necessary for such
manufacturing. CER Hong Kong has contractual arrangements with Shanghai
Engineering and Shanghai Environmental, and their respective shareholders, which
allow CER Hong Kong to substantially control Shanghai Engineering and Shanghai
Environmental. However, we cannot assure you that we will be able to enforce,
retain or renew these contracts. Any failure to enforce, retain or renew these
contracts or to enter into satisfactory substitute agreements with other
manufacturers would likely mean that we would be unable to continue to
manufacture and install energy recovery systems.
Although we believe that we comply with
current Chinese laws and regulations related to foreign ownership of
manufacturing operations, we cannot assure you that the Chinese government would
agree that our contractual arrangements comply with Chinese licensing,
registration or other regulatory requirements, with existing policies or with
requirements or policies that may be adopted in the future. If the Chinese
government determines that we do not comply with applicable law, it could revoke
our business and operating licenses, require us to discontinue or restrict our
operations, restrict our right to collect revenues, require us to restructure
our operations, impose additional conditions or requirements with which we may
not be able to comply, impose restrictions on our business operations or on our
customers, or take other regulatory or enforcement actions against us that could
be harmful to our business.
25
Our
contractual arrangements with Shanghai Engineering and Shanghai Environmental
and their respective shareholders may not be as effective in providing control
over these entities as direct ownership.
Because
Chinese law limits foreign equity ownership in companies in China, we operate
our business through affiliated Chinese companies, Shanghai Engineering and
Shanghai Environmental. We have no equity ownership interest in Shanghai
Engineering or Shanghai Environmental and rely on contractual arrangements to
control and operate such entities and their business. These contractual
arrangements may not be as effective in providing control as direct ownership.
For example, Shanghai Engineering or Shanghai Environmental could fail to take
actions required for our business despite their contractual obligation to do so.
If Shanghai Engineering or Shanghai Environmental fails to perform under their
agreements with us, we may have to rely on legal remedies under Chinese law to
enforce them, which may not be effective. In addition, we cannot assure you that
Shanghai Engineering or Shanghai Environmental's respective shareholders would
always act in our best interests.
Risks
Related to Doing Business in China
Our
business is exposed to risks associated with the economic, environmental and
political conditions in China because the substantial majority of our assets are
located in China and the majority of our revenues are derived from our
operations in China.
Because
our headquarters and manufacturing facilities are located in China, our business
is disproportionately exposed to the economic, environmental and political
conditions of the region. The country's political and economic systems are very
different from more developed countries and uncertainties may arise with
changing of governmental policies and measures. China also faces many social,
economic and political challenges that may produce instabilities in both its
domestic arena and in its relationship with other countries. These instabilities
may significantly and adversely affect our performance. In addition, as the
Chinese legal system develops, they can be no assurance that changes in laws and
regulations and their interpretation or their enforcement will not have a
material adverse effect on our business operations. As a large portion of our
target customers are also located in China and are subject to the aforementioned
risks, our business may also be adversely affected by the effects of the
conditions within the region upon them.
Adverse
changes in political and economic policies of the Chinese government could have
a material adverse effect on the overall economic growth of China, which could
reduce the demand for our products and materially and adversely affect our
competitive position.
A
majority of our business operations and sales are conducted and made in China.
Accordingly, our business, financial condition, results of operations and
prospects are affected significantly by economic, political and legal
developments in China. The Chinese economy differs from the economies of most
developed countries in many respects, including:
|
1.
|
the
amount of government involvement;
|
|
2.
|
the
level of development;
|
|
3.
|
the
growth rate;
|
|
4.
|
the
control of foreign exchange; and
|
|
5.
|
the
allocation of resources.
|
While the
Chinese economy has grown significantly in the past 20 years, the growth has
been uneven, both geographically and among various sectors of the economy. The
Chinese government has implemented various measures to encourage economic growth
and guide the allocation of resources. Some of these measures benefit the
overall Chinese economy, but may also have a negative effect on us. For example,
our financial condition and results of operations may be adversely affected by
government control over capital investments or changes in tax regulations that
are applicable to us.
The
Chinese economy has been transitioning from a planned economy to a more
market-oriented economy. Although in recent years the Chinese government has
implemented measures emphasizing the utilization of market forces for economic
reform, the reduction of state ownership of productive assets and the
establishment of sound corporate governance in business enterprises, a
substantial portion of the productive assets in China is still owned by the
Chinese government. The continued control of these assets and other aspects of
the national economy by the Chinese government could materially and adversely
affect our business. The Chinese government also exercises significant control
over Chinese economic growth through the allocation of resources, controlling
payment of foreign currency-denominated obligations, setting monetary policy and
providing preferential treatment to particular industries or companies. Efforts
by the Chinese government to slow the pace of growth of the Chinese economy
could result in decreased capital expenditure by companies in our target markets
for energy recovery systems, which in turn could reduce demand for our
products.
26
Any
adverse change in the economic conditions or government policies in China could
have a material adverse effect on the overall economic growth and the level of
investments and expenditures in China, which in turn could lead to a reduction
in demand for our products and consequently have a material adverse effect on
our businesses.
Uncertainties
with respect to the Chinese legal system could have a material adverse effect on
us.
We
conduct substantially all of our business through subsidiaries and affiliated
entities in China. These entities are generally subject to laws and regulations
applicable to foreign investment in China. China's legal system is based on
written statutes. Prior court decisions may be cited for reference but have
limited precedential value. Since 1979, Chinese legislation and regulations have
significantly enhanced the protections afforded to various forms of foreign
investments in China. However, since these laws and regulations are relatively
new and China's legal system continues to rapidly evolve, the interpretations of
many laws, regulations and rules are not always uniform and enforcement of these
laws, regulations and rules involve uncertainties, which may limit legal
protections available to us. In addition, any litigation in China may be
protracted and result in substantial costs and diversion of resources and
management attention.
Restrictions
on currency exchange may limit our ability to receive and use our revenues
effectively.
The
majority of our revenues and expenses are denominated in Renminbi. If our
revenues denominated in Renminbi increase or expenses denominated in Renminbi
decrease in the future, we may need to convert a portion of our revenues into
other currencies to meet our foreign currency obligations, including, among
others, payment of dividends declared, if any, in respect of our common
stock.
Due to
the global financial crisis, the Chinese government has strengthened measures to
control exchange of Renminbi into foreign currencies and outbound payments by,
among other things, requiring prior approval from the Chinese State
Administration of Foreign Exchange ("SAFE") before taking such actions in some
cases. As a result, it has become more difficult for us to exchange Renminbi
into foreign currencies and to make payments to entities and individuals outside
of China. In some cases we need SAFE's prior approval to do so. If these
measures are not loosened in the near future, our ability to pay dividends in
foreign currencies is restricted and if we are unable to obtain SAFE's prior
approval when needed, we will not be able to pay dividends in foreign currencies
at all. We cannot assure you that that the Chinese government will not further
restrict access to foreign currencies for current account transactions in the
future.
Foreign
exchange transactions by our subsidiaries and affiliated entities or under the
capital account continue to be subject to significant foreign exchange controls
and require the approval of China's governmental authorities, including the
SAFE. In particular, if our subsidiaries and affiliated entities borrow foreign
currency loans from us or other foreign lenders, these loans must be registered
with the SAFE, and if we finance our subsidiaries and affiliated entities by
means of additional capital contributions, these capital contributions must be
approved by certain government authorities including the Chinese Ministry of
Commerce or its local counterparts. These limitations could affect the ability
of our subsidiaries and affiliated entities to obtain foreign exchange through
debt or equity financing.
Our
business benefits from certain Chinese government incentives. Expiration of, or
changes to, these incentives could have a material adverse effect on our
operating results.
The
Chinese government has provided various incentives to high technology companies,
including our affiliate Shanghai Engineering, in order to encourage development
of the high technology industry. Such incentives include reduced tax rates and
other measures. For example, Shanghai Engineering has been qualified as a "high
or new technology enterprise." As a result, we are entitled to a preferential
enterprise income tax rate of 15% so long as Shanghai Engineering continues to
maintain its "high or new technology enterprise" status. A new Enterprise Income
Tax ("EIT") law replaced the old laws for Domestic Enterprises ("DEs") and
Foreign Invested Enterprises ("FIEs") in 2008. The key changes are: (a) the new
standard EIT rate of 25% replaces the 33% rate originally applicable to both DEs
and FIEs, except for companies with high or new technology enterprise status,
which will pay a reduced rate of 15%, and (b) companies established before March
16, 2007 will continue to enjoy tax holiday treatment approved by local
government for a grace period of the next five years or until the tax holiday
term is completed, whichever is sooner. These companies will pay the standard
tax rate as defined in point (a) above during the grace period. Because Shanghai
Engineering was established before March 16, 2007, it is qualified to continue
enjoying the reduced tax rate as described above. Any increase in our enterprise
income tax rate in the future could have a material adverse effect on our
financial condition and results of operations.
27
Risks
Related to our Common Stock
There
is not an active trading market for our common stock, and if a market for our
common stock does not develop, our investors may be unable to sell their
shares.
Our
common stock is currently quoted on the Pink Sheets trading system. The Pink
Sheets is not a listing service or exchange, but is instead a dealer quotation
service for subscribing members. The Pink Sheets tend to be highly illiquid, in
part because there is no national quotation system by which potential investors
can track the market price of shares except through information received or
generated by a limited number of broker-dealers that make markets in particular
stocks. There is a greater chance of market volatility for securities that trade
on the Pink Sheets as opposed to a national exchange or quotation system. This
volatility may be caused by a variety of factors including:
|
|
The
lack of readily available price
quotations;
|
|
|
The
absence of consistent administrative supervision of "bid" and "ask"
quotations;
|
|
|
Lower
trading volume;
|
|
|
Market
conditions;
|
|
|
Technological
innovations or new products and services by us or our
competitors;
|
|
|
Regulatory,
legislative or other developments affecting us or our industry
generally;
|
|
|
Limited
availability of freely-tradable "unrestricted" shares of our common stock
to satisfy purchase orders and
demand;
|
|
|
Our
ability to execute our business
plan;
|
|
|
Operating
results that fall below
expectations;
|
|
|
Industry
developments;
|
|
|
Economic
and other external factors; and
|
|
|
Period-to-period
fluctuations in our financial
results.
|
In
addition, the value of our common stock could be affected by:
|
|
Actual
or anticipated variations in our operating
results;
|
|
|
Changes
in the market valuations of other companies operating in our
industry;
|
|
|
Announcements
by us or our competitors of significant acquisitions, strategic
partnerships, joint ventures or capital
commitments;
|
|
|
Adoption
of new accounting standards affecting our
industry;
|
|
|
Additions
or departures of key personnel;
|
|
|
Introduction
of new services or technology by our competitors or
us;
|
|
|
Sales
of our common stock or other securities in the open
market;
|
|
|
Changes
in financial estimates by securities
analysts;
|
|
|
Conditions
or trends in the market in which we
operate;
|
|
|
Changes
in earnings estimates and recommendations by financial
analysts;
|
|
|
Our
failure to meet financial analysts' performance expectations;
and
|
|
|
Other
events or factors, many of which are beyond our
control.
|
In
addition, the securities markets have from time to time experienced significant
price and volume fluctuations that are unrelated to the operating performance of
particular companies. These market fluctuations may also significantly affect
the market price of our common stock.
In a
volatile market, you may experience wide fluctuations in the market price of our
securities. These fluctuations may have an extremely negative effect on the
market price of our securities and may prevent you from obtaining a market price
equal to your purchase price when you attempt to sell our securities in the open
market. In these situations, you may be required either to sell our securities
at a market price which is lower than your purchase price, or to hold our
securities for a longer period of time than you planned. An inactive market may
also impair our ability to raise capital by selling shares of capital stock and
may impair our ability to acquire other companies or technologies by using
common stock as consideration.
28
Because
we do not intend to pay any dividends on our common stock, purchases of our
common stock may not be suited for investors seeking dividend
income.
We do not
currently anticipate declaring and paying dividends to our stockholders in the
near future. It is our current intention to apply any net earnings in the
foreseeable future to the internal needs of our business. Prospective investors
seeking or needing dividend income or liquidity from our common stock should,
therefore, not purchase our common stock. There can be no assurance that we will
ever have sufficient earnings to declare and pay dividends to the holders of our
shares, and in any event, a decision to declare and pay dividends is at the sole
discretion of our board of directors, who currently do not intend to pay any
dividends on our common shares for the foreseeable future.
We
cannot assure you that we will list our common stock on NASDAQ or any other
national securities system or exchange.
Although
we intend to apply to list our common stock on NASDAQ or the American Stock
Exchange in the future, we do not currently meet the initial listing standards
of either of those markets and we cannot assure you that we will be able to
qualify for and maintain a listing of our common stock on either of those
markets or any other stock system or exchange in the future. Furthermore, in the
case that our application is approved, there can be no assurance that trading of
our common stock on such market will reach or maintain desired liquidity. If we
are unable to list our common stock on NASDAQ, the American Stock Exchange or
another national securities system or exchange, or to maintain the listing, we
expect that our common stock will be eligible to trade on the Pink Sheets,
maintained by NASDAQ, another over-the-counter quotation system, or on the "pink
sheets," where an investor may find it more difficult, or impossible, to dispose
of shares or obtain accurate quotations as to the market value of our common
stock. Under such circumstances, the probability of reduced liquidity would
hinder investors' ability to obtain accurate quotations for our common stock,
and our common stock could become substantially less attractive to
investors.
Securities
analysts may not continue to cover our common stock, and this may have a
negative impact on our common stock's market price.
The
trading market for our common stock will depend, in part, on the research and
reports that securities analysts publish about us and our business. We do not
have any control over these analysts. If securities analysts do not cover our
common stock, the lack of research coverage may adversely affect its market
price. If we are covered by securities analysts, and our stock is downgraded,
our stock price would likely decline. If one or more of these analysts ceases to
cover us or fails to publish regular reports on us, we could lose visibility in
the financial markets, which could cause our stock price or trading volume to
decline.
We
have raised substantial amounts of capital in private placements, and if we fail
to comply with the applicable securities laws, ensuing rescission rights or
lawsuits would severely damage our financial position.
Our
private placements consist of securities that were not registered under the
Securities Act of 1933, as amended (the "Securities Act"), or any state "blue
sky" law as a result of exemptions from such registration requirements. Such
exemptions are highly technical in nature and if we inadvertently failed to
comply with any of such exemptive provisions, investors could have the right to
rescind their purchase of our securities and also sue for damages. If any
investors were to successfully seek such rescission or prevail in any such suit,
we could face severe financial demands that could have significant, adverse
affects on our financial position. Future financings may involve sales of our
common stock at prices below prevailing market prices on the exchange on which
our common stock is quoted or listed at that time, as well as the issuance of
warrants or convertible securities at a discount to market
price.
29
The application of the "penny stock"
rules could adversely affect the market price of our common stock and increase
your transaction costs to sell those shares.
The SEC
has adopted regulations which generally define a "penny stock" to be an equity
security that has a market price of less than $5.00 per share or an exercise
price of less than $5.00 per share, subject to specific exemptions. The last
reported trade of our common stock on the Pink Sheets was at a price below $5.00
per share, and, accordingly, our common stock is currently considered a penny
stock. The SEC's penny stock rules require a broker-dealer, before a transaction
in a penny stock not otherwise exempt from the rules, to deliver a standardized
risk disclosure document that provides information about penny stocks and the
risks in the penny stock market. The broker-dealer must also provide the
customer with current bid and offer quotations for the penny stock, the
compensation of the broker-dealer and the salesperson in the transaction, and
monthly account statements showing the market value of each penny stock held in
the customer's account. In addition, the penny stock rules generally require
that before a transaction in a penny stock, the broker-dealer make a special
written determination that the penny stock is a suitable investment for the
purchaser and receive the purchaser's agreement to the transaction. If
applicable in the future, these rules may restrict the ability of
brokers-dealers to sell our common stock and may affect the ability of investors
to sell their shares, until our common stock no longer is considered a penny
stock.
Sales
of a significant number of shares of common stock in the public market could
lower the market price of our common stock.
A
significant amount of common stock is subject to issuance upon the conversion of
our Series A Convertible Preferred Stock and upon exercise of warrants to
purchase common stock. The conversion, exercise and sale of these financial
instruments could depress the market price of our common stock.
As of
September 30, 2010, we had 200,000 shares of our Series A Convertible Preferred
Stock currently exercisable into 105,882 shares of common stock outstanding.
Also, all of the warrants issued in the Financing, currently exercisable into
3,415,320 shares of common stock, remain outstanding.
Sales of
a significant number of shares of our common stock in the public market after
the conversion or exercise of these securities could lower the market price of
our common stock.
Risks
Related to Our Company
Mr.
Qinghuan Wu, one of our directors and our Chairman of the Board and Chief
Executive Officer, may have potential conflicts of interest with us, which may
adversely affect our business, and beneficially owns a significant number of
shares of our common stock, which will have an impact on all major decisions on
which our stockholders may vote and which may discourage an acquisition of our
Company.
Mr.
Qinghuan Wu, who is our Chairman of the Board and Chief Executive Officer, is
also an Executive Director of each of Shanghai Engineering and Shanghai
Environmental. Shanghai Engineering is owned jointly by Mr. Qinghuan Wu and his
spouse, Mrs. Jialing Zhou, who is one of our directors. Shanghai Environmental
is wholly-owned by Mr. Qinghuan Wu. Conflicts of interest may arise between his
duties to our company and his duties to Shanghai Engineering or Shanghai
Environmental, or his interest as an owner of Shanghai Engineering and Shanghai
Environmental. As Mr. Qinghuan Wu is a director and executive officer of our
company, he has a duty of loyalty and care to us under Delaware law when there
are any potential conflicts of interest between our company and Shanghai
Engineering and Shanghai Environmental. We cannot assure you that when conflicts
of interest arise, Mr. Qinghuan Wu will act completely in our interests or that
conflicts of interest will be resolved in our favor. In addition, Mr. Qinghuan
Wu could violate his legal duties by diverting business opportunities from us to
others. If we cannot resolve any conflicts of interest between us and Mr.
Qinghuan Wu, we would have to rely on legal proceedings, which could disrupt our
business.
Further,
the design, manufacturing and installation of energy recovery systems are
conducted by Shanghai Engineering. We do not own Shanghai Engineering but
instead rely on contractual arrangements between our wholly-owned subsidiary CER
Hong Kong and it to control the company and to participate in its profitability.
Shanghai Engineering, in turn, has entered into contractual agreements with
Shanghai Si Fang for the manufacture of our energy recovery systems. The
agreements constituting these contractual arrangements provide that CER Hong
Kong may assign them to other parties, in some cases freely, and that Shanghai
Engineering may assign them to other parties with CER Hong Kong's consent. Mr.
Qinghuan Wu, as an owner and member of management of Shanghai Engineering, and
as our Chairman of the Board and Chief Executive Officer, has the power to
direct the operations of Shanghai Engineering and CER Hong Kong and to cause
them to terminate, fail to renew, assign or consent to the assignment of the
agreements constituting these contractual arrangements, even if contrary to Mr.
Qinghuan Wu's duties to us. If these agreements were terminated, not renewed or
assigned to a party unaffiliated with us, and we were unable to enter into
satisfactory substitute agreements with other design firms, manufacturers,
installers and sales firms, we would likely be unable to continue to design,
manufacture, install and sell energy recovery systems and our stockholders would
hold stock in a company without meaningful business operations.
30
Currently,
Mr. Qinghuan Wu directly owns approximately 37% of our currently outstanding
common stock (including the shares escrowed in the Share Exchange; and
beneficially together with his spouse approximately 64%). In addition, he is
also our Chairman of the Board and Chief Executive Officer. The interests of Mr.
Qinghuan Wu may differ from the interests of other stockholders. As a result,
Mr. Qinghuan Wu has the ability to significantly impact all corporate actions
requiring stockholder approval, including the following actions:
|
|
Election
of our directors;
|
|
|
The
amendment of our organizational documents;
and
|
|
|
The
merger of our company or the sale of our assets or other corporate
transaction; and
|
Mr.
Qinghuan Wu's beneficial stock ownership may discourage potential investors from
investing in shares of our common stock due to the lack of influence they could
have on our business decisions, which in turn could reduce our stock
price.
If
we fail to implement effective internal controls required by the Sarbanes-Oxley
Act of 2002, to remedy any material weaknesses in our internal controls that we
may identify, such failure could result in material misstatements in our
financial statements, cause investors to lose confidence in our reported
financial information and have a negative effect on the trading price of our
common stock.
Section
404 of the Sarbanes-Oxley Act of 2002 requires management of public companies to
develop and implement internal controls over financial reporting and evaluate
the effectiveness thereof,.
During
our assessment of the effectiveness of our disclosure controls and procedures
and internal controls over financial reporting as of December 31, 2009, our
management identified material weaknesses. We found that our accounting staff
lacked sufficient accounting skills and experience necessary to fulfill our
public reporting obligations according to accounting principles generally
accepted in the United States and the SEC's rules and regulations. We also lack
qualified resources to perform our internal audit functions properly. In
addition, we have not yet fully developed the scope and effectiveness of our
internal audit function.
Any
failure to complete our assessment of our internal controls over financial
reporting, to remediate any material weaknesses that we may identify, including
those identified above, or to implement new or improved controls, or
difficulties encountered in their implementation, could harm our operating
results, cause us to fail to meet our reporting obligations or result in
material misstatements in our financial statements.. Inadequate disclosure
controls and procedures and internal controls over financial reporting could
also cause investors to lose confidence in our public disclosures and reported
financial information, which could have a negative effect on the trading price
of our common stock.
Further,
because some members of our management team have limited or no experience
operating a publicly-traded company, we are keeping recruit, hire, train and
retain additional financial reporting, internal controls and other personnel to
develop and implement appropriate internal controls and reporting procedures.
This may be time consuming, difficult and costly for us.
Our
Amended and Restated Certificate of Incorporation authorizes our board of
directors to create new series of preferred stock without further approval by
our stockholders, which could adversely affect the rights of the holders of our
common stock or delay or prevent a change in control.
Our board
of directors has the authority to fix and determine the relative rights and
preferences of our preferred stock. Our board of directors also has the
authority to issue preferred stock without further stockholder approval. As a
result, our board of directors could authorize the issuance of a series of
preferred stock that would grant to holders the preferred right to our assets
upon liquidation, the right to receive dividend payments before dividends are
distributed to the holders of common stock and the right to the redemption of
the shares, together with a premium, prior to the redemption of our common
stock. In addition, our board of directors could authorize the issuance of a
series of preferred stock that has greater voting power than our common stock or
that is convertible into our common stock, which could decrease the relative
voting power of our common stock or result in dilution to our existing
stockholders. In addition, our issuing preferred stock could have the effect of
delaying or preventing a change in control.
31
Item
1B Unresolved Staff Comments
Not
applicable.
Item
2 Properties
Our
corporate headquarters are currently located at 7F, No. 267 Qu Yang Road,
Hongkou District, Shanghai 200081, China. The telephone number of our corporate
headquarters is +86 (0)21 5556-0020.
On March
19, 2009, CER Shanghai entered into an office lease agreement with Shanghai
Zhangjiang Integrated Circuit Industrial Zone Development Co., Ltd. to lease
space to serve as our new main office and design and engineering center in
China. The lease term began on March 1, 2009 and ends on February 28, 2011. Our
annual rent payment is approximately $146,304 for the first year and
approximately $849,958 for the second year. The rental expense is recorded on a
straight-line basis. We were also required to make a security deposit of
approximately $292,613 in addition to the annual rent payments. CER
Shanghai has an option to purchase the office space for approximately
$8,221,478, if purchasing before December 31, 2010. If CER Shanghai were to
exercise the purchase option, the deposit and lease payments made would be
credited towards the purchase price. The Company has not made
final decision to exercise the purchase option yet.
Through a
contractual arrangement with Shanghai Engineering, our subsidiary CER Hong Kong
currently operates a manufacturing facility in Shanghai, China. The facility
occupies approximately 10 acres (4 hectares) of land with 191,300 square feet of
manufacturing space and storage. The manufacturing equipment includes cranes,
press bending machines, cutting machines, welding machines, lathes, air
compressors and other equipment. Shanghai Engineering does not own the
manufacturing facility but operates it pursuant to the terms of a cooperative
manufacturing agreement with Shanghai Si Fang. Pursuant to the agreement,
Shanghai Si Fang leases its subsidiary Vessel Works Division to Shanghai
Engineering. The manufacturing facility and equipment are in good working
condition and we expect them to meet our capacity need for 2010.
On August
18, 2009, CER Hong Kong entered into a series of contracts with Yangzhou
(Yizheng) Automobile Industrial Park Administration Committee, a government
entity of the City of Yangzhou, Jiangsu Province, China, to acquire a tract of
land on which CER Hong Kong plans to build a new manufacturing facility. The
planned facility is part of the Company’s business plan for expanding
its production capacity and to develop additional demand for its products within
China and from overseas. Phase 1 construction of the new plant is expected to be
completed by October 2010.
Item
3 Legal Proceedings
We are
not a party to any pending material legal proceedings and are not aware of any
threatened or contemplated proceeding by any governmental authority against
us.
Item
4 [Reserved]
32
PART
II
Item
5 Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
Market
Information
Our
common stock has been quoted since May 20, 2010 under the symbol "CGYV.PK" on
the Pink Sheets. Prior to May 20, 2010, the common stock was quoted on the
OTC:BB under symbol “CGYV.OB”, until the trading was ended because of the
delinquency in the SEC reporting obligations of the Company. The following table
sets forth, for the periods indicated the high and low bid prices of our common
stock as reported on the OTC:BB and Pink Sheets and adjusted for stock
splits.
Period
|
High
|
Low
|
||||||
2010
|
||||||||
Third
Quarter
|
$ | 0.55 | $ | 0.21 | ||||
Second
Quarter
|
$ | 0.8 | $ | 0.15 | ||||
First
Quarter
|
$ | 1.05 | $ | 0.59 | ||||
2009
|
||||||||
Fourth
Quarter
|
$ | 1.25 | $ | 0.85 | ||||
Third
Quarter
|
$ | 1.72 | $ | 0.85 | ||||
Second
Quarter
|
$ | 2.03 | $ | 1.46 | ||||
First
Quarter
|
$ | 2.20 | $ | 1.15 | ||||
2008
|
||||||||
Fourth
Quarter
|
$ | 2.00 | $ | 0.95 | ||||
Third
Quarter
|
$ | 10.01 | $ | 2.00 | ||||
Second
Quarter
|
$ | 12.50 | $ | 3.00 | ||||
First
Quarter
|
$ | 6.50 | $ | 0.54 |
As of
September 30, 2010, the last reported sales price on the Pink Sheets for our
common stock was $0.45 per share. These over-the-counter market quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission and
may not necessarily represent actual transactions.
Stockholders
As of
September 30, 2010, we had approximately 89 stockholders of record of our common
stock.
Dividends
We have
not declared any cash dividends on our common stock since our inception and do
not anticipate paying such dividends in the foreseeable future. We plan to
retain any future earnings for use in our business. Any decisions as to future
payments of dividends will depend on our earnings and financial position and
such other facts as the board of directors deems relevant.
33
Recent
Sales of Unregistered Securities
On May
21, 2009, the Company entered into a series of agreements for an unsecured term
loan arrangement (“Convertible Note Agreement”) with a private investor. In
connection with the drawdown of the funds under the Convertible Note Agreement,
equal to $5,000,000, the Company may have to issue up to 2,777,777 shares of
common stock to the lender upon conversion of the principal amount, which
carries a conversion rate of $1.80, subject to adjustment. In connection with
the loan, the Company issued a transferable warrant on May 21, 2009 to the
lender, to purchase up to 1,388,889 shares of common stock, at an exercise price
of $1.80, exercisable for five years. The note, the warrants and the
underlying shares were issued to an accredited entity, pursuant to Section 4(2)
of the Securities Act.
Securities
Authorized for Issuance under Equity Compensation Plans
The
following table sets forth, as of December 31, 2009, certain information related
to our compensation plans under which shares of our common stock are authorized
for issuance.
Plan Category
|
Number of
Securities to be
Issued upon
Exercise of
Outstanding
Options Warrants
and Rights
(a)
|
Weighted-Average
Exercise Price of
Outstanding
Options, Warrants
and Rights
|
Number of
Securities
Remaining
Available For
Future Issuance
Under Equity
Compensation
Plans (excluding
securities reflected
in column (a))
|
|||||||||
Equity
compensation plans approved by security holders
|
—
|
—
|
—
|
|||||||||
Equity
compensation plans not approved by security holders
|
66,141
|
$
|
1.56
|
0
|
||||||||
Total
|
66,141
|
$
|
1.56
|
0
|
On July
20, 2009, the Company terminated the service contract with a consultant. As a
result, the options granted to him on September 18, 2008 to purchase 25,000
shares of the Company’s common stock expired on October 21, 2009.
In
September 2009, another consultant gave up the options to purchase 50,000 shares
of the Company’s common stock.
On
September 7, 2009, one of the Company’s independent directors resigned from the
Company’s Board of Directors, effective October 1, 2009. The options granted to
her on September 18, 2008 to purchase 50,000 shares of the Company’s common
stock expired on December 31, 2009.
On
December 31, 2009, two of the Company’s independent directors resigned from the
Company’s Board of Directors, effective January 1, 2010. The options granted to
them on September 18, 2008 to purchase 210,000 shares of the Company’s common
stock expired on March 31, 2010.
No
options have been exercised as of the date of this Annual Report on Form
10-K.
34
Item
6 Selected Financial Data
Not
applicable.
Item
7 Management's Discussion and Analysis of Financial Condition and
Results of Operations
The
following discussion and analysis of the results of operations and financial
condition for the fiscal years ended December 31, 2008 and 2009 should be read
in conjunction with our financial statements and the notes to those financial
statements that are included elsewhere in this report. Our discussion
includes forward-looking statements based upon current expectations that involve
risks and uncertainties, such as our plans, objectives, expectations, and
intentions. Actual results and the timing of events could differ
materially from those anticipated in these forward-looking statements as a
result of a number of factors, including those set forth under the Risk Factors,
Cautionary Statement Regarding Forward-Looking Information, and Business
sections in this report. We use words such as "anticipate," "estimate,"
"plan," "project," "continuing," "ongoing," "expect," "believe," "intend,"
"may," "will," "should," "could," and similar expressions to identify
forward-looking statements.
Overview
On
January 24, 2008, we entered into a Share Exchange Agreement (the "Share
Exchange Agreement") with Poise Profit International, Ltd. ("Poise Profit") and
the shareholders of Poise Profit. Pursuant to the Share Exchange Agreement, we
acquired 100% of the issued and outstanding shares of Poise Profit's common
stock in exchange for the issuance of 41,514,179 (pre reverse split) shares of
our common stock to the shareholders of Poise Profit. The share exchange (the
"Share Exchange") transaction was consummated on April 15, 2008.
As a
result of Share Exchange, our business operations consist of those of Poise
Profit's Chinese subsidiary, Hi-tech, which were subsequently transferred to CER
Hong Kong on December 3, 2008. CER Hong Kong is principally engaged in
designing, marketing, licensing, fabricating, implementing and servicing
industrial energy recovery systems capable of capturing industrial waste energy
for reuse in industrial processes or to produce electricity and thermal
power.
CER Hong
Kong carries out its operations through its subsidiary CER Shanghai and an
affiliated entity with which CER Hong Kong has a contractual relationship,
Shanghai Engineering. Shanghai Engineering's manufacturing activities are
carried out by Vessel Works Division located in Shanghai, China, through a lease
agreement with Vessel Works Division's owner. The term “Company” refers to the
group of companies described above.
The
energy recovery systems that we produce capture industrial waste energy for
reuse in industrial processes or to produce electricity and thermal power, which
allow industrial manufacturers to reduce a portion of their energy costs, shrink
their emissions and potentially generate sellable emissions credits. We have
primarily sold energy recovery systems to chemical manufacturing plants to
reduce their energy costs by increasing the efficiency of their manufacturing
equipment and help control their pollution output. We have installed more than
100 energy recovery systems throughout China and in a variety of international
markets.
35
December
31, 2008 Financial Statements
On May
27, 2010, after substantial investigation and internal audit work by the
Company, our Board of Directors determined that the financial results for the
fiscal year ended December 31, 2008 presented in the Annual Report on Form 10-K
filed for the fiscal year ended December 31, 2008 should not be relied upon
because of errors in the financial statements. The details are as
follows:
Consolidated
Balance Sheet Impact-
The
following tables set forth the effects of the restatement adjustments and
reclassification adjustments on the Company’s 2008 consolidated balance
sheets:
2008
|
Adjustment
|
2008
|
||||||||||
|
Previously
reported
|
Restated
|
||||||||||
ASSETS
|
||||||||||||
CURRENT
ASSETS:
|
||||||||||||
Cash
|
$ | 6,136,403 | $ | - | $ | 6,136,403 | ||||||
Restricted
cash
|
597,949 | - | 597,949 | |||||||||
Notes
receivable
|
120,749 | - | 120,749 | |||||||||
Accounts
receivable, net of allowance for doubtful accounts (note
(a))
|
4,935,142 | 174,314 | 5,109,456 | |||||||||
Accounts
receivable - related party
|
1,006,060 | - | 1,006,060 | |||||||||
Inventories
|
7,774,775 | - | 7,774,775 | |||||||||
Other
current assets and receivables
|
98,271 | - | 98,271 | |||||||||
Advances
on inventory purchases
|
1,044,807 | - | 1,044,807 | |||||||||
Total
current assets
|
21,714,156 | 174,314 | 21,888,470 | |||||||||
EQUIPMENT,
net
|
850,888 | - | 850,888 | |||||||||
OTHER
ASSETS:
|
||||||||||||
Deferred
tax assets (note (b))
|
- | 63,241 | 63,241 | |||||||||
Long
term accounts receivable (note (a))
|
377,368 | (274,678 | ) | 102,690 | ||||||||
Total
other assets
|
377,368 | (211,437 | ) | 165,931 | ||||||||
Total
assets
|
$ | 22,942,412 | $ | (37,123 | ) | $ | 22,905,289 | |||||
LIABILITIES
AND SHAREHOLDERS' EQUITY
|
||||||||||||
CURRENT
LIABILITIES:
|
||||||||||||
Accounts
payable (note (c))
|
$ | 3,331,293 | $ | 95,633 | $ | 3,426,926 | ||||||
Other
payables
|
466,392 | - | 466,392 | |||||||||
Other
payables - related party
|
65,078 | - | 65,078 | |||||||||
Accrued
liabilities
|
21,228 | - | 21,228 | |||||||||
Advances
from customers
|
7,044,234 | - | 7,044,234 | |||||||||
Taxes
payable (note (c))
|
2,282,621 | 409,992 | 2,692,613 | |||||||||
Deferred
revenue (note (d))
|
1,726,701 | (1,726,701 | ) | - | ||||||||
Short-term
bank loans
|
381,420 | - | 381,420 | |||||||||
Total
current liabilities and total liabilities
|
15,318,967 | (1,221,076 | ) | 14,097,891 | ||||||||
SHAREHOLDERS'
EQUITY:
|
||||||||||||
Preferred
stock(US$0.001 par value; 50,000,000 shares authorized, 714,963 shares
issued and outstanding as of December 31, 2008)
|
715 | - | 715 | |||||||||
Common
stock(US$0.001 par value; 100,000,000 shares authorized, 29,912,573
shares issued and outstanding as of December 31, 2008)
|
29,913 | - | 29,913 | |||||||||
Additional
Paid-in-capital
|
7,645,404 | 1,412,879 | 9,058,283 | |||||||||
Accumulated
deficit
|
(363,147 | ) | 55,469 | (307,678 | ) | |||||||
Statutory
reserves
|
408,403 | (275,601 | ) | 132,802 | ||||||||
Accumulated
other comprehensive loss
|
(97,843 | ) | (8,794 | ) | (106,637 | ) | ||||||
Total
shareholders' equity
|
7,623,445 | 1,183,953 | 8,807,398 | |||||||||
Total
liabilities and shareholders' equity
|
$ | 22,942,412 | $ | (37,123 | ) | $ | 22,905,289 |
(a)
|
Accounts
receivable was increased by $174,314, representing a reclassification of
$274,678 from long term accounts receivable, because these accounts
receivables are due within one year, and netting off an additional
allowance of $100,364 for doubtful
accounts.
|
(b)
|
It
represents a reclassification of deferred tax assets of $63,241 which was
previously netted against tax payables as of December 31,
2008.
|
(c)
|
Cost
of revenues, sales taxes and enterprise income tax were understated by
$95,633, $96,556 and $250,195, respectively, as of December 31, 2008. The
remaining difference represents the reclassification of $63,241 (note b)
to deferred tax assets.
|
(d)
|
The
Company recognized retainage of $1,726,701 as revenue in 2008 since the
recoverability could be reasonably
assured.
|
36
Consolidated
Statements of Income and other comprehensive income Impact:
The
following table sets forth the effects of the restatement and reclassification
adjustments on the Company’s consolidated statements of income and other
comprehensive income:
2008
|
2008
|
|||||||||||
|
Previously reported
|
Adjustment
|
Restated
|
|||||||||
REVENUES
|
||||||||||||
Third
parties (note (d))
|
$ | 19,793,175 | $ | 1,522,051 | $ | 21,315,226 | ||||||
Related
party (note (d))
|
3,384,900 | 204,650 | 3,589,550 | |||||||||
Total
revenue
|
23,178,075 | 1,726,701 | 24,904,776 | |||||||||
COST
OF REVENUES
|
||||||||||||
Third
parties (note (e))
|
(16,155,562 | ) | (394,086 | ) | (16,549,648 | ) | ||||||
Related
party
|
(1,951,549 | ) | - | (1,951,549 | ) | |||||||
Total
cost of revenues
|
(18,107,111 | ) | (394,086 | ) | (18,501,197 | ) | ||||||
GROSS
PROFIT
|
5,070,964 | 1,332,615 | 6,403,579 | |||||||||
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES (note (f))
|
(3,463,682 | ) | (818,181 | ) | (4,281,863 | ) | ||||||
INCOME
FROM OPERATIONS
|
1,607,282 | 514,434 | 2,121,716 | |||||||||
OTHER
INCOME (EXPENSE), NET:
|
||||||||||||
Non-operating
income, net
|
126,512 | 22,865 | 149,377 | |||||||||
Interest
expenses
|
(57,411 | ) | (22,865 | ) | (80,276 | ) | ||||||
Total
other income net
|
69,101 | - | 69,101 | |||||||||
INCOME
FROM OPERATIONS BEFORE PROVISION FOR INCOME TAXES
|
1,676,383 | 514,434 | 2,190,817 | |||||||||
INCOME
TAXES EXPENSES (note (g))
|
(565,720 | ) | (250,195 | ) | (815,915 | ) | ||||||
NET
INCOME
|
1,110,663 | 264,239 | 1,374,902 | |||||||||
OTHER
COMPREHENSIVE INCOME
|
||||||||||||
Foreign
currency translation adjustment
|
(57,717 | ) | - | (57,717 | ) | |||||||
COMPREHENSIVE
INCOME
|
$ | 1,052,946 | $ | 264,239 | $ | 1,317,185 | ||||||
Earnings
per share
|
||||||||||||
Basic
|
$ | 0.04 | $ | 0.01 | $ | 0.05 | ||||||
Diluted
|
$ | 0.04 | $ | 0.01 | $ | 0.05 | ||||||
Weighted
average ordinary shares outstanding
|
||||||||||||
Basic
|
25,705,500 | (13,521 | ) | 25,691,979 | ||||||||
Diluted
|
27,033,819 | (731,556 | ) | 26,302,263 |
(e)
|
The
restated cost of revenues increased by $394,086, representing undercharged
certain cost and sales tax of $95,633 and $96,556 (note c), respectively,
and a reclassification of $201,897 (note f) from selling, general and
administrative expenses.
|
(f)
|
The
restated selling, general and administrative expenses increased by
$818,181, representing undercharged cost for consulting services of
$964,484 and allowance of doubtful accounts of $100,364(note a), offset by
overcharged stock based compensation of $44,770 in 2008 and a
reclassification of $201,897 (note e) to cost of
revenue.
|
(g)
|
The
adjustment to income tax expense has been calculated based on the above
adjustments.
|
37
Consolidated
Statement of Shareholders’ Equity Impact:
The
following table sets forth the effects of the restatement and reclassification
adjustments on the Company’s consolidated statements of shareholders’
Equity:
Preferred Stock
|
Common stock
|
Additional
paid-in
capital
|
Statutory
reserves
|
Accumulated
deficit
|
Accumulated
other
comprehensive
income (loss)
|
Total
|
||||||||||||||||||||||||||||||
Shares
|
Amount
|
Shares
|
Amount
|
|||||||||||||||||||||||||||||||||
BALANCE,
December
31, 2008,
previous reported
|
714,963 | $ | 715 | 29,912,573 | $ | 29,913 | $ | 7,645,404 | $ | 408,403 | $ | (363,147 | ) | $ | (97,843 | ) | $ | 7,623,445 | ||||||||||||||||||
Recognize
retainage as revenues (note (h))
|
- | - | - | - | - | - | 1,726,701 | - | 1,726,701 | |||||||||||||||||||||||||||
Undercharged
cost of revenues (note (h))
|
- | - | - | - | - | - | (192,189 | ) | - | (192,189 | ) | |||||||||||||||||||||||||
Undercharged
allowance for doubtful accounts (note i)
|
- | - | - | - | - | - | (100,364 | ) | - | (100,364 | ) | |||||||||||||||||||||||||
Undercharged
cost for consulting service (note (i))
|
- | - | - | - | 964,484 | - | (964,484 | ) | - | - | ||||||||||||||||||||||||||
Overcharged
stock based compensation (note (i))
|
- | - | - | - | (44,770 | ) | - | 44,770 | - | - | ||||||||||||||||||||||||||
Adjustment
of income taxes expenses (note (j))
|
- | - | - | - | - | - | (250,195 | ) | - | (250,195 | ) | |||||||||||||||||||||||||
Reclassification
due to dissolve of variable interest entities (note (k))
|
- | - | - | - | 484,371 | - | (484,371 | ) | - | - | ||||||||||||||||||||||||||
Over-accrued
statutory reserve (note (l))
|
- | - | - | - | - | (275,601 | ) | 275,601 | - | - | ||||||||||||||||||||||||||
Adjustment
to accumulated other comprehensive income (loss)
|
- | - | - | 8,794 | - | - | (8,794 | ) | - | |||||||||||||||||||||||||||
BALANCE,
December 31, 2008, restated
|
714,963 | $ | 715 | 29,912,573 | $ | 29,913 | $ | 9,058,283 | $ | 132,802 | $ | (307,678 | ) | $ | (106,637 | ) | $ | 8,807,398 |
(h)
|
Refer to note
(d) and note
(e).
|
(i)
|
Refer to note
(f).
|
(j)
|
Refer to note
(c).
|
(k)
|
The restatement
adjustment
mainly
represents
a reclassification of $484,371 profit distribution
from additional paid-in capital to accumulated deficit. This profit
distribution was made by Shanghai Environment and Zhuyi to
the
Company’s shareholders.
|
(l)
|
The restatement
adjustment represents the reversal of
over-accrued statutory reserve of $275,601 as of December
31, 2008.
|
(m)
|
Aggregated amounts
allocated to preferred stocks and warrants classified in additional
paid-in capital are restated to $5,307,539 and $1,336,739 based on the
Company’s change of
valuation
(Note 12).
The
previously reported amounts allocated to
preferred stocks and warrants were $3,017,296 and $3,626,982.
|
38
Consolidated
Statement of Cash Flows Impact:
The
following table presents selected consolidated statements of cash flows
information for the Company showing previously reported and restated cash flows,
for the years ended December 31, 2008:
|
Year ended December, 31
|
|||||||||||
|
2008
|
|||||||||||
|
Previously
reported
|
Adjustment
|
Restated
|
|||||||||
Net
cash used in operating activities
|
$ | (335,612 | ) | $ | (423,146 | ) | $ | (758,758 | ) | |||
Net
cash provided by/(used in) investing activities
|
241,311 | (521,328 | ) | (280,017 | ) | |||||||
Net
cash provided by financing activities
|
5,874,018 | 1,084,284 | 6,958,302 | |||||||||
Effect
of exchange rate changes on cash and cash equivalents
|
$ | 50,536 | $ | (139,810 | ) | $ | (89,274 | ) |
Critical
Accounting Policies and Estimates
While our
significant accounting policies are more fully described in Note 3 to our
consolidated financial statements in this Annual Report on Form 10-K, we believe
that the accounting policies described below are the most critical to aid you in
fully understanding and evaluating this management discussion and
analysis.
Fair
Value Measurements
Our
management's discussion and analysis of our financial condition and results of
operations is based on our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements as well as the reported net sales and expenses
during the reporting periods. On an ongoing basis, we evaluate our estimates and
assumptions. We base our estimates on historical experience and on various other
factors that we believe are reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying value of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or
conditions.
The
Company adopted the Financial Accounting Standard Board’s (“FASB”) accounting
standard regarding the fair value measurements, which defines fair value,
establishes a three-level valuation hierarchy for disclosures of fair value
measurement and enhances disclosures requirements for fair value measures.
The carrying amounts reported in the accompanying consolidated balance sheets
for current assets and current liabilities that qualify as financial instruments
are a reasonable estimate of fair value because of the short period of time
between the origination of such instruments and their expected realization and
the current market rates of interest. The three levels of valuation
hierarchy are defined as follows:
|
Level
1
|
Inputs
to the valuation methodology are quoted prices (unadjusted) for identical
assets or liabilities in active
markets.
|
39
|
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.
|
Liability
for Warrants
Effective
January 1, 2009, the Company adopted the provisions of an accounting
standard regarding instruments that are Indexed to an Entity’s Own Stock.
This accounting standard specifies that a contract that would otherwise meet the
definition of a derivative but is both (a) indexed to the Company’s own stock
and (b) classified in stockholders’ equity in the statement of financial
position would not be considered a derivative financial instrument. It
provides a new two-step model to be applied in determining whether a financial
instrument or an embedded feature is indexed to an issuer’s own stock and thus
able to qualify for the scope exception within the standards.
Consolidation
of Variable Interest Entities
In
accordance with the FASB’s Interpretation regarding the consolidation of
variable interest entities, variable interest entities 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. Each variable interest entity with which the Company is
affiliated must be evaluated to determine who the primary beneficiary of the
risks and rewards of ownership of the variable interest entity. The primary
beneficiary is required to consolidate the variable interest entity's financial
information for financial reporting purposes.
We have
concluded that Shanghai Engineering, Shanghai Zhuyi Industry Co., Ltd.
("Zhuyi"), a former affiliated company liquidated in July 2007 originally formed
to derive tax benefits, Shanghai Haiyin Hi-Tech Engineering Co., Ltd. ("Haiyin")
a former affiliated company liquidated in January 2008 originally formed to
derive tax benefits, and Shanghai Environmental are variable interest entities
and that Poise Profit and CER Hong Kong are the primary beneficiaries.
Under the requirements of FASB’s accounting standard, Poise Profit and CER Hong
Kong consolidated the financial statements of Shanghai Engineering, Zhuyi,
Haiyin and Shanghai Environmental. As all companies are under common control
(see Note 1 to our consolidated financial statements), the consolidated
financial statements have been prepared as if the arrangements by which these
entities became variable interest entities had occurred retroactively. We
have eliminated inter-company items from our consolidated financial
statements.
All of
Shanghai Engineering’s manufacturing activities are conducted through a Leasing
and Operation Agreement, a form of cooperative manufacturing agreement,
originally effective as of May 1, 2003 and subsequently renewed and amended with
a state-owned enterprise, Shanghai Si Fang. Pursuant to the agreement,
Shanghai Si Fang leases certain land use right, buildings and fixed assets
(lease elements) in one of its subsidiaries, Vessel Works Division, and provides
management services and licenses the “Si Fang” brand and manufacturing license
(non-lease elements) of Vessel Works Division to Shanghai Engineering.
Because the arrangement contains both the lease and non-lease elements, the
amount of quarterly payments is allocated between the lease and non-lease
deliverables. The lease elements are classified and accounted for as
operating leases and the lease expense is recorded on a straight-line
basis. The non-lease elements are accounted for as prepayment for
management and licensing fees and the payment is amortized on a straight-line
basis over each contractual period.
40
Shanghai
Engineering does not have a variable interest in Vessel Works Division through
this agreement as the arrangement is established between Shanghai Engineering
and Shanghai Si Fang. Shanghai Engineering does not have any contractual
or ownership interest in Vessel Works Division, and therefore, Shanghai
Engineering does not have variable interests in Vessel Works
Division.
The
arrangement, however, may result in Shanghai Engineering having variable
interests in Shanghai Si Fang, but as Shanghai Si Fang is a state-owned
enterprise that has substantive operations other than this lease and operation
arrangement, Shanghai Engineering is not the primary beneficiary of Shanghai Si
Fang.
Revenue
Recognition
We derive
revenue principally from (a) sales of our energy recovery systems; (b) provision
of design services; and (c) provision of Engineering, Procurement and
Construction ("EPC") services, which are essentially turnkey contracts where we
provide all the services in the construction process from design, development,
engineering, and manufacturing to installation. Sales of our energy recovery
systems and related products are essentially product sales. The products consist
mainly of waste heat boilers and other related equipment manufactured according
to specific customers' specifications. Once manufactured, we ship the products
to our customers in their entirety in one batch.
In
providing design services, we design energy recovery systems and other related
systems based on a customer's requirements and the deliverable consists of
engineering drawings. The customer may elect to engage us to manufacture the
designed system or choose to present our drawings to other manufacturers
for manufacturing and installation. In contrast, when providing EPC services,
the customer is purchasing a turnkey energy recovery system, and we are involved
throughout the entire process from design to installation. Our service
arrangements include a limited warranty to our customers pursuant to which our
customers retain between 5% and 10% of the particular contract price as
retainage during the limited warranty period (usually 12 to 18
months).
We
generally recognize revenues including retainage from product sales when (a)
persuasive evidence of an arrangement exists, which is generally represented by
a contract between us and the customer; (b) products are shipped; (c) title and
risk of ownership have passed to the customer, which generally occurs at the
time of delivery; (d) the customer accepts the products upon quality inspection
performed by the customer; (e) the purchase price is agreed to between us and
the customer; and (f) collectability is reasonably assured. Sales revenues
represent the invoiced value of products, less returns and discounts, and net of
value added tax.
We
recognize revenues including retainage from design services when (a) persuasive
evidence of an arrangement exists, which is generally represented by a contract
between us and the customer; (b) the design drawings are delivered; (c) the
purchase price is agreed to between us and the customer; and (d) collectability
is reasonably assured. We generally deliver the drawings in one
batch.
41
The
energy recovery system involved in an EPC project is highly customized to the
specific customer's facilities and essentially not transferable to any other
facilities without significant modification and cost. It would be difficult, if
not impossible, to beneficially use a single element of a specific EPC project
on a stand alone basis other than in connection with the facilities for
which it was intended. In accordance with the accounting standard regarding
performance of construction-type and certain production-type contracts (1981)
issued by the American Institute of Certified Public Accountants (“AICPA”), the
Company adopted the percentage of completion method in lieu of the completed
contract method when: (a) it is possible to make reasonably reliable estimates
of revenues and costs for the construction project; (b) the contract specifies
the parties' rights as to the goods, consideration to be paid and received, and
the resulting terms of payment or settlement; (c) the purchaser has the ability
and expectation to perform all contractual duties; and (d) the contractor has
the same ability and expectation to perform. In contrast, this AICPA
accounting standard provides that the completed contract method should be
used in rare circumstances where: (a) the contract is of a short duration; (b)
the contract violates any one of the prongs described above for the percentage
of completion method; or (c) the project involves documented extraordinary,
nonrecurring business risks. EPC contracts are by nature long-term
construction-type contracts, usually lasting more than one accounting period,
and we are able to reasonably estimate the progress toward completion, including
contracts revenues and contracts costs. EPC contacts specify the customers'
rights to the goods, the consideration to be paid and received, and the terms of
payment. Specifically, we have the right to require a customer to make
progress payments upon completion of determined stages of the project which
serve as evidence of the customer's approval and acceptance of the work
completed to date as complying with the terms of the particular EPC contract and
upon which we recognize revenues. The risks and rewards of ownership of the
installed goods pass to the customer upon completion of each stage of the
project. Hence, EPC contracts involve a continuous sale and transfer of
ownership rights that occurs as the work progresses. Further, a customer has the
right to require specific performance of the contract and the contracts do not
involve any documented extraordinary nonrecurring business risks. Finally,
according to the FASB’s accounting standard regarding long-term
construction-type contracts, the percentage of completion method is preferable
when recognizing revenues when the estimates of costs of completion and the
extent of progress toward completion of long-term contracts are reasonably
dependable. For the above-mentioned reasons, we recognize revenues including
retainage from EPC contracts using the percentage of completion method based on
the Accounting standards.
Recent
Accounting Pronouncements
In August
2009, the FASB issued Accounting Standards Update (ASU) 2009-05, Fair Value
Measurements and Disclosures (Topic 820) - Measuring Liabilities at Fair Value.
The fair value measurement of a liability assumes transfer to a market
participant on the measurement date, not a settlement of the liability with the
counterparty. ASU 2009-05 describes various valuation methods that can be
applied to estimating the fair values of liabilities, requires the use of
observable inputs and minimizes the use of unobservable valuation inputs. ASU
2009-05 is effective for the fourth quarter of 2009. The adoption of ASU 2009-05
did not have a material impact on our financial position, results of operations
or cash flows.
In
December 2009, the FASB issued ASU 2009-17, Consolidations (Topic 810) –
Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities. ASU 2009-17 changes how a reporting entity determines when an
entity that is insufficiently capitalized or is not controller through voting
(or similar rights) should be consolidated. ASU 2009-17 also requires a
reporting entity to provide additional disclosures about its involvement with
variable interest entities and any significant changes in risk exposure due to
that involvement. ASU 2009-17 is effective at the start of a reporting entity’s
first fiscal year beginning after November 15, 2009, or January 1, 2010, for a
calendar year entity. Early adoption is not permitted. We do not believe that
the adoption of ASU 2009-17 will have a material impact on our financial
position, results of operations or cash flows.
42
In
January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and
Disclosures (Topic 820) – Improving Disclosures about Fair Value Measurements.
This ASU requires new disclosures and clarifies certain existing disclosure
requirements about fair value measurements. ASU 2010-06 requires a reporting
entity to disclose significant transfers in and out of Level 1 and Level 2 fair
value measurements, to describe the reasons for the transfers and to present
separately information about purchases, sales, issuances and settlements for
fair value measurements using significant unobservable inputs. ASU 2010-06 is
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,
which is effective for interim and annual reporting periods beginning after
December 15, 2010; early adoption is permitted. We do not believe that the
adoption of ASU 2010-06 will have a material impact on our financial position,
results of operations or cash flows.
In
February 2010, the FASB issued ASU 2010-09 to amend ASC 855, Subsequent Events.
ASC 855, which was originally issued by the FASB in May 2009, provides guidance
on events that occur after the balance sheet date but prior to the issuance of
the financial statements. ASC 855 distinguishes events requiring recognition in
the financial statements and those that may require disclosure in the financial
statements. As a result of ASU 2010-09, SEC registrants will not disclose the
date through which management evaluated subsequent events in the financial
statements, either in originally issued financial statements or reissued
financial statements. ASC 855 was effective for interim and annual periods
ending after June 15, 2009, and ASU 2010-09 is effective immediately. We have
evaluated subsequent events in accordance with ASU 2010-09.
43
Results
of Operations
Comparison
of the Fiscal Years Ended December 31, 2008 and December 31, 2009
The
following table sets forth the results of our operations for the years indicated
as a percentage of revenues:
Fiscal Year ended December
31,
|
||||||||||||||||
2008
Restated
|
2009
|
|||||||||||||||
REVENUES
|
||||||||||||||||
Third
parties
|
$ | 21,315,226 | 85.6 | % | $ | 22,194,443 | 100.0 | % | ||||||||
Related
party
|
3,589,550 | 14.4 | % | - | 0.0 | % | ||||||||||
Total
revenue
|
24,904,776 | 100.0 | % | 22,194,443 | 100.0 | % | ||||||||||
COST
OF REVENUES
|
||||||||||||||||
Third
parties
|
(16,549,648 | ) | 66.5 | % | (18,842,557 | ) | 84.9 | % | ||||||||
Related
party
|
(1,951,549 | ) | 7.8 | % | - | 0.0 | % | |||||||||
Total
cost of revenues
|
(18,501,197 | ) | 74.3 | % | (18,842,557 | ) | 84.9 | % | ||||||||
GROSS
PROFIT
|
6,403,579 | 25.7 | % | 3,351,886 | 15.1 | % | ||||||||||
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
(4,281,863 | ) | 17.2 | % | (5,746,743 | ) | 25.9 | % | ||||||||
INCOME/(LOSS)
FROM OPERATIONS
|
2,121,716 | 8.5 | % | (2,394,857 | ) | (10.8 | %) | |||||||||
OTHER
INCOME, NET:
|
||||||||||||||||
Change
in fair value of warrant liability
|
- | - | 1,539,233 | 6.9 | % | |||||||||||
Change
in fair value of derivative liability
|
- | 0.0 | % | 399,500 | 1.8 | % | ||||||||||
Non-operating
income, net
|
149,377 | 0.6 | % | 80,692 | 0.4 | % | ||||||||||
Interest
expenses
|
(80,276 | ) | (0.3 | %) | (868,388 | ) | (3.9 | %) | ||||||||
Total
other income , net
|
69,101 | 0.3 | % | 1,151,037 | 5.2 | % | ||||||||||
|
||||||||||||||||
INCOME/(LOSS)
FROM OPERATIONS BEFORE PROVISION FOR INCOME TAXES
|
2,190,817 | 8.8 | % | (1,243,820 | ) | (5.6 | %) | |||||||||
|
||||||||||||||||
INCOME
TAXES (EXPENSES)/BENEFITS
|
(815,915 | ) | (3.3 | %) | 357,340 | 1.6 | % | |||||||||
NET
INCOME/(LOSS)
|
1,374,902 | 5.5 | % | (886,480 | ) | (4.0 | %) | |||||||||
OTHER
COMPREHENSIVE (LOSS)/INCOME
|
||||||||||||||||
Foreign
currency translation adjustment
|
(57,717 | ) | (0.2 | %) | 29,152 | 0.1 | % | |||||||||
COMPREHENSIVE
INCOME/(LOSS)
|
$ | 1,317,185 | 5.3 | % | $ | (857,328 | ) | (3.9 | %) |
Revenues Our revenues include
revenues from sales of energy recovery systems, provision of design services and
EPC services. Revenues decreased to $22,194,443 for the year ended December 31,
2009 as compared to $24,904,776 for the year ended December 31, 2008, a decrease
of $2,710,333 or 10.9%. This decrease was mainly due to the decrease in the
overall amount of revenue under our outstanding contracts which is consistent
with the worldwide economic crisis. We produced far fewer boilers during the
period though we finished one more EPC contract with stable pricing. The
detailed changes are as follows:
44
2008
Restated
|
2009
|
Change ($)
|
%
|
|||||||||||||
Average
Revenue per Contract
|
||||||||||||||||
Products
|
$ | 281,202 | $ | 326,660 | $ | 45,458 | 16 | % | ||||||||
Design
Services
|
$ | 100,905 | $ | 130,408 | $ | 29,503 | 29 | % | ||||||||
EPC
|
$ | 2,228,166 | $ | 2,380,138 | $ | 151,973 | 7 | % | ||||||||
Average
Revenue per Contract
|
$ | 350,771 | $ | 504,419 | $ | 153,648 | 44 | % | ||||||||
Number
of Contracts Completed
|
||||||||||||||||
Products
|
63 | 38 | (25 | ) | (40 | )% | ||||||||||
Design
Services
|
5 | 2 | (3 | ) | (60 | )% | ||||||||||
EPC
|
3 | 4 | 1 | 33 | % | |||||||||||
Total
Number of Contracts Completed
|
71 | 44 | (27 | ) | (38 | )% |
Although
the average sales revenue recognized per product contract increased by $45,458
from $281,202 for the year ended December 31, 2008 to $326,660 for the year
ended December 31, 2009, the number of product contracts we completed decreased
from 63 to 38 due to the worldwide financial crisis and also because we are
focusing more on EPC contracts.
With the
recovery of the economy and the Chinese government’s emphasis on energy
efficiency and pollution reduction, it is anticipated that the business will
continue to grow in future periods. We believe we are among the few
companies in the industry with the necessary design and engineering capability
to satisfy the growing market demand for larger energy recovery systems.
Further, we have been expanding our marketing efforts to win new contracts by
attending trade events both inside China and overseas, hosting focused industry
seminars, increasing selling efforts to repeat customers and actively
pursuing new customer prospects, and partnering with large engineering
houses and foreign industry leaders. We are also building a new state-of-the-art
manufacturing facility expected to be partly completed and into operation in
late 2010, which is designed to expand our production capacity and solve the
capacity limitations we experience at our current leased facility. The new plant
with its higher efficiency and greater capacity, once in place, is expected to
enable us to increase our sales and gross margin.
Cost of Revenues Cost of
revenues increased to $18,842,557 for the year ended December 31, 2009, as
compared to $18,501,197 for the year ended December 31, 2008, an increase of
$341,360, or 1.8%. As a percentage of revenues, cost of revenues increased
from74.3% for the year ended December 31, 2008 to 84.9% for the year ended 2009,
an increase of 6.4%. The increase is largely due to: 1) the price of raw
materials, such as steel, being higher in previous years, we used up most of
these materials in production of 2009; 2) the company carried more EPC projects,
which usually earn less gross profit margin especially from purchase parts; 3)
the increase in salaries or workers and engineers from April 2008 in recognition
of the Company becoming a U.S. public company. Although we tried to
anticipate the cost of production increases when bidding on contracts, there may
be contracts that we have entered which may not permit us to raise our prices,
and therefore, we experienced reduced margins under such agreements.
Management will continually assess any rising costs and any inflationary
pressures, and attempt to take action to protect our results of operations. We
expect that we will adjust the prices of our products and services accordingly
to minimize such an impact on our results of operations with the recovering
world economy.
45
Gross Profit Gross profit was
$3,351,886 for the year ended December 31, 2009 as compared to $6,403,579 for
the year ended December 31, 2008, a decrease of $3,051,693 or 47.7%. The
respective gross margins are 15.1% and 25.7% for the years ended December 31,
2009 and 2008. Besides the reasons mentioned for the increase of cost of
revenues, the decrease is also due to the revenue earned from related party in
2008 having a much higher margin than that from third parties.
Selling, General and Administrative
Expenses Selling, general and administrative expenses increased to
$5,746,743 for the year ended December 31, 2009, as compared to $4,281,863 for
the year ended December 31, 2008, an increase of $1,464,880 or 34%. Selling,
general and administrative expenses, as a percentage of revenue, increased from
17.2% for the year ended December 31, 2008 to 25.9% for the year ended December
31, 2009, an increase of 8.7%. The increase is mainly due to following
reasons. (1) Firstly, the increase in travel, shipping and handling
expenses from $645,107 in 2008 to $813,869 in 2009 resulting from greater
sales efforts. (2) Secondly, staff costs for year 2009 were $1,482,332 as a
result of more employees hired for future business expansion, salary increases
after the Company went public and more high-profile management staffs hired,
compared to $807,310 for year 2008. In addition, the increase in rental for
office space of $415,109 including a new engineering and R&D center in
Zhangjiang, Shanghai. On the other hand, the Company incurred fewer public
company expenses, such as legal, investor relationship and business development
and etc, for $ 2,194,045 and $1,798,460 of the year ended December 31, 2008 and
2009, respectively, with a decrease of $395,585, resulting from the company’s
public offering in April 2008.
Income/(loss) from Operations
As a result of the above, loss from operations totaled $2,394,857 for the year
ended December 31, 2009 as compared to income of $2,121,716 for the year ended
December 31, 2008, a decrease of $4,516,573 or 212.8%. As a percentage of
revenues, loss from operations was 10.8 % for the year ended December 31, 2009
as compared to an operating profit of 8.5% for the year ended December 31, 2008.
The decrease is mainly attributable to increase in operating expenses and
lower gross profit.
Other Income Other
income was $1,151,037 for the year ended December 31, 2009, as compared to
$69,101 for the year ended December 31, 2008. Interest expenses increased to
$868,388 for the year ended December 31, 2009, as compared to $80,276 for the
year ended December 31, 2008, an increase of $ 788,112 or 981.8%. This increase
is mainly due to the interest expense incurred for convertible notes of $118,750
and accretion of convertible notes of $232,628. In addition, the amortization of
deferred financing cost in relation to the convertible notes amounted to
$497,541 for the year ended December 31, 2009. The Company also had
non-operating income of $80,692 (consisting mainly of a VAT tax refund from the
government and compensation for breach of a contract by one customer) for the
year ended December 31, 2009, as compared to $149,377 (consisting mainly of
collection of receivable which has been impaired in previous years) for the
ended December 31, 2008. Also included in other income for 2009 was $1,539,233
for a change in fair value of warrant liability and $399,500 for a change in
fair value of derivative liability, resulting from the valuation of warrants and
derivative liabilities, mainly due to the decrease of the Company’s stock
price.
Income/(loss) before Provision
for Income Taxes As a result of the foregoing, loss before provision for
income taxes was $ 1,243,820 for the year ended December 31, 2009, as
compared to income of $2,190,817, for the year ended December, 2008, a decrease
of $3,434,637 or 156.8%.
46
Income Taxes
Expenses/(Benefits) Income taxes was a benefit of $357,340 for the
year ended December 31, 2009, representing 28.7% of the income before provision
for income taxes, as compared to $815,915 representing 37.2% of the income
before provision for income taxes, for the year ended December 31, 2008. The
changes are primarily because the Company had a loss in 2009, and no income tax
expense was generated for the year ended December 31, 2009, while the Company
incurred $815,915 income tax expenses from generated taxable income in 2008. In
addition, certain deferred tax assets which was provided as a result of tax loss
carry forward incurred in 2009, was offset against deferred tax liability
incurred in relation to the issuance of convertible notes. The recognition of
deferred tax liability in relation to the convertible notes was recorded as an
adjustment to additional paid in capital.
Net Income/(Loss) As a result
of the foregoing, we incurred a net loss of $886,480, for the year ended
December 31, 2009 as compared to net income of $1,374,902, for the year
ended December 31, 2008, a decrease of $2,261,382 or 164.5%. The decrease in net
income is mainly due to the decrease of gross profit and the increase in
operating expenses, offset by the change in fair value of the warrants and
derivative liability. Management believes that as a result of our ongoing
efforts to improve operational efficiency and implement stricter cost controls
and cost reduction measures, including attempts to minimize those expenses
related to public company operations, enhance accounts receivable collection to
reduce bad debt expenses, and control headcount and salary costs, our operating
expenses will not necessarily increase in proportion to the anticipated increase
in our sales, and we will also benefit from economies of scale as we grow our
sales and secure orders with larger contract values in the future periods.
Management expects that the current global recession will adversely affect the
demand for our products and thus slow our growth in 2010 as compared to prior
years. However, management anticipates that our sales revenues will continue to
grow in future as we currently have back-log orders and continue to see an
increasing awareness and demand for our energy efficiency solutions and systems
both in China and in other countries.
Liquidity
and Capital Resources
Our
principal sources of liquidity have been cash provided by operations, the
proceeds from the sale of equity to investors and borrowings from banks and
other lenders. Our principal uses of cash have been to finance working capital,
facility expansion and other capital expenditures. We anticipate these uses will
continue to be our principal uses of cash in the future. Global financial and
credit markets recently have been, and continue to be, extremely unstable and
unpredictable. Worldwide economic conditions have been weak and may be further
deteriorating. This instability could affect the prices at which we will be able
to sell our products and services, which likely would also adversely affect our
earnings and financial condition. These conditions could also negatively affect
our ability to secure funds or raise capital at a reasonable cost, as
needed.
It is our
practice to carefully monitor the state of our business, cash requirements and
capital structure. We believe that funds generated from our operations and
available from our credit facilities will be sufficient to fund current business
operations over at least the next twelve months. Notwithstanding our resources
for operations on a going forward basis at current operating levels, we
will need capital for our expansion plans, including funding for the building of
our proposed new plant. To improve our cash and cash requirement position,
we will take steps to improve the collection of receivables, examine costs
in an attempt to control or reduce expenses and use non-cash compensation, such
as stock grants, where appropriate, all of which should have a positive effect
on our working capital and increase our cash resources.
47
Cash
Flows
The
following table sets forth a summary of our cash flows for the periods indicated
below:
Year ended December, 31
|
||||||||
2008
|
2009
|
|||||||
Restated
|
||||||||
Net
cash used in operating activities
|
$ | (758,758 | ) | $ | (5,201,706 | ) | ||
Net
cash used in investing activities
|
(280,017 | ) | (4,076,319 | ) | ||||
Net
cash provided by financing activities
|
6,958,302 | 5,498,780 | ||||||
Effect
of exchange rate changes on cash and cash equivalents
|
(89,274 | ) | 29,415 | |||||
Net
increase/(decrease) in cash and cash equivalents
|
5,830,253 | (3,749,830 | ) | |||||
Cash
and cash equivalents at the beginning of period
|
306,150 | 6,136,403 | ||||||
Cash
and cash equivalents at the end of period
|
$ | 6,136,403 | $ | 2,386,573 |
Operating
Activities
Net cash
used in operating activities was $5,201,706 for the year ended December 31, 2009
compared with net cash used in operating activities of $758,758 for the year
ended December 31, 2008. The increase of cash used in operating activities was
due to the following reasons. First, the Company earned less revenue while it
incurred more cost in 2009 than in 2008; accordingly, the Company collected
fewer receipts from customers and paid more to suppliers. Secondly, the Company
entered into a major EPC contract in which the Company granted a four years
credit term to the customer; accordingly, the Company has made little
collections in 2009 for this contract, but has made most of the payments to
purchase inventories and for the costs incurred.
Investing
Activities
Net cash
used in investing activities was $4,076,319 for the year ended December 31, 2009
compared to net cash used in investing activities of $280,017 for the year ended
December 31, 2008. The increase was because the Company purchased land in
Yizheng and started construction for the new manufacturing
facility.
On August
18, 2009, CER Hong Kong entered into a series of contracts with Yangzhou
(Yizheng) Automobile Industrial Park Administration Committee, a government
entity of the City of Yangzhou, Jiangsu Province, China, to acquire a tract of
land on which CER Hong Kong plans to build a new manufacturing facility. The new
plant is intended to be a world-class, state-of-the-art facility and will be
dedicated to developing and manufacturing large-sized and sophisticated waste
heat recovery systems and other related energy efficiency equipment. The
planned facility is part of the Company’s business plan for expanding
its production capacity and to develop additional demand for its products within
China and from overseas.
To comply
with the terms of the plant agreements, a foreign investment enterprise, CER
Yangzhou, was established on August 28, 2009, with registered capital of $20
million of which $7.5 million was injected by March, 2010. The Company has been
following the construction schedules and fulfilling the investment
requirement.
48
Financing
Activities
Net cash
provided by financing activities was $5,498,780 for the year ended December 31,
2009 compared to net cash provided by financing activities of $6,958,302 for the
year ended December 31, 2008, an decrease of $1,459,522. The Company received
$5,000,000 pursuant to a drawdown under a convertible note made in
September 2009. The Company also borrowed short-term bank loans. On April
15, 2008, the Company closed a Series A Convertible Preferred Stock
financing with net proceeds of $6,644,278.
Capital
Resources
We
incurred the following bank loans during the years ended December 31, 2009 and
2008, respectively:
On
January 30, 2008, we borrowed RMB 2,600,000 (approximately $381,420 as of
December 31, 2008) on a short-term bank loan for working capital purposes from
Shenzhen Development Bank, Shanghai Branch, Baoshan Sub-branch. The term of the
loan was one year. The loan agreement provided for monthly interest payments at
an interest rate of 7.47% per annum, maturing in January 2009. We have repaid
the loan in January 2009.
In April
2008, we received net proceeds of approximately $6.6 million upon closing of our
Series A Convertible Preferred Stock financing. The proceeds from the financing
were primarily used for general working capital purposes, including funding
the purchase of raw materials for our products, the purchase of necessary
additional equipment for our current manufacturing facility, sales and marketing
expenses, and research and development expenses that we will need for the
planned operations.
On May
21, 2009, the Company entered into a series of agreements for an unsecured term
loan arrangement (“Convertible Note Agreement”) with a private investor. In
connection with this financing, we agreed to issue a two-year 9.5% Unsecured
Convertible Promissory Note in the principal amount of $5 million, which may be
converted into common stock at a conversion price of $1.80 per share. The
Convertible Note Agreement permitted the Company to draw down up to $5,000,000
in principal amount, within six months of the making. Any amount borrowed bears
interest at 9.5%, payable every six months, calculated and compounded
quarterly. Each draw is due twenty-four months after the draw down date,
together with any accrued and unpaid interest. The Company may pre-pay the
note at any time, at its option. On September 28, 2009, the Company drew down
$5,000,000, the full amount available. The proceeds of this loan are restricted
to only the expenses related to the acquisition and construction of a new plant
to be located in China to expand our production capacity, including the purchase
of land for the plant, buildings and equipment and for facilitating loans from
one or more in-China banks and institutional lenders for the plant. We have used
$3,510,000 of the Convertible Note Agreement proceeds for the purchase
of land use rights and design and construction costs for the plant, and we will
use the balance of the proceeds for the commitments to the local government
to purchase more land use rights and other costs associated with the plant.
No interest was paid in 2009.
On
September 1, 2009, we borrowed a short-term loan of RMB 6,000,000
(approximately $879, 660) for working capital purpose from Shanghai Pudong
Development Bank, Luwan Branch. The term of the loan is one year. The loan
agreement provides for monthly interest payments at an annual interest rate of
5.841%, maturing on August 31, 2010. The loan has been repaid on January 5,
2010. The related interest in 2009 is $17,423.
49
On
February 1, 2010, the Company entered into a series of agreements for a loan
arrangement with two lenders (the “Loan Agreements”). The proceeds of this loan
are generally for construction of a new plant in China. The aggregate principal
amount of the loan under the two Loan Agreements is $4,000,000. The
principal is due January 15, 2013, and bears interest at the annual rate of
15.1%. As security for this Loan Agreement and the other loan agreements of all
the lenders, Mr. Qinghuan Wu, the Chairman and Chief Executive Officer of CER
pledged 8,000,006 shares of common stock of CER, which shares will be held in
escrow for the benefit of all the lenders.
As a
result of the Company not filing its reports with the Securities and Exchange
Commission ("SEC") under the Securities Exchange Act of 1934, as amended, on a
timely basis for the fiscal year ended December 31, 2009 and the quarters ended
March 31, 2010 and June 30, 2010, the Company was in violation of various loan
covenants and default terms with respect its obligation to file SEC reports and
comply with applicable laws under the terms of the loan for $4,000,000 in
principal amount due January 15, 2013. The violation of the covenants and
default permit the note holders to accelerate the repayment of the full amount
of the principal and interest due on the loan. To date, the lenders have not
delivered any notice of acceleration and have not indicated that they intend to
give such a notice. One of the lenders representing $2,000,000 in principal
amount of the loans provided to the Company on November 1, 2010, a waiver of the
covenant and default terms and also provided sufficient time to make the
necessary past due filings and the report for the quarter ended September 30,
2010, before a covenant violation or default would result again concerning these
issues.
Additionally,
since the repayment amount is fixed in United States dollars, the lenders will
receive shares of common stock on each principal payment date in that number of
shares representing the value of the difference in the Renmenbi/US Dollar
exchange rate between February 1, 2010, and the payment date, provided the
Renmenbi exchange rate increases against the US dollar, times the amount of
principal being repaid, divided by the closing price of the common stock on the
repayment date.
Contemporaneously
with the funding of the Loan Agreements, on February 1, 2010, Mr. Qinghuan Wu,
the Chairman of the Board and Chief Executive Officer of the Company, arranged
for a loan from Haide Engineering (Hong Kong) Limited (“Haide”), a company that
Mr. Qinghuan Wu controls, to lend to CER Hong Kong the sum of $1,000,000.
The loan is an interest only loan, bearing interest at the annual rate of 9.5%,
interest payable quarterly, and is unsecured. The principal is due in full
on January 30, 2012. The loan is unsecured and there are no guarantees of
the interest or principal. CER Hong Kong has subordinated its loan to
those under the Loan Agreements.
Table
Disclosure of Contractual Obligations
The
following table sets forth our contractual obligations as of December 31,
2009:
Payment Due by Period
|
||||||||||||
Total
|
Less than 1 year
|
1-3 years
|
||||||||||
Investment
capital commitments
|
$ | 17,120,000 | $ | 1,620,000 | $ | 15,500,000 | ||||||
Convertible
notes
|
5,831,250 | 2,975,000 | 2,856,250 | |||||||||
Operating
lease obligations
|
1,402,640 | 1,402,640 | - | |||||||||
Purchasing
obligations
|
6,536,936 | 4,161,362 | 2,375,574 | |||||||||
Total
|
$ | 30,890,826 | $ | 10,159,002 | $ | 20,731,824 |
50
On May
21, 2009, the Company entered into a term loan agreement (“Convertible Notes
Agreement”) with an investment company (the “Lender”). Pursuant to the
Convertible Notes Agreement, the lender provides term loan
financing (“Convertible Notes”) to the Company in an amount of up to
$5,000,000. The Company drew down the money on September 30, 2009. Accordingly,
it is due twenty-four (24) months after the draw down date, together with any
accrued and unpaid interest. The estimated interest expense on the convertible
notes amounted to $831,250.
51
Off-Balance
Sheet Arrangements
We have
not entered into any other financial guarantees or other commitments to
guarantee the payment obligations of any third parties. We have not entered into
any derivative contracts that are indexed to our shares and classified as
stockholder's equity or that are not reflected in our consolidated financial
statements. Furthermore, we do not have any retained or contingent interest in
assets transferred to an unconsolidated entity that serves as credit, liquidity
or market risk support to such entity. We do not have any variable interest in
any unconsolidated entity that provides financing, liquidity, market risk or
credit support to us or engages in leasing, hedging or research and development
services with us.
Item
7A Quantitative and Quantitative Disclosures about Market Risk
Not
applicable.
Item
8 Financial Statements and Supplementary Data
CHINA
ENERGY RECOVERY, INC.
Index
to Consolidated Financial Statements
Page
No.
|
|
Report
of Independent Registered Public Accounting Firm
|
F-1
|
Consolidated
Balance Sheets as of December 31, 2008 and 2009
|
F-2
|
|
|
Consolidated
Statements of Income and Other Comprehensive Income for the Years
Ended December 31, 2008 and 2009
|
F-3
|
Consolidated
Statements of Shareholders' Equity for the Years ended December 31,2008
and 2009
|
F-4
|
Consolidated
Statements of Cash Flows for the Years Ended December 31, 2008 and
2009
|
F-5
|
Notes
to the Consolidated Financial Statements
|
F-6
|
普华永道中天会计师事务所有限公司
11th Floor PricewaterhouseCoopers Center
2 Corporate Avenue
202 Hu Bin Road, Luwan District
Shanghai 200021, PRC
Telephone +86 (21) 2323 8888
Facsimile +86 (21) 2323 8800
www.pwccn.com
|
Report of Independent Registered Public
Accounting Firm
To the Board of Directors and
Shareholders of China
Energy Recovery, Inc.:
In our opinion, the accompanying consolidated balance
sheets and the related consolidated statements of income and other comprehensive income, of shareholders’ equity and of cash flows present
fairly, in all material respects, the financial position of China Energy Recovery, Inc. and its subsidiaries (collectively, the “Company”) as of December 31, 2008 and December 31, 2009, and the results of their operations and
their cash flows for each of the two years in the period ended December
31, 2009 in conformity with accounting
principles generally accepted in the United States of America. These
financial statements are
the responsibility of the
Company’s management. Our responsibility is to express an opinion
on these financial statements based on our audits. We conducted our audits of
these statements in accordance with the standards of the Public Company Accounting Oversight
Board (United
States). Those standards
require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the
financial statements, assessing the accounting principles
used and significant
estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
As discussed in Note 2 to the
consolidated financial
statements, the Company has restated its 2008
consolidated financial statements. Such consolidated financial
statements, before the restatement referred to
above, were reported on by another independent
registered public accounting firm.
As discussed in Note 13 to the
consolidated financial
statements, the Company changed the manner in which it accounts for
warrants issued in connection with Series A Convertible Preferred Stock as of
January 1, 2009.
PricewaterhouseCoopers Zhong Tian CPAs
Limited Company
November 3, 2010
F-1
CHINA
ENERGY RECOVERY, INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
AS OF
DECEMBER 31, 2008 AND 2009
December 31
2008
Restated
|
December 31
2009
|
|||||||
ASSETS
|
||||||||
CURRENT
ASSETS:
|
||||||||
Cash
|
$ | 6,136,403 | $ | 2,386,573 | ||||
Restricted
cash
|
597,949 | - | ||||||
Notes
receivable
|
120,749 | 411,049 | ||||||
Accounts
receivable, net of allowance for doubtful accounts
|
5,109,456 | 6,601,921 | ||||||
Accounts
receivable - related party
|
1,006,060 | - | ||||||
Inventories
|
7,774,775 | 8,574,775 | ||||||
Other
current assets and receivables
|
98,271 | 892,657 | ||||||
Deferred
financial cost - current
|
- | 674,748 | ||||||
Deferred
tax assets - current
|
- | 67,276 | ||||||
Advances
on inventory purchases
|
1,044,807 | 4,271,054 | ||||||
Total
current assets
|
21,888,470 | 23,880,053 | ||||||
EQUIPMENT,
net
|
850,888 | 758,888 | ||||||
OTHER
ASSETS:
|
||||||||
Deferred
tax assets
|
63,241 | 133,758 | ||||||
Intangible
assets
|
- | 2,439,022 | ||||||
Deferred
financial cost
|
- | 215,623 | ||||||
Long-term
accounts receivable
|
102,690 | 6,830,615 | ||||||
Total
other assets
|
165,931 | 9,619,018 | ||||||
Total
assets
|
$ | 22,905,289 | $ | 34,257,959 | ||||
LIABILITIES AND
SHAREHOLDERS' EQUITY
|
||||||||
CURRENT
LIABILITIES:
|
||||||||
Accounts
payable
|
$ | 3,426,926 | $ | 4,188,205 | ||||
Other
payables
|
466,392 | 1,100,111 | ||||||
Other
payables - related party
|
65,078 | - | ||||||
Accrued
liabilities
|
21,228 | 644,971 | ||||||
Advances
from customers
|
7,044,234 | 11,226,273 | ||||||
Taxes
payable
|
2,692,613 | 2,956,476 | ||||||
Short-term
bank loans
|
381,420 | 880,200 | ||||||
Derivative
liability, current
|
- | 435,500 | ||||||
Convertible
note, current
|
- | 2,023,720 | ||||||
Total
current liabilities
|
14,097,891 | 23,455,456 | ||||||
NON-CURRENT
LIABILITIES:
|
||||||||
Warrant
liability
|
- | 1,372,947 | ||||||
Derivative
liability
|
- | 435,500 | ||||||
Convertible
note
|
- | 1,938,408 | ||||||
Total
non-current liabilities
|
- | 3,746,855 | ||||||
Total
Liabilities
|
14,097,891 | 27,202,311 | ||||||
Commitment
and contingency
|
- | - | ||||||
SHAREHOLDERS'
EQUITY:
|
||||||||
Preferred
stock(US$0.001 par value; 50,000,000 shares authorized, 714,963 and
662,963 shares issued and outstanding as of December 31, 2008 and 2009,
respectively)
|
715 | 626 | ||||||
Common
stock(US$0.001 par value; 100,000,000 shares authorized, 29,912,573
and 30,638,720 shares issued and outstanding as of December 31, 2008 and
2009, respectively)
|
29,913 | 30,639 | ||||||
Additional
Paid-in-capital
|
9,058,283 | 8,163,224 | ||||||
Accumulated
deficit
|
(307,678 | ) | (1,194,158 | ) | ||||
Statutory
reserves
|
132,802 | 132,802 | ||||||
Accumulated
other comprehensive loss
|
(106,637 | ) | (77,485 | ) | ||||
Total
shareholders' equity
|
8,807,398 | 7,055,648 | ||||||
Total
liabilities and shareholders' equity
|
$ | 22,905,289 | $ | 34,257,959 |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-2
CHINA
ENERGY RECOVERY, INC.
CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
FOR YEARS
ENDED DECEMBER 31, 2008 AND 2009
Year ended December 31,
|
||||||||
2008
Restated
|
2009
|
|||||||
REVENUES
|
||||||||
Third
parties
|
$ | 21,315,226 | $ | 22,194,443 | ||||
Related
party
|
3,589,550 | - | ||||||
Total
revenue
|
24,904,776 | 22,194,443 | ||||||
COST
OF REVENUES
|
||||||||
Third
parties
|
(16,549,648 | ) | (18,842,557 | ) | ||||
Related
party
|
(1,951,549 | ) | - | |||||
Total
cost of revenues
|
(18,501,197 | ) | (18,842,557 | ) | ||||
GROSS
PROFIT
|
6,403,579 | 3,351,886 | ||||||
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
(4,281,863 | ) | (5,746,743 | ) | ||||
INCOME/(LOSS)
FROM OPERATIONS
|
2,121,716 | (2,394,857 | ) | |||||
OTHER
INCOME, NET:
|
||||||||
Change
in fair value of warrant liability
|
- | 1,539,233 | ||||||
Change
in fair value of derivative liability
|
- | 399,500 | ||||||
Non-operating
income, net
|
149,377 | 80,692 | ||||||
Interest
expenses
|
(80,276 | ) | (868,388 | ) | ||||
Total
other income , net
|
69,101 | 1,151,037 | ||||||
INCOME/(LOSS)
FROM OPERATIONS BEFORE PROVISION FOR INCOME TAXES
|
2,190,817 | (1,243,820 | ) | |||||
INCOME
TAXES (EXPENSES)/BENEFITS
|
(815,915 | ) | 357,340 | |||||
NET
INCOME/(LOSS)
|
1,374,902 | (886,480 | ) | |||||
OTHER
COMPREHENSIVE INCOME/(LOSS)
|
||||||||
Foreign
currency translation adjustment
|
(57,717 | ) | 29,152 | |||||
COMPREHENSIVE
INCOME/(LOSS)
|
$ | 1,317,185 | $ | (857,328 | ) | |||
Earnings/(loss)
per share
|
||||||||
Basic
|
$ | 0.05 | $ | (0.03 | ) | |||
Diluted
|
$ | 0.05 | $ | (0.03 | ) | |||
Weighted
average ordinary shares outstanding
|
||||||||
Basic
|
25,691,979 | 29,952,798 | ||||||
Diluted
|
26,302,263 | 29,952,798 |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-3
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Preferred Stock
|
Common stock
|
Additional
paid-in
capital
|
Statutory
reserves
|
Accumulated
deficit
|
Accumulated
other
comprehensive
income/(loss)
|
Total
|
||||||||||||||||||||||||||||||
Shares
|
Amount
|
Shares
|
Amount
|
|||||||||||||||||||||||||||||||||
BALANCE,
at January 1, 2008
|
- | $ | - | 20,757,090 | $ | 20,757 | $ | 870,787 | $ | 204,758 | $ | (1,270,165 | ) | $ | (40,126 | ) | $ | (213,989 | ) | |||||||||||||||||
- | ||||||||||||||||||||||||||||||||||||
Issuance
of preferred stock
|
7,874,241 | 7,874 | - | 6,636,404 | - | - | - | 6,644,278 | ||||||||||||||||||||||||||||
Issuance
of common stock for reorganization
|
- | - | 4,717,890 | 4,718 | 3,697 | - | - | - | 8,415 | |||||||||||||||||||||||||||
Common
stock for consulting services
|
- | - | 662,500 | 663 | 1,443,698 | - | - | - | 1,444,361 | |||||||||||||||||||||||||||
Cashless
exercise of warrant
|
- | - | 195,454 | 195 | (195 | ) | - | - | - | - | ||||||||||||||||||||||||||
Warrants
issued for consulting services
|
- | - | - | - | 52,279 | - | - | - | 52,279 | |||||||||||||||||||||||||||
Stock
based compensation
|
- | - | - | - | 85,928 | - | - | - | 85,928 | |||||||||||||||||||||||||||
Conversion
of preferred stock
|
(7,159,278 | ) | (7,159 | ) | 3,579,639 | 3,580 | 3,579 | - | - | - | - | |||||||||||||||||||||||||
Capital
deduction on Haiyin & Zhuyi
|
- | - | - | - | (37,894 | ) | - | - | - | (37,894 | ) | |||||||||||||||||||||||||
Profit
Distribution to Mr. Qinghuan Wu for the profits earned before
2008
|
- | - | - | - | - | (110,617 | ) | (373,754 | ) | (8,794 | ) | (493,165 | ) | |||||||||||||||||||||||
Statutory
reserves
|
- | - | - | - | - | 38,661 | (38,661 | ) | - | - | ||||||||||||||||||||||||||
Net
income
|
- | - | - | - | - | - | 1,374,902 | - | 1,374,902 | |||||||||||||||||||||||||||
Foreign
currency translation loss
|
- | - | - | - | - | - | - | (57,717 | ) | (57,717 | ) | |||||||||||||||||||||||||
BALANCE,
at December 31, 2008 - restated
|
714,963 | $ | 715 | 29,912,573 | $ | 29,913 | $ | 9,058,283 | $ | 132,802 | $ | (307,678 | ) | $ | (106,637 | ) | $ | 8,807,398 | ||||||||||||||||||
Cumulative
effect of reclassification of warrants (Note 13)
|
- | - | - | - | (1,524,268 | ) | - | - | - | (1,524,268 | ) | |||||||||||||||||||||||||
BALANCE,
at January 1, 2009, as adjusted
|
714,963 | $ | 715 | 29,912,573 | $ | 29,913 | $ | 7,534,015 | $ | 132,802 | $ | (307,678 | ) | $ | (106,637 | ) | $ | 7,283,130 | ||||||||||||||||||
Common
stock for consulting services
|
- | - | 700,000 | 700 | 839,300 | - | - | - | 840,000 | |||||||||||||||||||||||||||
Change
of convertible rate
|
- | (37 | ) | - | - | 37 | - | - | - | - | ||||||||||||||||||||||||||
Stock
based compensation
|
- | - | - | - | 221,816 | - | - | - | 221,816 | |||||||||||||||||||||||||||
Conversion
of preferred stock
|
(52,000 | ) | (52 | ) | 26,147 | 26 | 26 | - | - | - | - | |||||||||||||||||||||||||
Deferred
tax liability due to discount unconvertible notes
|
- | - | - | - | (431,970 | ) | - | - | - | (431,970 | ) | |||||||||||||||||||||||||
Net
loss
|
- | - | - | - | - | - | (886,480 | ) | - | (886,480 | ) | |||||||||||||||||||||||||
Foreign
currency translation loss
|
- | - | - | - | - | - | - | 29,152 | 29,152 | |||||||||||||||||||||||||||
BALANCE,
at December 31, 2009
|
662,963 | $ | 626 | 30,638,720 | $ | 30,639 | $ | 8,163,224 | $ | 132,802 | $ | (1,194,158 | ) | $ | (77,485 | ) | $ | 7,055,648 |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-4
CHINA
ENERGY RECOVERY, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
2008
|
2009
|
|||||||
Restated
|
||||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
Net
income/(loss)
|
$ | 1,374,902 | $ | (886,480 | ) | |||
Adjustments
to reconcile net income/(loss) to cash used in operating
activities:
|
||||||||
Depreciation
and amortization
|
113,520 | 178,446 | ||||||
Non-cash
structuring charges
|
8,415 | - | ||||||
Change
in allowance for uncollectible accounts
|
(2,645 | ) | 337,383 | |||||
Common
stock issued for services
|
1,444,361 | 840,000 | ||||||
Stock
based compensation
|
138,207 | 221,816 | ||||||
Change
in fair value of warrant and derivative liabilities
|
- | (1,938,733 | ) | |||||
Interest
expenses of convertible note
|
- | 730,169 | ||||||
Loss
from disposal of fixed assets
|
13,186 | - | ||||||
Deferred
income taxes
|
(63,241 | ) | (569,763 | ) | ||||
Change
in operating assets and liabilities
|
||||||||
Restricted
cash
|
(508,834 | ) | 597,949 | |||||
Notes
receivable
|
231,050 | (290,300 | ) | |||||
Accounts
receivable
|
(3,390,525 | ) | (1,830,055 | ) | ||||
Accounts
receivable - related party
|
(434,024 | ) | 1,006,060 | |||||
Inventories
|
(2,512,446 | ) | (800,000 | ) | ||||
Other
current assets and receivables
|
(60,419 | ) | (794,386 | ) | ||||
Advances
on inventory purchases
|
950,538 | (1,675,452 | ) | |||||
Long-term
accounts receivable
|
485,743 | (6,727,925 | ) | |||||
Accounts
payable
|
1,230,418 | 761,279 | ||||||
Other
payables
|
190,801 | 633,719 | ||||||
Other
payables - related party
|
4,259 | (65,078 | ) | |||||
Accrued
liabilities
|
(6,623 | ) | 548,055 | |||||
Advances
from customers
|
(1,008,336 | ) | 4,182,039 | |||||
Salary
payable
|
- | 75,688 | ||||||
Taxes
payable
|
1,973,481 | 263,863 | ||||||
Deferred
revenue
|
(930,546 | ) | - | |||||
Net
cash used in operating activities
|
(758,758 | ) | (5,201,706 | ) | ||||
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||
Purchase
of equipment
|
(289,441 | ) | (1,637,248 | ) | ||||
Proceeds
from disposal of fixed assets
|
9,424 | - | ||||||
Purchase
of intangible assets
|
- | (2,439,071 | ) | |||||
Net
cash used in investing activities
|
(280,017 | ) | (4,076,319 | ) | ||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
Repayment
of loans to shareholder
|
463,663 | - | ||||||
Capital
deduction of variable interest entities
|
(294,995 | ) | - | |||||
Proceeds
from issuing preferred stock, net of issuance costs
|
6,644,278 | - | ||||||
Distribution
to shareholders
|
(236,064 | ) | - | |||||
Proceeds
from short-term bank loans
|
381,420 | 880,200 | ||||||
Proceeds
from convertible note
|
- | 5,000,000 | ||||||
Repayment
of short-term bank loans
|
- | (381,420 | ) | |||||
Net
cash provided by financing activities
|
6,958,302 | 5,498,780 | ||||||
EFFECTS
OF EXCHANGE RATE CHANGE IN CASH
|
(89,274 | ) | 29,415 | |||||
INCREASE/(DECREASE)
IN CASH
|
5,830,253 | (3,749,830 | ) | |||||
CASH,
beginning
|
306,150 | 6,136,403 | ||||||
CASH,
ending
|
$ | 6,136,403 | $ | 2,386,573 | ||||
Supplemental
disclosure of cash flow information
|
||||||||
Cash
paid during the year for income taxes
|
91,737 | 55,703 | ||||||
Cash
paid during the year for interest
|
27,997 | 19,469 | ||||||
Supplemental
schedule of non-cash investing and financing activities:
|
||||||||
Warrants
issued for convertible note
|
1,669,132 | 1,387,912 |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-5
Note
1 – Organization
China
Energy Recovery, Inc. ("CER" or the "Company"), formerly known as MMA Media Inc.
and Commerce Development Corporation Ltd., was incorporated under the laws of
the State of Maryland in May, 1998. On April 7, 2006, the Company entered into
an Agreement and Plan of Merger with its wholly-owned subsidiary, Commerce
Development Corporation, Ltd., a Delaware corporation, and changed the Company's
state of incorporation from Maryland to Delaware as a result. On February 5,
2008, the Company changed its name to China Energy Recovery, Inc.
On
January 24, 2008, the Company entered into a Share Exchange Agreement with Poise
Profit International, Ltd. ("Poise Profit"), a company incorporated on November
23, 2007, under the laws of the British Virgin Islands, and the shareholders of
Poise Profit. The share exchange transaction (the "Share Exchange") was
consummated on April 15, 2008 and Poise Profit became a wholly-owned subsidiary
of the Company. On April 16, 2008, the Company conducted a 1-for-2 reverse stock
split pursuant to which each two shares of CER's common stock, issued and
outstanding on the record date of April 15, 2008, converted into one share of
CER's common stock. Pursuant to the Share Exchange Agreement, the Company agreed
to acquire all of the issued and outstanding shares of Poise Profit's common
stock in exchange for the issuance of 20,757,090 shares, or 81.5% of the
Company's common stock on a post 1-for-2 reverse stock split basis, to the
shareholders of Poise Profit. Because the acquisition is treated as a reverse
acquisition and recapitalization whereby Poise Profit is deemed to be the
accounting acquirer (legal acquiree) and the Company to be the accounting
acquiree (legal acquirer), the financial statements of the Company have been
retroactively adjusted to reflect the acquisition from the beginning of the
reported period. The historical financial statements for periods prior to April
15, 2008 are those of Poise Profit except that the equity section and earnings
per share have been retroactively restated to reflect the reverse acquisition
and recapitalization.
Poise
Profit is an off-shore holding company and has no operating business activities.
Poise Profit owns 100% of HAIE Hi-tech Engineering (Hong Kong) Company, Limited
("Hi-tech") and CER (Hong Kong) Holdings Limited (“CER Hong Kong”), which were
incorporated in Hong Kong on January 4, 2002 and August 13, 2008,
respectively.
Shanghai
Hai Lu Kun Lun Hi-tech Engineering Co., Ltd ("Shanghai Engineering") was
established in Shanghai, China in July 1999. Shanghai Xin Ye Environmental
Protection Engineering Technology Co., Ltd ("Shanghai Environmental") was
incorporated in Shanghai on May 23, 2007. Mr. Qinghuan Wu, the Company’s
chairman and Chief Executive Officer, became the sole shareholder of Shanghai
Environmental in November 2007. Shanghai Environmental is not an operating
company but serves as a vehicle for arranging sales and maximizing tax
benefits.
All of
Shanghai Engineering’s manufacturing activities are conducted through a Leasing
and Operation Agreement, a form of cooperative manufacturing agreement,
originally effective as of May 1, 2003 and subsequently renewed and amended with
a state-owned enterprise, Shanghai Si Fang. Pursuant to the agreement,
Shanghai Si Fang leases certain land use right, buildings and fixed assets
(lease elements) in one of its subsidiaries, Vessel Works Division, and provides
management services and licenses the “Si Fang” brand and manufacturing license
(non-lease elements) of Vessel Works Division to Shanghai Engineering.
Because the arrangement contains both the lease and non-lease elements, the
amount of quarterly payment is allocated between the lease and non-lease
deliverables based on their fair values. The lease elements are classified
and accounted for as operating leases and the lease expense is recorded on a
straight-line basis. The non-lease elements are accounted for as
prepayment for management and licensing fees and the payment is amortized on a
straight-line basis over each contractual period.
Shanghai
Engineering does not have a variable interest in Vessel Works Division through
this agreement as the arrangement is established between Shanghai Engineering
and Shanghai Si Fang. Shanghai Engineering does not have any contractual
or ownership interest in Vessel Works Division, and therefore, Shanghai
Engineering does not have variable interests in Vessel Works
Division.
F-6
The
arrangement, however, may result in Shanghai Engineering having variable
interests in Shanghai Si Fang, but as Shanghai Si Fang is a state-owned
enterprise that has substantive operations other than the Lease and Operation
arrangement, Shanghai Engineering is not the primary beneficiary of Shanghai Si
Fang.
Effective
on January 1, 2006, Hi-tech executed a series of contractual arrangements with
Shanghai Engineering and its shareholders, including a Consulting Services
Agreement and an Operating Agreement, through which Hi-tech has the right to
advise, consult, manage and operate Shanghai Engineering, and collect and own
all of its net profits. Additionally, Shanghai Engineering's shareholders have
granted their voting rights over Shanghai Engineering to Hi-tech. In order to
further reinforce Hi-tech's rights to control and operate Shanghai Engineering,
Shanghai Engineering and its shareholders have granted Hi-tech the exclusive
right and option to acquire all of their equity interests in Shanghai
Engineering. Further, Shanghai Engineering shareholders have pledged all of
their rights, titles and interests in Shanghai Engineering to
Hi-tech.
Effective
on May 23, 2007, Hi-tech executed a series of contractual arrangements with
Shanghai Environmental and its shareholders, including a Consulting Services
Agreement and an Operating Agreement, through which Hi-tech has the right to
advise, consult, manage and operate Shanghai Environmental, and collect and own
all of its net profits. Additionally, Mr. Qinghuan Wu, Shanghai Environmental's
sole shareholder has granted his voting rights over Shanghai Environmental to
Hi-tech. In order to further reinforce Hi-tech's rights to control and operate
Shanghai Environmental, Shanghai Environmental and Mr. Qinghuan Wu have granted
Hi-tech the exclusive right and option to acquire all of the shareholders'
equity interest in Shanghai Environmental. Further, Shanghai Environmental's
shareholder has pledged all of his rights, titles and interests in Shanghai
Environmental.
In order
to restructure the holding structure of the Company (the “Restructuring”), on
December 2, 2008, 100% of the shares of CER Hong Kong were transferred to Poise
Profit from Mr. Qinghuan Wu and his wife, Mrs. Zhou, and all the contracts
between Hi-tech and Shanghai Engineering, and between Hi-tech and Shanghai
Environmental were transferred to CER Hong Kong. Thereafter, CER Hong
Kong, through its variable interest entities located in the People's Republic of
China ("PRC"), designs, develops, manufactures and markets waste heat boilers
and pressure vessels in the fields of chemical industry, petrochemical industry,
oil refinery, fine chemicals, water and power conservancy, metallurgical,
environmental protection, waste heat utilization and power generation from waste
heat recovery.
On
November 11, 2008, CER Energy Recovery (Shanghai) Co., Ltd. (“CER Shanghai”) was
incorporated in Shanghai by CER Hong Kong. CER Shanghai’s registered capital is
$5,000,000. As of December 31, 2009, CER Hong Kong has contributed approximately
$3,380,000 capital in CER shanghai. CER Shanghai is mainly engaged in the
development of energy recovery and environmental protection technologies, and
design, installation and servicing of waste heat recovery systems.
CER
Energy Recovery (Yangzhou) Co., Ltd. (“CER Yangzhou”) was incorporated on August
28, 2009 in Yangzhou by CER Hong Kong. CER Yangzhou’s registered capital is
$20,000,000 and the contributed capital was approximately $4,500,000 as of
December 31, 2009 and an additional capital of approximately $3,000,000 was
contributed in 2010. CER Yangzhou is mainly engaged in the development and
manufacturing of waste heat recovery systems and other related energy efficiency
equipment.
Shanghai
Haiyin Hi-Tech Engineering Co. Ltd. ("Haiyin") was incorporated in Shanghai on
December 3, 2003. Haiyin was engaged in four technology services (development,
transfer, consultation and other technology services) in chemical engineering,
energy saving, computer and other professional technical fields. Haiyin also was
engaged in processing, selling and installing computer hardware, heat recovery
boiler and auxiliary equipment, and chemical engineering devices. Haiyin
dissolved in November 29, 2007 legally and the registered capital had been
returned as the result of a distribution to shareholders in 2008,
Shanghai
Zhuyi Industry Co. Ltd. ("Zhuyi") was incorporated in Shanghai on November 28,
2005. The business scope of Zhuyi was trading in construction materials, metal
materials, mechanical equipment, and computers hardware, and providing
mechanical equipment design and consultation services. Zhuyi was dissolved in
May 31, 2007 legally and the registered capital had been returned as the result
of a distribution to shareholders in 2008 also.
On March
5, 2008, Hi-tech and Shanghai Engineering jointly formed Shanghai Haie
Investment Consultation Co., Ltd. ("JV Entity"). JV Entity was 10% owned by
Shanghai Engineering and 90% owned by Hi-tech. JV Entity was dissolved on
September 1, 2008. The paid-in portion of registered capital was returned to
Hi-tech on September 19, 2008.
F-7
As all
the above entities are under common control, the arrangements described above
have been accounted for as a reorganization of entities and the financial
statements have been prepared as if the reorganization had occurred
retroactively. CER, Poise Profit, CER Hong Kong, Hi-tech, Shanghai Engineering,
CER Shanghai, CER Yangzhou, Haiyin, Shanghai Environmental, Zhuyi, and JV Entity
are collectively hereinafter referred to as the “Group".
Note 2
Restatement of Consolidated Financial Statements for Year ended December 31,
2008
Consolidated
Balance Sheet Impact:
The
following tables set forth the effects of the restatement adjustments and
reclassification adjustments on the Company’s 2008 consolidated balance
sheets:
2008
|
Adjustment
|
2008
|
||||||||||
|
Previously
reported
|
Restated
|
||||||||||
ASSETS
|
||||||||||||
CURRENT
ASSETS:
|
||||||||||||
Cash
|
$ | 6,136,403 | $ | - | $ | 6,136,403 | ||||||
Restricted
cash
|
597,949 | - | 597,949 | |||||||||
Notes
receivable
|
120,749 | - | 120,749 | |||||||||
Accounts
receivable, net of allowance for doubtful accounts (note
(a))
|
4,935,142 | 174,314 | 5,109,456 | |||||||||
Accounts
receivable - related party
|
1,006,060 | - | 1,006,060 | |||||||||
Inventories
|
7,774,775 | - | 7,774,775 | |||||||||
Other
current assets and receivables
|
98,271 | - | 98,271 | |||||||||
Advances
on inventory purchases
|
1,044,807 | - | 1,044,807 | |||||||||
Total
current assets
|
21,714,156 | 174,314 | 21,888,470 | |||||||||
EQUIPMENT,
net
|
850,888 | - | 850,888 | |||||||||
OTHER
ASSETS:
|
||||||||||||
Deferred
tax assets (note (b))
|
- | 63,241 | 63,241 | |||||||||
Long
term accounts receivable (note (a))
|
377,368 | (274,678 | ) | 102,690 | ||||||||
Total
other assets
|
377,368 | (211,437 | ) | 165,931 | ||||||||
Total
assets
|
$ | 22,942,412 | $ | (37,123 | ) | $ | 22,905,289 | |||||
LIABILITIES
AND SHAREHOLDERS' EQUITY
|
||||||||||||
CURRENT
LIABILITIES:
|
||||||||||||
Accounts
payable (note (c))
|
$ | 3,331,293 | $ | 95,633 | $ | 3,426,926 | ||||||
Other
payables
|
466,392 | - | 466,392 | |||||||||
Other
payables - related party
|
65,078 | - | 65,078 | |||||||||
Accrued
liabilities
|
21,228 | - | 21,228 | |||||||||
Advances
from customers
|
7,044,234 | - | 7,044,234 | |||||||||
Taxes
payable (note (c))
|
2,282,621 | 409,992 | 2,692,613 | |||||||||
Deferred
revenue (note (d))
|
1,726,701 | (1,726,701 | ) | - | ||||||||
Short-term
bank loans
|
381,420 | - | 381,420 | |||||||||
Total
current liabilities and total liabilities
|
15,318,967 | (1,221,076 | ) | 14,097,891 | ||||||||
SHAREHOLDERS'
EQUITY:
|
||||||||||||
Preferred
stock(US$0.001 par value; 50,000,000 shares authorized, 714,963 shares
issued and outstanding as of December 31, 2008)
|
715 | - | 715 | |||||||||
Common
stock(US$0.001 par value; 100,000,000 shares authorized, 29,912,573
shares issued and outstanding as of December 31, 2008)
|
29,913 | - | 29,913 | |||||||||
Additional
Paid-in-capital
|
7,645,404 | 1,412,879 | 9,058,283 | |||||||||
Accumulated
deficit
|
(363,147 | ) | 55,469 | (307,678 | ) | |||||||
Statutory
reserves
|
408,403 | (275,601 | ) | 132,802 | ||||||||
Accumulated
other comprehensive loss
|
(97,843 | ) | (8,794 | ) | (106,637 | ) | ||||||
Total
shareholders' equity
|
7,623,445 | 1,183,953 | 8,807,398 | |||||||||
Total
liabilities and shareholders' equity
|
$ | 22,942,412 | $ | (37,123 | ) | $ | 22,905,289 |
F-8
(a)
|
Accounts
receivable was increased by $174,314, representing a reclassification of
$274,678 from long term accounts receivable, because these accounts
receivables are due within one year, and netting off an additional
allowance of $100,364 for doubtful
accounts.
|
(b)
|
It
represents a reclassification of deferred tax assets of $63,241 which was
previously netted against tax payables as of December 31,
2008.
|
(c)
|
Cost
of revenues, sales taxes and corporate income tax were understated by
$95,633, $96,556 and $250,195, respectively, as of December 31, 2008. The
remaining difference represents the reclassification of $63,241 (note b)
to deferred tax assets.
|
(d)
|
The
Company recognized retainage of $1,726,701 as revenue in 2008 since the
recoverability could be reasonably
assured.
|
Consolidated
Statements of Income and other comprehensive income Impact:
The
following table sets forth the effects of the restatement and reclassification
adjustments on the Company’s consolidated statements of income and other
comprehensive income:
2008
|
2008
|
|||||||||||
|
Previously reported
|
Adjustment
|
Restated
|
|||||||||
REVENUES
|
||||||||||||
Third
parties (note (d))
|
$ | 19,793,175 | $ | 1,522,051 | $ | 21,315,226 | ||||||
Related
party (note (d))
|
3,384,900 | 204,650 | 3,589,550 | |||||||||
Total
revenue
|
23,178,075 | 1,726,701 | 24,904,776 | |||||||||
COST
OF REVENUES
|
||||||||||||
Third
parties (note (e))
|
(16,155,562 | ) | (394,086 | ) | (16,549,648 | ) | ||||||
Related
party
|
(1,951,549 | ) | - | (1,951,549 | ) | |||||||
Total
cost of revenues
|
(18,107,111 | ) | (394,086 | ) | (18,501,197 | ) | ||||||
GROSS
PROFIT
|
5,070,964 | 1,332,615 | 6,403,579 | |||||||||
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES (note (f))
|
(3,463,682 | ) | (818,181 | ) | (4,281,863 | ) | ||||||
INCOME
FROM OPERATIONS
|
1,607,282 | 514,434 | 2,121,716 | |||||||||
OTHER
INCOME (EXPENSE), NET:
|
||||||||||||
Non-operating
income, net
|
126,512 | 22,865 | 149,377 | |||||||||
Interest
expenses
|
(57,411 | ) | (22,865 | ) | (80,276 | ) | ||||||
Total
other income net
|
69,101 | - | 69,101 | |||||||||
INCOME
FROM OPERATIONS BEFORE PROVISION FOR INCOME TAXES
|
1,676,383 | 514,434 | 2,190,817 | |||||||||
INCOME
TAXES EXPENSES (note (g))
|
(565,720 | ) | (250,195 | ) | (815,915 | ) | ||||||
NET
INCOME
|
1,110,663 | 264,239 | 1,374,902 | |||||||||
OTHER
COMPREHENSIVE INCOME
|
||||||||||||
Foreign
currency translation adjustment
|
(57,717 | ) | - | (57,717 | ) | |||||||
COMPREHENSIVE
INCOME
|
$ | 1,052,946 | $ | 264,239 | $ | 1,317,185 | ||||||
Earnings
per share
|
||||||||||||
Basic
|
$ | 0.04 | $ | 0.01 | $ | 0.05 | ||||||
Diluted
|
$ | 0.04 | $ | 0.01 | $ | 0.05 | ||||||
Weighted
average ordinary shares outstanding
|
||||||||||||
Basic
|
25,705,500 | (13,521 | ) | 25,691,979 | ||||||||
Diluted
|
27,033,819 | (731,556 | ) | 26,302,263 |
(e)
|
The
restated cost of revenues increased by $394,086, representing undercharged
certain cost and sales tax of $95,633 and $96,556 (note c), respectively,
and a reclassification of $201,897 (note f) from selling, general and
administrative expenses.
|
(f)
|
The
restated selling, general and administrative expenses increased by
$818,181, representing undercharged cost for consulting services of
$964,484 and allowance of doubtful accounts of $100,364, offset by
overcharged stock based compensation of $44,770 in 2008 and a
reclassification of $201,897 to cost of
revenue.
|
(g)
|
The
adjustment to income tax expense has been calculated based on the above
adjustments.
|
F-9
Consolidated
Statement of Shareholders’ Equity Impact:
The
following table sets forth the effects of the restatement and reclassification
adjustments on the Company’s consolidated statements of shareholders’
Equity:
Preferred Stock
|
Common stock
|
Additional
paid-in
capital
|
Statutory
reserves
|
Accumulated
deficit
|
Accumulated
other
comprehensive
income (loss)
|
Total
|
||||||||||||||||||||||||||||||
Shares
|
Amount
|
Shares
|
Amount
|
|||||||||||||||||||||||||||||||||
BALANCE, December 31, 2008,
previous reported
|
714,963 | $ | 715 | 29,912,573 | $ | 29,913 | $ | 7,645,404 | $ | 408,403 | $ | (363,147 | ) | $ | (97,843 | ) | $ | 7,623,445 | ||||||||||||||||||
Recognize
retainage as revenues (note (h))
|
- | - | - | - | - | - | 1,726,701 | - | 1,726,701 | |||||||||||||||||||||||||||
Undercharged
cost of revenues (note (h))
|
- | - | - | - | - | - | (192,189 | ) | - | (192,189 | ) | |||||||||||||||||||||||||
Undercharged
allowance for doubtful accounts (note i)
|
- | - | - | - | - | - | (100,364 | ) | - | (100,364 | ) | |||||||||||||||||||||||||
Undercharged
cost for consulting service (note (i))
|
- | - | - | - | 964,484 | - | (964,484 | ) | - | - | ||||||||||||||||||||||||||
Overcharged
stock based compensation (note (i))
|
- | - | - | - | (44,770 | ) | - | 44,770 | - | - | ||||||||||||||||||||||||||
Adjustment
of income taxes expenses (note (j))
|
- | - | - | - | - | - | (250,195 | ) | - | (250,195 | ) | |||||||||||||||||||||||||
Reclassification
due to dissolve of variable interest entities (note (k))
|
- | - | - | - | 484,371 | - | (484,371 | ) | - | - | ||||||||||||||||||||||||||
Over-accrued
statutory reserve (note (l))
|
- | - | - | - | - | (275,601 | ) | 275,601 | - | - | ||||||||||||||||||||||||||
Adjustment
to accumulated other comprehensive income (loss)
|
- | - | - | 8,794 | - | - | (8,794 | ) | - | |||||||||||||||||||||||||||
BALANCE,
December 31, 2008, restated
|
714,963 | $ | 715 | 29,912,573 | $ | 29,913 | $ | 9,058,283 | $ | 132,802 | $ | (307,678 | ) | $ | (106,637 | ) | $ | 8,807,398 |
(h)
|
Refer to note (d) and
note (e).
|
(i)
|
Refer to note
(f).
|
(j)
|
Refer to note
(c).
|
(k)
|
The restatement
adjustment mainly represents a reclassification of $484,371 profit
distribution from additional paid-in capital to
accumulated deficit. This profit distribution was made by Shanghai
Environment and Zhuyi to the Company’s
shareholders.
|
(l)
|
The restatement
adjustment represents the reversal of over-accrued statutory reserve of
$275,601
as of December 31,
2008.
|
(m)
|
Aggregated amounts
allocated to preferred stocks and warrants classified in additional
paid-in capital are restated to $5,307,539 and $1,336,739 based on the
Company’s change of valuation
(Note 12).
The
previously reported amounts
allocated
to preferred stocks and warrants were $3,017,296 and $3,626,982.
|
F-10
Consolidated
Statement of Cash Flows Impact:
The
following table presents selected consolidated statements of cash flows
information for the Company showing previously reported and restated cash flows,
for the years ended December 31, 2008:
Year
ended December, 31
|
||||||||||||
2008
|
||||||||||||
Previously
reported |
Adjustment
|
Restated
|
||||||||||
Net
cash (used in) operating activities
|
$ | (335,612 | ) | $ | (423,146 | ) | $ | (758,758 | ) | |||
Net
cash (used in) investing activities
|
241,311 | (521,328 | ) | (280,017 | ) | |||||||
Net
cash provided by financing activities
|
5,874,018 | 1,084,284 | 6,958,302 | |||||||||
Effect
of exchange rate changes on cash and cash equivalents
|
$ | 50,536 | $ | (139,810 | ) | $ | (89,274 | ) |
Note
3 – Summary of Significant Accounting Policies
The
principal accounting policies adopted in the preparation of these consolidated
financial statements are set out below:
(a)
|
Principal
of consolidation
|
The
accompanying consolidated financial statements have been prepared in accordance
with Generally Accepted Accounting Principles in the United States of America
(“US GAAP”). The consolidated financial statements include
the financial statements of the Company, its wholly-owned subsidiaries Poise
Profit, CER Hong Kong, Hi-tech, CER Shanghai, CER Yangzhou, and JV Entity, and
its variable interest entities (“VIEs”) Shanghai Engineering, Shanghai
Environmental, Zhuyi, and Haiyin. All significant inter-company
transactions and balances among the Company, its subsidiaries and VIEs are
eliminated upon consolidation.
In
accordance with the Accounting Standard Codification (“ASC”) 810-10, variable
interest entities (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.
The
Company has concluded that Shanghai Engineering, Haiyin, Shanghai Environmental,
and Zhuyi are VIEs and that the Company is the primary beneficiary. Under the
requirements of US GAAP, the Company consolidated the financial statements of
Shanghai Engineering, Haiyin, Shanghai Environmental and Zhuyi.
(b) Use
of estimates
In
preparing financial statements in conformity with US GAAP, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements and revenues and expenses during the
reported periods. Significant estimates include useful lives of equipment,
allowance for doubtful accounts, and the completion percentage of the
construction contracts. Actual results could differ from those
estimates.
(c)
Concentration of risk
The
Company maintains cash balances at financial institutions within the U.S. Hong
Kong and PRC. Balances at financial institutions or state owned banks within the
PRC are not covered by insurance. Balances at financial institutions within the
United States are covered by the Federal Deposit Insurance Corporation for
$250,000 per depositor per institution. Balances at financial institutions
within Hong Kong are fully covered by the government provided insurance
until the end of 2010. The Company has not experienced any losses in such
accounts and believes it is not exposed to any significant credit risks on its
cash in bank accounts.
F-11
For the
years ended December 31, 2008 and 2009, the Company’s five top customers
accounted for 50% and 69% of the Company's sales, respectively. Receivables
from the five top customers were 47% and 66% of total accounts receivable at
December 31, 2009 and 2008 respectively.
For
the years ended December 31, 2009, five suppliers provided approximately
62% of the Company's purchases of raw materials. There are almost no payables to
these five suppliers. Five suppliers provided approximately 23% of the
Company's purchases of raw materials for the years ended December 31, 2008.
Payables to these five suppliers were 4% of accounts payable at December 31,
2008.
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 country, and by the general
state of the country's economy. The Company's operations in the PRC are subject
to specific considerations and significant risks not typically associated with
companies carrying out operations in the United States. 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.
(d)
Foreign currency translations
The
reporting currency of the Company is the U.S. dollar. Shanghai Engineering, CER
Shanghai, CER Yangzhou, Haiyin, Shanghai Environmental, Zhuyi, Hi-tech and CER
Hong Kong use Renminbi ("RMB") as their functional currency. Results
of operations and cash flow are translated at average exchange rates during the
period, and assets and liabilities are translated at the end of period exchange
rates. Cash flows are also translated at average translation rates for the
period, therefore, amounts reported on the statement of cash flows will not
necessarily agree with changes in the corresponding balances on the balance
sheet. Translation adjustments resulting from this process are included in
accumulated other comprehensive income (loss) in stockholders' equity.
Transaction gains and losses that arise from exchange rate fluctuations from
transactions denominated in a currency other than the functional currency are
included in the results of operations as incurred. For the years ended December
31, 2008 and 2009, foreign currency translation loss amounted to $57,717 and
$29,152, respectively.
The PRC
government imposes significant exchange restrictions on fund transfers out of
the PRC that are not related to business operations. These restrictions have not
had a material impact on the Company because it has not engaged in any
significant transactions that are subject to the restrictions.
Accumulated
other comprehensive loss amounted to $106,637 and $77,485 as of December 31,
2008 and December 31, 2009, respectively. The balance sheet accounts with the
exception of equity at December 31, 2008 and December 31, 2009 were translated
at RMB6.82 to $1.00, and were translated at RMB6.82 to $1.00
respectively.
The
average translation rates applied to income and cash flow statement amounts for
the years ended December 31, 2008 and 2009 were RMB6.94 to $1.00 and RMB6.82 to
$1.00, respectively.
(e) Cash
and restricted cash
Cash
includes cash on hand and demand deposits with banks.
Restricted
cash represents a cash portion of the guaranty for the bids of contracts and is
deposited in a separate bank account subject to withdrawal restrictions
controlled by the customer to secure the Company’s performance of the projects
in process. The deposit cannot be drawn or transferred by the Company until the
restriction period has expired. The Company also classified certain cash as
restricted cash that is not available for use in its operations. The
amounts of restricted cash were $597,949 and $0 as of December 31, 2008 and
December 31, 2009, respectively.
(f) Notes
receivable
Notes
receivable represent trade accounts receivable due from various customers where
the customers’ banks have guaranteed the payment of the receivables. The notes
are non-interest bearing and normally paid within three to six months. The
Company has the ability to submit request for payment to the customer’s bank
earlier than the scheduled payment date, but will incur an interest charge and a
processing fee.
F-12
(g)
Receivables and allowance for doubtful accounts
Receivables
include trade accounts due from the customers, and other receivables from cash
advances to employees, related parties or third parties. Management regularly
reviews aging of receivables and changes in payment trends by its customers, and
records a reserve when they believe collection of amounts due are at
risk.
$ | 237,475 | |||
Addition
|
156,730 | |||
Recovery
|
(159,375 | ) | ||
Translation
adjustment
|
16,628 | |||
Allowance
for doubtful account, December 31, 2008
|
$ | 251,458 | ||
Addition
|
337,383 | |||
Translation
adjustment
|
207 | |||
Allowance
for doubtful account, December 31, 2009
|
$ | 589,048 |
Accounts
receivables which are expected to be collected after twelve months are
reclassified as long-term accounts receivables. The Company reserved a
provision for account receivable balances based on the nature of the business
and collection history (further discussed in Note 4). All the reserved allowance
for doubtful accounts was related to the receivables expected to be collected
within twelve months.
(h)
Inventories
Inventories
are comprised of raw materials, work in progress and finished goods and are
stated at the lower of cost or market value. Costs of work in progress include
direct labor, direct materials, and production overhead before the goods are
ready for sale. Management reviews inventories for obsolescence or cost in
excess of market value periodically. The obsolescence, if any, is recorded as a
reserve against the inventory. The cost in excess of market value is written off
and recorded as additional cost of revenues.
(i)
Advances on inventory purchase
Advances
on inventory purchases are monies advanced to outside vendors for inventory
purchases. This amount is refundable and bears no interest.
(j)
Equipment, net
Equipment
is stated at cost. Depreciation is provided principally by use of the
straight-line method over the estimated useful lives of the related assets.
Expenditures for maintenance and repairs, which do not improve or extend the
expected useful lives of the assets, are charged to operations as incurred,
while renewals and betterments are capitalized.
Management
established a 5% residual value for equipment. The estimated useful lives of the
equipment are as follows:
Transportation
equipment
|
3-10
years
|
Machinery
equipment
|
5-10
years
|
Office
equipment
|
3-5
years
|
The gain
or loss on disposal of equipment is the difference between the net sales
proceeds and the carrying amount of the relevant assets; gains or losses, if
any, are recognized in the consolidated statements of income and other
comprehensive income. For the years ended December 31, 2008 and 2009, loss from
disposition of fixed assets amounted to $13,186 and$0,
respectively.
F-13
(k)
Impairment of assets
The
Company assesses the carrying value of long-lived assets at each reporting
period, more often when factors indicating impairment are present, and reduces
the carrying value of such assets by the amount of the impairment. The Company
determines the existence of such impairment by measuring the expected future
cash flows (undiscounted and without interest charges) and comparing such amount
to the net asset carrying value. An impairment loss, if it exists, is measured
as the amount by which the carrying amount of the asset exceeds the fair
value of the asset. Fair value generally means based on either quoted market
price, if available, or discounted cash flow analysis. There were no impairment
of long lived assets recognized for the years ended December 31, 2008 and
2009.
(l)
Advances from customers
Advances
from customers represent amounts advanced by customers on product or service
orders. The product (service) normally is shipped (rendered) within one year
after receipt of the advance payment, and the related sales are recognized
in accordance with the Company’s revenue recognition policy.
(m)
Income taxes
Income
taxes are accounted for under the asset and liability method. Deferred income
taxes are recognized for temporary differences between the tax bases of assets
and liabilities and their reported amounts in the financial statements, net
operating loss carry forwards and credits, by applying enacted statutory tax
rate in the year in which those temporary differences are expected to be
recovered or settled. Deferred tax assets are reduced by a valuation allowance
when it is more likely than not that some portion or all of the deferred tax
assets will not be realized. Current income taxes are provided for in accordance
with the laws of the relevant taxing authorities.
(n) Value
added tax
Sales
revenue represents the invoiced value of goods, net of a value-added tax
("VAT"). All of the Company's products that are sold in the PRC are subject to a
Chinese value-added tax at a rate of 17% of the gross sales price. This VAT may
be offset by VAT paid by the Company on raw materials and other
materials included in the cost of producing its finished product. The
Company recorded VAT payable and VAT receivable net of payments in the financial
statements. The VAT tax return is filed offsetting the payables against the
receivables.
(o)
Operation leases
Leases
where substantial all the rewards and risks of ownership of assets remain with
the leasing company are accounted for as operating leases. Payments made under
operating leases are charged to the statement of operation on a straight line
basis over the lease periods.
(p) Stock
based compensation
In
accordance with ASC 718, Compensation-Stock
Compensation, the Company measures the cost of employee services received
in exchange for stock based compensation at the grant date fair value of the
award.
The Group
recognizes the stock based compensation costs, net of a forfeiture rate, on a
straight-line basis over the requisite service period for each
award.
ASC 718
requires forfeitures to be estimated at the time of grant and revised in
subsequent periods if actual forfeitures differ from those
estimates. For the stock options granted in the years ended December
31, 2008 and 2009, the Group used 0% forfeiture rate.
Cost of
goods acquired or services received from non-employees is measured based on the
fair value of the awards issued on the measurement date as defined in ASC 505.
Awards granted to non-employees are remeasured at each reporting date using the
fair value as at each period end. Changes in fair values between the interim
reporting dates are attributed consistent with the method used in recognizing
the original stock based compensation costs.
F-14
(q)
Revenue recognition
The Group
derives revenues principally from
|
(i)
|
Sales of energy recovery systems,
and
|
(ii)
|
Provision of design services,
and
|
(iii)
|
Provision of Engineering,
Procurement and Construction ("EPC") services, which are essentially
turnkey contracts where the Company provides all services in the whole
construction process from design, development, engineering,
manufacturing, procurement to
installation.
|
Revenue
by the above categories for the years ended December 31, 2008 and 2009 are
summarized as follows:
2008
Restated
|
2009
|
|||||||
Revenue:
|
||||||||
Product
|
$ | 17,715,743 | 12,413,075 | |||||
Services
|
504,525 | 260,815 | ||||||
EPC
contracts
|
6,684,508 | 9,520,553 | ||||||
Totals
|
$ | 24,904,776 | 22,194,443 |
In
providing design services, the Company designs energy recovery systems and other
related systems based on a customer's requirements and the deliverable consists
of engineering drawings. The customer may elect to engage the Company to
manufacture the designed system or choose to present the Company's drawings to
other manufacturers for manufacturing and installation. In contrast, when
providing EPC services, the customer is purchasing a turnkey energy recovery
system and the Company is involved throughout the entire process from design to
installation.
Sales of
the Company's energy recovery systems and related products are essentially
product sales. The products consist mainly of waste heat boilers and other
related equipment manufactured according to specific customers' specifications.
Once manufactured, the Company ships the products to its customers in their
entirety in one batch. The Company’s service arrangement also
includes a limited warranty to its customers pursuant to which the customers
retain between 5% and 10% of the particular contract price as retainage during
the limited warranty period (usually 12-18 months). The Company generally
recognizes revenues including retainage from product sales when (i) persuasive
evidence of an arrangement exists, which is generally represented by a contract
between the Company and the customer; (ii) products are shipped; (iii) title and
risk of ownership have passed to the customer, which generally occurs at the
time of delivery; (iv) the customer accepts the products upon quality inspection
performed by them; (v) the purchase price is agreed to between the Company and
the customer; and (vi) collectability is reasonably assured. Net revenues
represent the invoiced value of products, less returns and discounts, and net of
value-added tax.
The
Company recognizes revenues including retainage from design services when the
services are provided, the design drawings are delivered and collectability is
reasonably assured. The Company generally delivers the drawings in one
batch.
In
accordance with the accounting standard regarding long-term construction-type
contracts, the company adopted the percentage of completion method to recognize
revenues including retainage and cost of sales for EPC contracts. EPC contracts
are long-term, complex contracts involving multiple elements, such as design,
manufacturing and installation, which all form one integral EPC project. The
energy recovery system involved in an EPC project is highly customized to the
specific customer's facilities and essentially not transferable to any other
facilities without significant modification and cost. It would be difficult, if
not impossible, to beneficially use a single element of a specific EPC project
on a standalone basis other than in connection with the facilities for which it
was intended. EPC contracts are by nature long-term construction-type contracts,
usually lasting more than one accounting period, and the Company is able to
reasonably estimate the progress toward completion, including contracts revenues
and contracts costs. EPC contacts specify the customers' rights to the goods,
the consideration to be paid and received, and the terms of payment.
Specifically, the Company has the right to require a customer to make progress
payments upon completion of determined stages of the project which serve as
evidence of the customer's approval and acceptance of the work completed to date
as complying with the terms of the particular EPC contract and upon which the
company recognizes revenue.
Shipping
and handling costs are included in selling, general and administrative expenses
which totaled $351,035 and $497,089 for the years ended December 31, 2008
and 2009, respectively.
F-15
(r) Fair
value of financial instruments
On
January 1, 2008, the Company adopted ASC820, "Fair Value Measurements and
Disclosures" which defines fair value, establishes a three-level valuation
hierarchy for disclosures of fair value measurement and enhances disclosure
requirements for fair value measurements. The carrying amounts reported in the
balance sheets for current assets and current liabilities qualify as financial
instruments and are a reasonable estimate of fair value because of the short
period of time between the origination of such instruments and their expected
realization and if applicable the stated interest rate is equivalent to rates
currently available. The three levels are defined as follow:
¨
|
Level
1
|
Inputs to the valuation
methodology are quoted prices (unadjusted) for identical assets or
liabilities in active markets. Fair valued assets and liabilities that are
generally included in this category are assets comprised of cash,
restricted cash, accounts and notes receivable, and liabilities comprised
of bank loans, accounts payable, convertible notes, accrued liabilities
and other payables. As of December 31, 2008 and 2009, the carrying values
of these assets and liabilities approximated their fair
values.
|
¨
|
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. At December 31, 2008 and 2009, the Company
did not have any fair value assets or liabilities classified as Level
2.
|
¨
|
Level
3
|
Inputs
to the valuation methodology are unobservable and significant to the fair
value. Inputs reflected management’s best estimate of what market
participants would use in pricing the asset or liability at the
measurement date. Consideration is given to the risk inherent in the
valuation technique and the risk inherent in the inputs to the
model.
|
The
following table presents information about the company’s financial liabilities
classified as Level 3 as of December 31, 2009.
Balance
as of December 31, 2009
|
||||||||||||||||
Carrying
|
Fair
Value Measurements
|
|||||||||||||||
Value
|
Using Fair Value Hierarchy
|
|||||||||||||||
Level
1
|
Level
2
|
Level
3
|
||||||||||||||
Derivative
liability, current (Note 13)
|
$ | 435,500 | $ | 435,500 | ||||||||||||
Derivative
liability (Note 13)
|
$ | 435,500 | - | - | $ | 435,500 | ||||||||||
Warrant
liability (Note 13)
|
$ | 1,372,947 | - | - | $ | 1,372,947 |
As of
December 31, 2008 the Company had no warrant liability, as the warrant was
classified as equity prior to adoption of ASC 470.
A summary
of changes in Level 3 derivative and warrant liabilities for the years ended
December 31, 2008 and 2009 were as follows:
Warrants
issued at issuance of Series A convertible preferred stocks and
others
|
$ | 0 | ||
Balance
at December 31, 2008
|
0 | |||
Cumulative
effect of reclassification of warrants
|
1,524,268 | |||
Balance
at January1, 2009
|
1,524,268 | |||
Warrants
issued at issuance of convertible notes (Note 13)
|
1,387,912 | |||
Derivative
liability at issuance of convertible notes (Note 13)
|
1,270,500 | |||
Change
in fair value of warrant liability recognized in earnings
|
(1,539,233 | ) | ||
Change
in fair value of derivative liability recognized in
earnings
|
(399,500 | ) | ||
Balance
at December 31, 2009
|
$ | 2,243,947 |
F-16
(s)
Segment reporting
The group
has adopted ASC 280, Segment Reporting, for its Segment reporting. The group
mainly operates in china and measures its business as a single
segment.
(t)
Recent accounting pronouncements
In August
2009, the FASB issued Accounting Standards Update (ASU) 2009-05, Fair Value
Measurements and Disclosures (Topic 820) - Measuring Liabilities at Fair Value.
The fair value measurement of a liability assumes transfer to a market
participant on the measurement date, not a settlement of the liability with the
counterparty. ASU 2009-05 describes various valuation methods that can be
applied to estimating the fair values of liabilities, requires the use of
observable inputs and minimizes the use of unobservable valuation inputs. ASU
2009-05 is effective for the fourth quarter of 2009. The adoption of ASU 2009-05
did not have a material impact on our financial position, results of operations
or cash flows.
In
December 2009, the FASB issued ASU 2009-17, Consolidations (Topic 810) –
Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities. ASU 2009-17 changes how a reporting entity determines when an
entity that is insufficiently capitalized or is not controller through voting
(or similar rights) should be consolidated. ASU 2009-17 also requires a
reporting entity to provide additional disclosures about its involvement with
variable interest entities and any significant changes in risk exposure due to
that involvement. ASU 2009-17 is effective at the start of a reporting entity’s
first fiscal year beginning after November 15, 2009, or January 1, 2010, for a
calendar year entity. Early adoption is not permitted. We do not expect that the
adoption of ASU 2009-17 will have a material impact on our financial position,
results of operations or cash flows.
In
January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and
Disclosures (Topic 820) – Improving Disclosures about Fair Value Measurements.
This ASU requires new disclosures and clarifies certain existing disclosure
requirements about fair value measurements. ASU 2010-06 requires a reporting
entity to disclose significant transfers in and out of Level 1 and Level 2 fair
value measurements, to describe the reasons for the transfers and to present
separately information about purchases, sales, issuances and settlements for
fair value measurements using significant unobservable inputs. ASU 2010-06 is
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,
which is effective for interim and annual reporting periods beginning after
December 15, 2010; early adoption is permitted. We do not expect that the
adoption of ASU 2010-06 will have a material impact on our financial position,
results of operations or cash flows.
In
February 2010, the FASB issued ASU 2010-09 to amend ASC 855, Subsequent Events.
ASC 855, which was originally issued by the FASB in May 2009, provides guidance
on events that occur after the balance sheet date but prior to the issuance of
the financial statements. ASC 855 distinguishes events requiring recognition in
the financial statements and those that may require disclosure in the financial
statements. As a result of ASU 2010-09, SEC registrants will not disclose the
date through which management evaluated subsequent events in the financial
statements, either in originally issued financial statements or reissued
financial statements. ASC 855 was effective for interim and annual periods
ending after June 15, 2009, and ASU 2010-09 is effective immediately. We have
evaluated subsequent events in accordance with ASU 2010-09.
Note
4 – Accounts Receivable
(a)
|
Account
Receivable
|
December
31,
|
December
31,
|
|||||||
2008
|
2009
|
|||||||
Restated
|
||||||||
Current
accounts receivable
|
$ | 6,366,974 | $ | 7,190,969 | ||||
Subtract:
Allowance for doubtful accounts
|
(251,458 | ) | (589,048 | ) | ||||
Current
account receivable, net
|
6,115,516 | 6,601,921 |
F-17
The
Company reclassified accounts receivable which are expected to be collected
after one year as long-term assets.
Current
receivables also consisted of revenue recognized in excess of amounts billed for
the EPC contracts recognized using the percentage of completion method. As of
December 31, 2008 and 2009, the revenue recognized in excess of amounts billed
amounted to approximately $1.7 million and $2.4 million,
respectively.
(b)
|
Long-term
Account Receivable
|
As of
December 31, 2008 and 2009, amounts billed under contracts estimated to be
collected in longer than one year was $ 102,690 and $ 6,830,615,
respectively.
As of
December 31, 2009, long-term accounts receivable consisted of revenue recognized
in excess of amounts billed of approximately $6.2 million.
As of
December 31, 2008 and 2009, inventories consist of the following:
December
31,
|
December
31,
|
|||||||
2008
Restated
|
2009
|
|||||||
Raw
materials
|
$ | 2,013,311 | $ | 1,539,322 | ||||
Work
in progress
|
5,761,464 | 6,988,199 | ||||||
Finished
goods
|
- | 47,254 | ||||||
Total
inventories - current
|
$ | 7,774,775 | $ | 8,574,775 |
As of
December 31, 2008 and 2009 respectively, management determined that the carrying
amount of certain raw materials exceeded prices currently available; therefore,
$98,251 and $117,126 was written off and the amount has been included in cost of
revenues for the years ended December 31, 2008 and 2009,
respectively.
Note
6 – Equipment, Net
As of
December 31, 2008 and 2009, equipments consist of the following:
2008
Restated |
2009
|
|||||||
Machinery
equipment
|
$ | 602,728 | $ | 626,485 | ||||
Transportation
equipment
|
249,177 | 270,419 | ||||||
Office
equipment
|
390,398 | 431,905 | ||||||
Subtotal
|
1,242,303 | 1,328,809 | ||||||
Accumulated
depreciation
|
(391,415 | ) | (569,921 | ) | ||||
Equipment,
net
|
$ | 850,888 | $ | 758,888 |
Depreciation
expense for the years ended December 31, 2008 and 2009 was $113,520 and
$178,397, respectively.
Note
7 – Intangible Assets
F-18
Note
8 – Short-term Bank Loans
The
Company had a short-term loan from one bank in China for $381,420 borrowed
in at January 2008 with a 7.47% annual interest rate. The bank loan was
collateralized by Shanghai Engineering’s leased office space, which is owned
jointly by Mr. Qinghuan Wu and his son. The full amount of $381,420 was repaid
on January 16, 2009.
On
September 1, 2009, the Company borrowed $880,200 a short-term loan from one bank
in China which matures on August 31, 2010 with a 5.841% annual interest rate.
The bank loan was collateralized by Shanghai Engineering’s leased office space,
which is owned jointly by Mr. Qinghuan Wu and his son. This loan has been repaid
on January 5, 2010.
Interest
expenses of short-term bank loans for the years ended December 31, 2008 and 2009
were $27,997 and $19,469, respectively.
Note
9 – Convertible Notes
On May
21, 2009, the Company entered into a term loan agreement (“Convertible Notes
Agreement”) with an investment company (the “Lender”). Pursuant to the
Convertible Notes Agreement, the lender provides term loan
financing (“Convertible Notes”) to the Company in an amount of up to
$5,000,000 within 6 months of the making, which may be drawn from time
to time, in whole or in installments, upon notice, but once repaid shall not be
subject to reborrowing. The proceeds from this Convertible Note are for the
construction of a new plant located in China for the production of the products,
including, but not limited to, the purchase of land for the plant, buildings,
equipment and for the facilitating of financing loans from one or more in-China
banks and other institutional lenders. Any amount borrowed will bear interest at
9.5%, payable every six months, calculated and compounded quarterly. Each draw
is due twenty-four (24) months after the draw down date, together with any
accrued and unpaid interest. The Company drew down $5,000,000 on September 29,
2009. For the year ended December 31, 2009, interest expenses of $118,750 was
incurred. The Convertible Notes could be converted to 2,777,778 shares of common
stock at the conversion price of $1.80. In addition, the Company has issued the
Lender a five-year common stock purchase warrant (“Warrants”) to purchase
up to 1,388,889 shares of the Company’s common stock, which is that number of
shares of the Company’s common stock equal to 50% of the principal sum of these
Convertible Note divided by the conversion price of $1.80. In connection with
this Convertible Notes, the Company issued to the Lender one hundred shares of
Series B preferred stock, that provide for voting rights and directorships in
the event of defaults equal to or exceeding $1,000,000 in the aggregate
amount.
The
Lender may recall the Convertible Note after the 1st
anniversary of the draw down at a redemption price equal to the outstanding
principal plus any accrued and unpaid interest. The amount that may
be requested to be prepaid by the Lender may be no more than 50% of the amount
drew down by the Company. Additionally, upon occurrence of certain
events, the Lender can demand the entire outstanding principal, together with
any accrued and unpaid interest to be immediately repaid in full or in
part. The Company can also prepay the Convertible Note at any
time it desires with accrued interest and unpaid interest. On September 13,
2010, the Lender agreed not to exercise its right to request an early repayment
prior to January 1, 2011.
As of
December 31, 2009, 50% of the convertible notes are classified as a current
liability, while the remaining 50% are classified as a long-term liability. Its
embedded conversion feature is accounted for as a derivative liability
separately in the balance sheet in accordance with ASC 815, Derivatives and Hedging,
because the conversion price is denominated in USD, which is a currency other
than the Company’s functional currency, RMB. Approximately 50% of the
derivative liability is classified as a current liability while the other 50% is
classified as a long-term liability based on the timing of the cash flows
derived from the convertible notes. The Convertible Notes were
recorded with a discount equal to the fair value of the conversion feature at
the transaction date and were accreted to the redemption value of the
Convertible Notes from the draw down date to the earliest redemption date using
interest method. The change in fair value of the derivative liability of
$399,500 was recorded in the consolidated statements of operations for the
year ended December 31, 2009. The interest expenses recognized for accretion to
the redemption value of the Convertible Notes was $232,628 for the year ended
December 31, 2009.
F-19
The
value of the Warrants at the grant date on May 21, 2009 was treated as a
commitment fee for obtaining the Convertible Notes, and therefore the value was
recorded as deferred financing cost to be amortized over the period from grant
date to the earliest redemption date of the Convertible Notes. For the year
ended December 31, 2009, $497,541 of deferred financing cost was amortized and
charged to interest expenses. The Warrants were recorded as
derivative liabilities in accordance with ASC 815, Derivatives and Hedging,
because the exercise price of the Warrant is denominated in USD, which is a
currency other than the Company’s functional currency, RMB. Changes
in fair value of the Warrants (Note 13) for the year ended December 31, 2009
was recorded in the consolidated statements of operations.
Note
10 – Taxation
USA
CER USA
was subject to Delaware income tax at a rate of 34% on their assessable profits.
No such profit tax has been provided as the Group did not have assessable profit
that was earned in or derived from Delaware during the years
presented.
Hong
Kong
CER Hong
Kong subsidiaries were subject to Hong Kong profit tax at a rate of 16.5% on
their assessable profits. No Hong Kong profit tax has been provided as the Group
did not have assessable profit that was earned in or derived from Hong Kong
subsidiaries during the years presented.
PRC
The New
Enterprise Income Tax ("EIT") law was effective January 1, 2008 and the standard
EIT rate is 25%. Pursuant to the PRC tax law, net operating loss can
be carried forward 5 years to offset future taxable income.
Pursuant
to the PRC income tax laws, Shanghai Engineering is subject to enterprise income
tax at a statutory rate of 15% as a high technology entity. CER Shanghai and CER
Yangzhou are subject to enterprise income tax at a statutory rate of 25%.
Shanghai Environmental enjoyed a tax exemption from June 2007 to December
2008 according to a tax bureau declaration and is subject to a 25% income tax
rate after January 1, 2009.
2008
Restated
|
2009
|
|||||||
Statutory
CIT rate
|
34.00 | % | 34.00 | % | ||||
Tax
differential from statutory rate applicable to entities in the
PRC
|
(34.08 | )% | (5.42 | )% | ||||
Permanent
difference
|
(0.39 | )% | 45.98 | % | ||||
Utilization
of deferred income tax liability
|
- | 6.36 | % | |||||
Allowance
for deferred income tax assets
|
37.71 | % | (52.19 | )% | ||||
Effective
CIT rate
|
37.24 | % | 28.73 | % |
Deferred
tax assets and liabilities without taking into consideration the offsetting of
balances are as follows:
December
31,
|
||||||||
2008
Restated
|
2009
|
|||||||
Deferred
tax assets, current
|
||||||||
Rental
expenses
|
- | 67,276 | ||||||
Deferred
tax assets, non-current:
|
||||||||
Tax
loss carry forwards
|
1,173,146 | 2,178,667 | ||||||
Deductible
temporary differences related to:
|
||||||||
-Allowance
for doubtful accounts and provision for inventory
|
63,241 | 130,192 | ||||||
Valuation
allowance
|
(1,173,146 | ) | (1,822,225 | ) | ||||
63,241 | 486,634 | |||||||
Total
deferred tax assets
|
63,241 | 553,910 | ||||||
Deferred
tax liabilities, non-current:
|
||||||||
Taxable
temporary difference related to derivative liabilities
|
- | (352,876 | ) | |||||
Total
deferred tax liabilities
|
- | (352,876 | ) |
F-20
The net
balances of deferred tax assets and liabilities after offsetting are as
follows:
December
31,
|
||||||||
2008
Restated
|
2009
|
|||||||
Deferred
tax assets, current, net
|
- | 67,276 | ||||||
Deferred
tax assets, non-current net
|
63,241 | 133,758 | ||||||
Deferred
tax liabilities, net
|
- | - |
On
February 22, 2008, the Ministry of Finance (“MOF”) and the State Administration
of Taxation (“SAT”) jointly issued Cai Shui [2008] Circular 1 (“Circular 1”).
According to Article 4 of Circular 1, distributions of accumulated profits
earned by a FIE prior to January 1, 2008 to foreign investor(s) in 2008 or after
will be exempt from withholding tax (“WHT”) while distribution of the profit
earned by an FIE after January 1, 2008 to its foreign investor(s) shall be
subject to WHT at a rate up to 10% (lower rate is available under the protection
of tax treaties). Since the Company intends to indefinitely reinvest its
earnings to further expand the businesses in mainland China, the foreign
invested enterprises do not intend to declare dividends to their immediate
foreign holding companies in the foreseeable future. As a result, if any
dividends are declared out of the cumulative retained earnings as of December
31, 2007, they should be exempt from WHT. Accumulated profit of foreign
subsidiaries as of December 31, 2008 and 2009 were approximately $2,095,000 (RMB
14,907,000) and $1,059,500 (RMB 7,844,000), respectively, and they are
considered to be indefinitely reinvested. Accordingly, no provision
has been made. No dividend was declared out of the cumulative
retained earnings as of December 31, 2008 and 2009.
No
provision for taxation has been made for Hi-tech, CER Hong Kong, and CER
Yangzhou for the years ended December 31, 2008 and 2009, as those
subsidiaries did not generate any taxable profits during the
periods.
2008
Restated
|
2009
|
|||||||
US
income tax benefit
|
$ | - | $ | (431,970 | ) | |||
HK
income tax expense
|
- | - | ||||||
PRC
income tax expense
|
815,915 | 74,630 | ||||||
Total provision
for income taxes expense /(benefit)
|
$ | 815,915 | $ | (357,340 | ) |
F-21
The
valuation allowances as of December 31, 2008 and December 31, 2009 were as
follow:
Amount
|
||||
Balance
of January 1, 2008
|
$ | 346,977 | ||
Increase
|
826,169 | |||
Balance
of December 31, 2008
|
1,173,146 | |||
Increase
|
649,079 | |||
Balance
of December 31, 2009
|
$ | 1,822,225 |
Note
11 – Earnings/(Loss) per Share
The
Company reports earnings per share in accordance with the provisions of ASC 260,
“Earnings Per Share”. This standard 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(losses) per share excludes dilution and is computed by dividing net
income(losses) available to common stockholders by the weighted average common
shares outstanding during the period under the two-class method. 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. In computing the dilutive effect of convertible securities,
the number of shares is adjusted for the additional common stock to be
issued as if the convertible securities are converted at the beginning of the
period (or at the time of issuance, if later). In computing the dilutive effect
of options and warrants, the treasury method is used. Under this method, options
and warrants are assumed to be exercised at the beginning of the period and as
if funds obtained thereby were used to purchase common stock at the average
market price during the period.
The
following is a reconciliation of the basic and diluted earnings per share
computations for the years ended December 31, 2008 and 2009:
2008
|
2009
|
|||||||
Numerator:
|
||||||||
Net
income/(loss) for the year
|
1,374,902 | (886,480 | ) | |||||
Amount
allocated to preferred stockholders
|
(117,026 | ) | - | |||||
Net
income available to common stock holders – Basic and
diluted
|
1,257,876 | (886,480 | ) | |||||
Denominator:
|
||||||||
Denominator
for basic earnings per share—weighted average common stocks
outstanding
|
25,691,979 | 29,952,798 | ||||||
Dilutive
effect of warrants and options
|
610,284 | - | ||||||
Denominator
for diluted earnings per share
|
26,302,263 | 29,952,798 | ||||||
Basic
earnings/(loss) per share
|
0.05 | (0.03 | ) | |||||
Diluted
earnings/(loss) per share
|
0.05 | (0.03 | ) |
For the
year ended December 31, 2009, there was no diluted effect due to the net loss
incurred. The potentially dilutive Company’s convertible notes to convert into
2,777,778 common stocks as of December 31, 2009, warrants to purchase 1,968,561
and 3,357,450 common stocks as of December 31, 2008 and 2009, respectively, and
options to purchase 335,000 and 560,000 common stocks as of December 31, 2008
and 2009, respectively, were not included in the calculation of dilutive
earnings/(loss) per share because of their anti-dilutive effect.
F-22
Note
12 – Convertible Preferred Stocks
Series A Convertible
Preferred
Stock
On April
15, 2008 and as a condition to closing of the Share Exchange, CER entered into
Securities Purchase Agreements with 25 accredited investors pursuant to which
CER issued and sold an aggregate of 7,874,241 units at a unit price of $1.08
(the "Financing"). Each unit consisted of one share of CER's Series A
convertible preferred stock, par value of $0.001, and one warrant to purchase
one-half of one share of CER's common stock at an exercise price of $1.29 per
share. After the 1-for-2 reverse stock split conducted on April 16, 2008,
the 7,874,241 shares of the Company’s Series A convertible preferred stock are
convertible into 3,937,121 shares of common stock and the warrants are
exercisable into 1,968,561 shares of the Company's common stock at an exercise
price of $2.58 per share. The issuance costs of $1,859,902, including
commissions, legal fees and transaction expenses were reduced from the
proceedings. The net proceeds were allocated between the Series A convertible
preferred stocks and warrants based on their relative fair values. As of the
closing date, the fair value of Series A convertible preferred stock is
estimated at $1.68 where as the fair value of the warrants is estimated at
$0.85. As a result, an aggregate amount of $5,307,539 was allocated
to Series A convertible preferred stocks and $1,336,739 was allocated to the
warrants. The fair value of the warrants was initially valued using the binomial
model with assumptions such as, stock price, volatility, expected term,
dividend, risk-free interest rate, etc.
The
rights, preferences and privileges with respect to the Series A convertible
preferred stock are as follows:
Voting
Holders
of Series A convertible preferred stock are entitled to the number of votes
equal to the number of shares of common stock into which such shares of
preferred stock could be converted and to vote as a single class.
Dividends
Holders
of Series A convertible preferred stock are entitled to dividends when dividends
are declared for common stockholders. There have been no dividends
declared to date.
Liquidation
In the
event of any liquidation, dissolution or winding up of the Company, the holders
of Series A convertible preferred stock shall be entitled to receive the amount
of the original issue price per share (as adjusted for the 1-for-2 reverse stock
split) for each Series A convertible preferred stock, plus all declared and
unpaid dividends.
Conversion
Each
share of Series A convertible preferred stock is convertible into common stock
on a one-for-one basis, anytime at the option of the holder. The initial
conversion price is $2.16 after taking into effect the 1-for-2 reverse stock
split, and the conversion price is subject to adjustment in accordance with the
anti-dilution clause.
No
beneficial conversion feature charge was recognized for the issuance of Series A
convertible preferred stock on the issuance date as the estimated fair value of
the common stock is less than the conversion price on the date of
issuance. The Company’s common stock was quoted on the OTCBB and has
been publicly traded. However, with the high volatility and extremely
low volume traded during the time when the Company entered into this Financing
transaction, the fair value of the Company’s common stock as of April 15, 2008
was determined based on the Company’s estimate relied in part on a valuation
report prepared by an independent valuer. The estimated fair value of
the common stock was $1.55 per share.
Adjustment of Series A
Convertible Preferred Stock Conversion Price and Warrant Exercise
Price
In May
2009, accordance to the anti-dilution clause of the afore-mentioned Financing,
if the Company shall issue additional shares without consideration or for
consideration per share less than the conversion Price and Warrant Exercise
Price immediately prior to the issuance, such conversion price and
exercise price shall be adjusted.
For the
years ended 2008 and 2009, 7,159,278 and 52,000 shares of Series A convertible
preferred stock were converted to 3,579,639 and 26,147 shares of common stock
respectively.
No further
beneficial conversion feature charge was recognized for the adjustment of
conversion price and exercise price.
As of
December 31, 2009 and December 31, 2008, the Company had 662,963 and
714,963 shares of Series A convertible preferred stock issued and outstanding,
respectively.
F-23
In
connection with the Convertible Notes Agreement discussed in Note 9, the
Company was required to issue the Lender one hundred shares of Series B
Preferred Stock, par value at $0.001. The Series B preferred stock provides
voting rights and directorships only in the event of defaults which equal or
exceed $1,000,000 in the aggregate. The Series B preferred stock is senior to
all other capital stock of the Company. The holder of the Series B preferred
stock will not be entitled to any dividends, any liquidation preference of any
kind, or any conversion right to convert the Series B preferred stock into the
Company’s common stock.
Note
13 – Warrant and Derivative Liabilities
In June
2008, the FASB issued authoritative guidance on determining whether an
instrument (or embedded feature) is indexed to an entity’s own stock.
Under the authoritative guidance, effective January 1, 2009, instruments,
which do not have fixed settlement provisions, are deemed to be derivative
instruments. The conversion feature of the Company’s convertible note
(described in Note 9), the related warrants and the warrants issued in
connection with Series A convertible preferred stock, do not have fixed
settlement provisions because their conversion and exercise prices are
denominated in USD, which is a currency other than the Company’s functional
currency, RMB. Additionally, the Company was required to include the
reset provision in order to protect the holders from potential dilution
associated with future financings. In accordance with the FASB authoritative
guidance, the conversion feature of the Convertible Notes was separated from the
host contract (i.e. the Convertible Notes) and recognized as a derivative
liability in the balance sheet, and the warrants issued in connection with the
Convertible Notes and Series A preferred stocks have been recorded as warranty
liabilities in the balance sheet to be re-measured at the end of every reporting
period with changes in fair values reported in the consolidated statements of
income and other comprehensive income.
The
derivative liabilities were valued using both the Black-Scholes and Binomial
valuation techniques with the following assumptions:
September 29, 2009
(Issuance
date)
|
December 31, 2009
|
|||||||
Conversion
feature of Convertible Note:
|
||||||||
Risk-free
interest rate
|
0.95 | % | 1.14 | % | ||||
Expected
volatility
|
79.86 | % | 83.32 | % | ||||
Expected
life (in years)
|
2.00
years
|
1.75
years
|
||||||
Expected
dividend yield
|
0 | 0 | ||||||
Fair
Value:
|
||||||||
Conversion
feature
|
$ | 1,270,500 | $ | 871,000 |
Commitment
warrants issued in connection with convertible notes;
May
21, 2009
|
December
31, 2009
|
|||||||
(Issuance date)
|
|
|||||||
Number
of shares exercisable
|
1,388,889 | 1,388,889 | ||||||
Stock
price
|
$ | 1.73 | 1.05 | |||||
Exercise
price
|
$ | 1.80 | 1.80 | |||||
Expected
dividend yield
|
- | - | ||||||
Expected
life (in years)
|
5.00 | 4.39 | ||||||
Risk-free
interest rate
|
$ | 2.15 | % | 2.38 | % | |||
Expected
volatility
|
$ | 70 | % | 73 | % | |||
Fair
Value:
|
||||||||
Commitment
Warrants issued in connection with Convertible Note
|
$ | 1,387,912 | 666,793 |
F-24
Warrants
issued in connection with Series A convertible preferred stocks:
December 31, 2008
Restated
|
December 31, 2009
|
|||||||
Number
of shares exercisable
|
1,968,561 | 1,968,561 | ||||||
Risk-free
interest rate
|
1.18 | % | 1.81 | % | ||||
Expected
volatility
|
65 | % | 79 | % | ||||
Expected
life (in years)
|
4.29 years
|
3.29 years
|
||||||
Expected
dividend yield
|
- | - | ||||||
Fair
Value:
|
||||||||
Warrants
issued in connection with Series A convertible preferred
stock
|
$ | 1,492,977 | $ | 703,850 |
(a)
|
The
risk-free interest rate is based on the U.S. Treasury securities with
compatible life terms.
|
(b)
|
Due
to the short trading history of the Company’s stock, the Company uses the
volatility of comparable guideline companies to estimate
volatility.
|
(c)
|
The
expected life of the conversion feature of the notes was based on the term
of the notes and the expected life of the warrants was determined by the
expiration date of the warrants.
|
(d)
|
The
expected dividend yield was based on the fact that the Company has not
paid dividends to common shareholders in the past and does not expect to
pay dividends to common shareholders in the
future.
|
The
warrants issued in connection with Series A convertible preferred stock were
originally recorded at their relative fair value as an increase in additional
paid-in capital. Upon the implementation of the FASB authoritative guidance in
the first quarter of 2009, such warrants were reclassified to derivative
liabilities at fair value on January 1, 2009. The change in fair value is
reported as a cumulative change in accounting principles. The cumulative effect
on the accounting for the warrants issued in connection with Series A preferred
stock at January 1, 2009 is as follows:
Additional
Paid-in
Capital
|
Warrant
Liability
|
|||||||
Warrants
issued in connection with Series A convertible preferred
stocks
|
1,524,268
|
(1,524,268)
|
Note
14 - Stock-Based Compensation
Common
Stock
From
January to March 2008, the Company entered into several agreements with third-
party consulting companies and agreed to issue a total of 662,500 shares (post
1-for-2 reverse stock split conducted on April 16, 2008) of common stock in
exchange for investor relationship and consulting services. Amongst
the 662,500 shares of common stock, 475,000 shares were issued in May 2008 and
187,500 shares were issued in June 2008. The Company recognized
approximately $1,026,875 of compensation expense that was measured based on the
fair value of the common stock estimated by the Company in April
2008.
On
December 7, 2009, the Board approved the issuance of 700,000 shares of the
Company common stock to a consulting company in exchange for consulting service
received for the period of July 1, 2009 through December 31, 2009. The value of
those shares issued is $840,000, which was measured based on the fair value of
the Company’s common stock at December 7, 2009.
Warrants
On June
20, 2008, the Company entered into a consulting agreement with ARC China,
Inc., a company controlled by Adam Roseman. Pursuant to the agreement,
250,000 warrants were vested and became exercisable upon execution of the
consulting agreement. The exercise price is $2.16 and the warrant can be
exercised within 5 years. The fair value of the warrants was
estimated at $135,361 at the grant date and was immediately
expensed. In June 2008, the warrants were exercised in a cashless
manner and 195,454 shares of common stock were issued.
F-25
Stock
Options
On
September 18, 2008, the Company appointed three new independent directors and
granted them stock options to purchase an aggregate of 260,000 shares of the
Company’s common stock. The options will vest and become exercisable in eight
equal installments evenly spread out during the two year period beginning from
October 1, 2008. On June 24, 2009, the Company appointed another independent
director and granted him stock options to purchase 500,000 shares of the
Company’s common stock. The options will vest and become exercisable in eight
equal installments evenly spread out during the three year period beginning
from July 1, 2009. On September 7, 2009, the Company appointed another
independent director and granted her a stock option to purchase 60,000 shares of
the Company’s common stock. The options will vest and become exercisable in
eight equal installments evenly spread out during the two year period beginning
from October 1, 2009. Unvested options shall be terminated and forfeited upon
the termination of a holder’s director status.
Also on
September 18, 2008, the Company granted options to purchase an aggregate of
75,000 shares of the Company’s common stock to two consultants who contract with
the Company on a month-to-month basis. Those options vested immediately upon
being granted, but have since expired.
F-26
The
Company used the Black-Scholes Model to value the options at the time they were
granted. The following table summarizes the assumptions used in the
Black-Scholes Model when calculating the fair value of the options at the grant
dates:
Grant
Date
|
Number of
Options
|
Expected
Term (Years)
|
Exercise
Price
|
Expected
Volatility
|
Dividend
Yield
|
Risk Free
Interest Rate
|
Grant Date
Fair
Value
|
|||||||||||||||||||||
18-Sep-08
|
260,000 | 1.81 | $ | 2.90 | 79.00 | % | - | 1.45 | % | $ | 311,350 | |||||||||||||||||
18-Sep-08
|
75,000 | 0.38 | $ | 2.90 | 79.00 | % | - | 0.75 | % | $ | 41,820 | |||||||||||||||||
24-Jun-09
|
500,000 | 1.81 | $ | 1.58 | 92.00 | % | - | 1.01 | % | $ | 370,650 | |||||||||||||||||
1-Oct-09
|
60,000 | 1.81 | $ | 1.22 | 94.00 | % | - | 0.84 | % | $ | 34,926 |
Since the
Company does not have sufficient applicable history of employee stock options
activity, the Company uses the simplified method to estimate the life of the
options by taking the sum of the vesting period and the contractual life and
then calculating the midpoint which is the estimated term of the
options.
For the
year ended December 31, 2008, the Company recognized $85,928, of compensation
expense in the form of options. For the year ended December 31, 2009, the
company recognized $221,876 compensation expenses in the form of
options.
Following
is a summary of the status of options outstanding at December 31,
2009:
Outstanding
Options
|
Exercisable
Options
|
||||||||||||||||||||
Average
|
|
|
Average
|
||||||||||||||||||
remaining
|
Average
|
remaining
|
|||||||||||||||||||
Exercise
|
contractual
|
exercise
|
contractual
|
||||||||||||||||||
price
|
Number
|
Term
|
Price
|
Number
|
term
|
||||||||||||||||
$
|
1.22
|
60,000 | 3.00 | $ | 1.22 | 7,500 | 3.00 | ||||||||||||||
$
|
1.58
|
500,000 | 2.75 | $ | 1.58 | 125,000 | 2.75 | ||||||||||||||
Total
|
560,000 | 132,500 |
Following
is a summary of the option activity:
Outstanding
as of January 1, 2008
|
-
|
|||
Granted
|
335,000
|
|||
Forfeited
|
-
|
|||
Exercised
|
-
|
|||
Outstanding
as of December 31, 2008
|
335,000
|
|||
Granted
|
560,000
|
|||
Forfeited
|
(335,000
|
) | ||
Exercised
|
-
|
|||
Outstanding
as of December 31, 2009
|
560,000
|
|||
Vested
and exercisable as of December 31, 2009
|
132,500
|
On July
20, 2009, the Company terminated the service contract with a consultant. As a
result, the options granted to him on September 18, 2008 to purchase 25,000
shares of the Company’s common stock expired on October 21, 2009.
In
September 2009, another consultant gave up the options to purchase 50,000 shares
of the Company’s common stock.
F-27
On
September 7, 2009, one of the Company’s independent directors resigned from the
Company’s Board of Directors, effective October 1, 2009. The options granted to
her on September 18, 2008 to purchase 50,000 shares of the Company’s common
stock expired on December 31, 2009.
On
December 31, 2009, two of the Company’s independent directors resigned from the
Company’s Board of Directors, effective January 1, 2010. The options granted to
them on September 18, 2008 to purchase 210,000 shares of the Company’s common
stock expired on March 31, 2010.
Note
15 – Interest Expenses
For
the year ended December 31,
|
||||||||
2008
|
2009
|
|||||||
Interest
of $5,000,000 convertible notes
|
- | 118,750 | ||||||
Amortization
of deferred financing cost
|
52,279 | 497,541 | ||||||
Accretion
of convertible notes
|
- | 232,628 | ||||||
Interest
of short-term bank loans
|
27,997 | 19,469 | ||||||
Total
|
80,276 | 868,388 |
The
Company bifurcated the conversion feature from the $5,000,000 convertible
notes (as in note 9). The conversion feature is calculated at fair value
at each reporting date and the variance is charged into interest
expenses.
Note
16 – Related Party Transactions
In 2005,
Shanghai Engineering entered into agreements with the son of Mr. Qinghuan Wu to
lease the office at Quyang Road, Hongkou District, Shanghai for 5 years. For the
years ended December 31, 2008 and 2009, the Company incurred $8,649 and $52,776,
respectively, as rental expense to Mr. Qinghuan Wu's son.
Mr.
Qinghuan Wu was the director of Zhejiang Jiahua Industry Park Investment
Development Co., Ltd (“Jiahua”) until August 2008. Jiahua was a major EPC
customer of the Company. Transactions between Jiahua and the Company were
presented as related party transactions prior to December 31, 2008. Since Mr.
Qinghuan Wu has resigned from the director position in 2009, Jiahua is no
longer presented as a related party of the Company.
Note
17 – Retirement Benefits
As
stipulated by the relevant laws and regulations applicable to enterprises
operating in the PRC, the Company and its PRC subsidiaries and affiliates are
required to maintain a defined contribution retirement plan for all of its
employees who are residents of the PRC. The Company contributes to a statutory
government retirement plan approximately 22% of the base salary of each of its
employees and has no further obligations for the actual pension payments or
post-retirement benefits beyond the annual contributions. The statutory
government retirement plan is responsible for the entire pension obligations
payable for all past and present employees.
The
Company made contributions of $62,227 and $90,674 for employment
benefits, including pension payments for the years ended December 31, 2008 and
2009, respectively.
Note
18 – Statutory Reserve
As
stipulated by the relevant laws and regulations applicable to enterprises
operating in the PRC, the Company and its PRC subsidiaries and affiliates are
required to make annual appropriations to a statutory surplus reserve fund.
Specifically, the Company is required to deposit 10% of its profits after
taxes, as determined in accordance with the PRC accounting standards applicable
to the Company, to a statutory surplus reserve until such reserve reaches 50% of
the registered capital of the Company.
F-28
The
surplus reserve fund is non-distributable other than during liquidation and can
be used to fund previous years' losses, if any, and may be utilized for business
expansion or converted into share capital by issuing new shares to existing
shareholders in proportion to their shareholding or by increasing the par
value of the shares currently held by them, provided that the remaining
reserve balance after such issue is not less than 50% of the registered
capital. The remaining required contributions to the statutory
reserves required were approximately $12,718,305 as of December 31,
2009.
Note
19 – Commitments and Contingencies
Capital contribution to CER
Shanghai and CER Yangzhou
As
described in Note 1, CER Shanghai has registered capital of $5,000,000 of which
approximately $3,380,000 has been invested before December 31, 2009, and the
remaining is scheduled to be injected before November 11, 2010. CER Yangzhou has
registered capital of $20,000,000 of which $4,500,000 has been invested before
December 31, 2009, and approximately $3,000,000 has been additionally invested
in 2010. The remaining capital is scheduled to be injected before August 28,
2011.
Lease and Operation
Commitments
According
to the renewed and amended Lease and Operation Agreement (Note
1) entered by Shanghai Engineering and Shanghai Si Fang, Shanghai
Engineering has recorded lease expense and integrated management fee in the
amount of $295,294 and $861,909 under cost of revenue and general
administrative expenses for the year ended December 31, 2008 and 2009,
respectively.
Minimum
future payments under Lease and Operation Agreement are as
follow:
December
31,
|
Lease
|
Non-lease
|
Total
|
|||||||||
2010
|
$ | 265,236 | 234,720 | 499,956 |
Rental
commitments
On
January 1, 2009, Shanghai Engineering renewed the lease agreement with the son
of Mr. Qinghuan Wu to continue the lease of the current office space
(approximately 375 square meters) for one year until December 31, 2010 and the
monthly rental was $4,398, which is approximately the market price in
Shanghai. After moving into the new office space in Zhangjiang (as
described below), this lease agreement will be terminated. For the
year ended December 31, 2008 and 2009, the company incurred $8,649 and $52,776,
respectively, under the lease.
On March
19, 2009, CER Shanghai entered into an office lease agreement with Shanghai
Zhangjiang Integrated Circuit Industrial Zone Development Co., Ltd., to lease an
office space (approximately 2,664 square meters) in the Shanghai Zhangjiang
Hi-tech Parck (“Zhangjiang”), which is to be the new office space and the design
and engineering center of the Company in China. The lease is for two
years from March 1, 2009 through February 28, 2011. The Company is
also required to make a security deposit of approximately $292,613 in addition
to the annual lease payments. The rental expenses have been
recognized on a straight-line basis.
CER
Shanghai also has an option to purchase the office space with the pre-determined
prices as follows:
F-29
Total Purchase Price
|
||||
If
purchased before December 31, 2009
|
$
|
7,831,478
|
||
If
purchased before December 31, 2010
|
$
|
8,221,478
|
If CER
Shanghai exercises the above purchase option, all the lease payments and the
deposit payment made can be credited against the purchase price and counted as a
partial purchase payment. As of December 31, 2009, management has not decided
yet whether the Company will purchase this office space. The Company has paid
the first year’s rental fee in the amount of $146,304 and the security deposit
of $292,613 in April 2009. The Company has amortized the total rental fee using
straight-line method over the 2-year lease period. For the year end December 31,
2009, $415,109 was charged to rental expense.
Minimum
future lease payments under these leases are as follow:
Year
ended December 31,
|
Amount
|
|||
2010
|
$
|
902,734
|
Commitments related to the
new manufacturing
facility
On August
18, 2009, CER Hong Kong entered into a series of contracts with Yangzhou
(Yizheng) Automobile Industrial Park Administration Committee, a government
entity of the City of Yangzhou, Jiangsu Province, China, to acquire a tract of
land on which the Company plans to build a new manufacturing
facility. The new plant is planned as a world-class, state-of-the-art
facility and will be dedicated to developing and manufacturing large-sized and
sophisticated waste heat recovery systems and other related energy efficiency
equipment.
Further
to support CER’s waste heat recovery system development, the government will
provide various preferential policies, including a government research and
development grant estimated at $2.44 million, to be available to CER over
time. CER is obligated to establish a foreign investment
enterprise for its investment, to meet certain minimum capital levels, to make
certain minimum levels of investment in the plant (Approximately $293,255, RMB2
million, per Chinese acre; If not in two years, the land that is short of
investment would need to be returned or the deficient investment would need to
be made.), and to satisfy established construction schedules (Start construction
within 6 months upon obtaining the land. If construction would not start in one
year, or the area developed would be less than 1/3 of the land, or the
investment is less than 1/4 of the proposed investment and stop the development
without approval, unused land fee would be imposed; the part of the unused land
for over 2 years would need to be returned).
Note
20 – Subsequent events
On
February 1, 2010, the Company, through its subsidiaries, CER Shanghai
(“Borrower”) and CER Hong Kong (“Paying Agent”) entered into a series of
agreements for a loan arrangement with two lenders (the “Loan Agreements”). The
proceeds of this loan are for construction of the new plant in China for the
production of the Company’s products.
The
aggregate principal amount of the loan under the two Loan Agreements is
$4,000,000. The principal is due January 15, 2013, and bears interest
at the annual rate of 15.1%. The loan repayments are to be made three
times a year starting May 15, 2010, and are fully amortizing, such that the
principal and interest will be fully repaid at maturity. The Borrower
has entered into other agreements to provide that moneys due from a certain sale
and service contract and related guarantee will be directed to pay the amounts
due under the Loan Agreements, with the balance paid to the Borrower or its
affiliates. The loan agreement between the Paying Agent and Borrower
and related agreements have been registered with State Administration of Foreign
Exchange (SAFE) for the inflow of funds and the repayment of the loan
obligations. The loans may be prepaid at any time with a premium of 1.25%
of the principal amount being paid. The Loan Agreements provide
for the typical events of default, including a cross default clause, and the
Company has made various representations and given various covenants to the
lenders as are typical of such arrangements.
As a
guarantee of the payments under the Loan Agreements, Mr. Qinghuan Wu, the Chief
Executive Officer of the Company and the principal officer of the Borrower,
Paying Agent and other affiliates, has pledged 8,000,006 shares for the
repayment of the obligations under the Loan Agreements. Additionally,
since the repayment amount is fixed in United States dollars, the lenders will
receive shares of common stock on each principal payment date in that number of
shares representing the value of the difference in the Renmenbi/US Dollar
exchange rate between February 1, 2010, and the payment date, provided the
Renmenbi exchange rate increases against the US dollar, times the amount of
principal being repaid, divided by the closing price of the common stock on
the repayment date.
F-30
As a
result of the Company not filing its reports with the Securities and Exchange
Commission ("SEC") under the Securities Exchange Act of 1934, as amended, on a
timely basis for the fiscal year ended December 31, 2009 and the quarters ended
March 31, 2010 and June 30, 2010, the Company was in violation of various loan
covenants and default terms with respect its obligation to file SEC reports and
comply with applicable laws under the terms of the loan for $4,000,000 in
principal amount due January 15, 2013. The violation of the covenants and
default permit the note holders to accelerate the repayment of the full amount
of the principal and interest due on the loan. To date, the lenders have not
delivered any notice of acceleration and have not indicated that they intend to
give such a notice. One of the lenders representing $2,000,000 in principal
amount of the loans provided to the Company on November 1, 2010, a waiver of the
covenant and default terms and also provided sufficient time to make the
necessary past due filings and the report for the quarter ended September 30,
2010, before a covenant violation or default would result again concerning these
issues.
Contemporaneously
with the funding of the Loan Agreements, on February 1, 2010, Mr. Qinghuan Wu,
arranged for a loan from Haide, a company controlled by Mr. Qinghuan Wu, to lend
to the Paying Agent the sum of $1,000,000. The proceeds of this loan
will be forwarded to CER Yangzhou for additional paid-in capital which will help
fund the new plant being built in China. The loan is an interest only
loan, bearing interest at the annual rate of 9.5%, interest payable quarterly,
and is unsecured. The principal is due in full on January 30,
2012. The loan is unsecured and there are no guarantees of the
interest or principal. Shanghai Engineering has subordinated its loan
to those under the Loan Agreements.
Note
21 – Restricted Net Assets
Relevant
PRC laws and regulations permit PRC companies to pay dividends only out of their
retained earnings, if any, as determined in accordance with PRC accounting
standards and regulations. Additionally, the Company’s VIE subsidiaries can only
distribute dividends upon approval of the shareholders after they have met the
PRC requirements for appropriation to statutory reserve. The statutory general
reserve fund requires annual appropriations of 10% of net after-tax income
should be set aside prior to payment of any dividends. As a result of these and
other restrictions under PRC laws and regulations, the PRC subsidiaries and
affiliates are restricted in their ability to transfer a portion of their net
assets to the Company either in the form of dividends, loans or advances, which
restricted portion amounted to approximately $8,861,000, or 125.6% of the
Company’s total consolidated net assets as of December 31, 2009. Even though the
Company currently does not require any such dividends, loans or advances from
the PRC subsidiaries and affiliates for working capital and other funding
purposes, the Company may in the future require additional cash resources from
our PRC subsidiaries and affiliates due to changes in business conditions, to
fund future acquisitions and developments, or merely declare and pay dividends
to or distributions to the Company’s shareholders. The Company is required to
include the condensed financial statements of the Company in accordance with
Regulation S-X promulgated by the United States Securities and Exchange
Commission.
Additional
Information — Condensed Financial Statements of the Company
The
separate condensed financial statements of the Company as presented below have
been prepared in accordance Securities and Exchange Commission Regulation S-X
Rule 5-04 and Rule 12-04 and present the Company’s investments in its
subsidiaries under the equity method of accounting. Such investment
is presented on the separate condensed balance sheets of the Company as
‘Investments in subsidiaries.” Subsidiaries income or loss is included as the
Company’s “Share of income from subsidiaries” on the statement of
operations.
As of
December 31, 2008 and 2009, there were no material contingencies, significant
provisions for long-term obligations, or guarantees of the Company, except for
those which have been separately disclosed in the Consolidated Financial
Statements, if any.
F-31
FINANCIAL
INFORMATION OF CHINA ENERGY RECOVERY, INC.
Condensed
Statements of Operations:
For
the years ended December 31,
|
||||||||
2008
Restated
|
2009
|
|||||||
REVENUES
|
$ | - | $ | - | ||||
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
(2,337,238 | ) | (1,134,290 | ) | ||||
LOSS
FROM OPERATIONS
|
(2,337,238 | ) | (1,134,290 | ) | ||||
OTHER
INCOME (EXPENSE), NET:
|
||||||||
Change
in fair value of warrants liabilities
|
- | 1,539,233 | ||||||
Change
in fair value of derivative liabilities
|
- | 399,500 | ||||||
Non-operating
income/(loss), net
|
7,679 | (2,731 | ) | |||||
Interest
expenses
|
(52,279 | ) | (848,919 | ) | ||||
Total
other income/(expense), net
|
(44,600 | ) | 1,087,083 | |||||
LOSS
FROM OPERATIONS BEFORE PROVISION FOR INCOME TAXES
|
(2,381,838 | ) | (47,207 | ) | ||||
INCOME
TAXES BENIFITS
|
- | 431,970 | ||||||
Share
of income/(loss) from subsidiaries and VIEs
|
3,756,740 | (1,271,244 | ) | |||||
NET
INCOME/(LOSS)
|
1,374,902 | (886,481 | ) | |||||
COMPREHENSIVE
INCOME/(LOSS)
|
$ | 1,374,902 | $ | (886,481 | ) |
F-32
Condensed
Balance Sheet
December
31,
2008
Restated
|
December
31,
2009
|
|||||||
ASSETS
|
||||||||
CURRENT
ASSETS:
|
||||||||
Cash
|
$ | 18,358 | $ | 4,492 | ||||
Other
current assets and receivables
|
25,000 | 4,900 | ||||||
Other
receivables - inter companies
|
- | 5,115,560 | ||||||
Deferred
financial cost, current
|
- | 674,748 | ||||||
Advances
on inventory purchases
|
29,656 | 229 | ||||||
Total
current assets
|
73,014 | 5,799,929 | ||||||
OTHER
ASSETS:
|
||||||||
Deferred
financial cost
|
- | 215,623 | ||||||
Long
term accounts receivable
|
6,316,817 | 6,316,817 | ||||||
Long
term investment
|
3,759,201 | 2,487,957 | ||||||
Total
other assets
|
10,076,018 | 9,020,397 | ||||||
Total
assets
|
$ | 10,149,032 | $ | 14,820,326 | ||||
LIABILITIES AND
SHAREHOLDERS' EQUITY
|
||||||||
CURRENT
LIABILITIES:
|
||||||||
Accounts
payable
|
$ | 67,428 | $ | 4,109 | ||||
Other
payables - inter companies
|
460,000 | 659,529 | ||||||
Accrued
liabilities
|
11,441 | 121,353 | ||||||
Derivative
liability, current
|
- | 435,500 | ||||||
Convertible
note, current
|
- | 2,023,720 | ||||||
Total
current liabilities
|
538,869 | 3,244,211 | ||||||
NON-CURRENT
LIABILITIES:
|
||||||||
Warrant
liabilities
|
- | 1,372,947 | ||||||
Derivative
liability
|
- | 435,500 | ||||||
Convertible
note
|
- | 1,938,408 | ||||||
Total
non-current liabilities
|
- | 3,746,855 | ||||||
SHAREHOLDERS'
EQUITY:
|
||||||||
Preferred
stock(US$0.001 par value; 50,000,000 shares authorized, 714,963 and
662,963 shares issued and outstanding as of December 31, 2008 and 2009,
respectively)
|
715 | 626 | ||||||
Common
stock(US$0.001 par value; 100,000,000 shares authorized,
29,912,573 and 30,638,720 shares issued and outstanding as of December 31,
2008 and 2009, respectively)
|
29,913 | 30,639 | ||||||
Additional
Paid-in-capital
|
8,204,663 | 7,309,574 | ||||||
Retained
Earnings
|
1,374,902 | 488,421 | ||||||
Total
shareholders' equity
|
9,610,163 | 7,829,260 | ||||||
Total
liabilities and shareholders' equity
|
$ | 10,149,032 | $ | 14,820,326 |
F-33
Condensed
Cash flow:
For
the year ended December 31,
|
||||||||
2008
|
2009
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
Net
income/(loss)
|
$ | 1,374,902 | $ | (886,481 | ) | |||
Adjustments
to reconcile net income/(loss) to cash provided by (used in)
operating activities:
|
||||||||
Common
stock issued for services
|
1,444,361 | 840,000 | ||||||
Stock
based compensation
|
138,207 | 221,816 | ||||||
Change
in fair value of warrants
|
- | (1,938,733 | ) | |||||
Proceeds
from issuing ordinary stock, net
|
8,415 | - | ||||||
Interest
expenses of convertible note
|
- | 730,169 | ||||||
Deferred
income tax
|
- | (431,970 | ) | |||||
Investment
loss
|
(3,756,740 | ) | 1,271,244 | |||||
Change
in operating assets and liabilities
|
||||||||
Other
current assets and receivables
|
(25,000 | ) | (5,095,460 | ) | ||||
Advances
on inventory purchases
|
(29,656 | ) | 29,427 | |||||
Accounts
payable
|
67,428 | (63,319 | ) | |||||
Other
payables
|
460,000 | 199,529 | ||||||
Accrued
liabilities
|
11,441 | 109,912 | ||||||
Net
cash used in operating activities
|
(306,642 | ) | (5,013,866 | ) | ||||
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||
Entrusted
Fund due from subsidiary
|
(6,316,817 | ) | - | |||||
Investments
in subsidiary
|
(2,461 | ) | - | |||||
Net
cash used in investing activities
|
(6,319,278 | ) | - | |||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
Proceeds
from issuing preferred stock, net
|
6,644,278 | - | ||||||
Proceeds
from convertible note
|
- | 5,000,000 | ||||||
Net
cash provided by financing activities
|
6,644,278 | 5,000,000 | ||||||
EFFECTS
OF EXCHANGE RATE CHANGE IN CASH
|
- | |||||||
INCREASE/(DECREASE)
IN CASH
|
18,358 | (13,866 | ) | |||||
CASH,
beginning
|
- | 18,358 | ||||||
CASH,
ending
|
$ | 18,358 | $ | 4,492 |
F-34
Item
9
|
Change
in and Disagreements with Accountants on Accounting and Financial
Disclosure
|
On
November 30, 2009, Moore Stephens Wurth Frazer and Torbet, LLP (“MSWF&T”)
notified Company that it was resigning as the Company’s principal independent
accountant, effective immediately.
MSWF&T’s
reports on the Company’s financial statements for the fiscal years ended
December 31, 2008 and 2007 did not contain an adverse opinion or disclaimer of
opinion and were not qualified or modified as to uncertainty, audit scope or
accounting principles.
During
the Company’s two most recent fiscal years ended December 31, 2008 and 2007, and
through November 30, 2009, there were no disagreements between the Company and
MSWF&T on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements, if
not resolved to the satisfaction of MSWF&T, would have caused MSWF&T to
make reference to the subject matter of such disagreement in connection with
their report on the Company’s financial statements for such years. There were no
reportable events (as described under Item 304(a)(1)(v) of Regulation S-K)
during the Company’s two most recent fiscal years ended December 31, 2008 and
2007, or the interim period through November 30, 2009.
53
MSWF&T
was provided a copy of the above disclosure which was made in a Current Report
on Form 8-K, and MSWF&T furnished the Company with a letter addressed to the
Securities and Exchange Commission stating that it agreed with the
statements.
On
December 21, 2009, the Company engaged PricewaterhouseCoopers Zhong Tian CPAs
Limited Company (“PwC”) as its new independent registered public accounting
firm. The engagement of PwC was approved by the Company’s Board of
Directors.
During
the Company’s two most recent fiscal years ended December 31, 2008 and December
31, 2007 and through December 21, 2009, neither the Company nor anyone acting on
its behalf consulted with PwC regarding either (i) the application of accounting
principles to a specific transaction, either completed or proposed; or the type
of audit opinion that might be rendered on the Company’s financial statements,
and no written report was provided to the Company or oral advice was provided
that PwC concluded was an important factor considered by the Company in reaching
a decision as to the accounting, auditing or financial reporting issue; or (ii)
any matter that was the subject of either a disagreement (as defined in Item
304(a)(1)(iv) of Regulation S-K) or a reportable event (as described in Item
304(a)(1)(v) of Regulation S-K.
Item
9A (T) Controls and Procedures
(a) Evaluation
of Disclosure Controls and Procedures.
The
management team evaluated the effectiveness of our disclosure controls and
procedures as of December 31, 2009. The term “disclosure controls and
procedures,” as defined in Rule 13a-15(e) under the Exchange Act, means controls
and other procedures of a company that are 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 recorded, processed, summarized and reported, within
the time periods specified in the SEC’s 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, to allow timely decisions regarding required disclosure.
Notwithstanding improvement made by the management in respect of its disclosure
controls and procedures during the fiscal year, based on the evaluation of our
disclosure controls and procedures as of December 31, 2009, management concluded
that, as of such date, our disclosure controls and procedures were not
effective.
(b) Management’s
Annual Report on Internal Control over Financial Reporting.
Management’s
Report on Internal Control over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting. Internal control over financial reporting is
defined in Rule 13a-15(f) under the Exchange Act as a process designed by, or
under the supervision of, the company’s principal executive officer and
principal financial officer and effected by the Company’s Board of Directors,
Audit Committee of the Board of Directors, management and other personnel, to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles and includes those policies and
procedures that:
• pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
Company;
• provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are
being made only in accordance with management authorization; and
54
• provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Company’s assets that could have a
material effect on the financial statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
Our
management conducted an evaluation of the effectiveness of our internal control
over financial reporting as of December 31, 2009, using the framework
established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission ("COSO"). The COSO framework
summarizes each of the components of a company's internal control system,
including (a) the control environment, (b) risk assessment, (c) control
activities, (d) information and communication, and (e) monitoring. In the course
of the controls evaluation, management reviewed any errors or control problems
identified and sought to confirm that appropriate corrective actions, including
process improvements, were being undertaken. Based on this
assessment, our management concluded that, as of December 31, 2009, our internal
control over financial reporting was not effective.
In
assessing the effectiveness of our internal control over financial reporting,
management identified the following material weaknesses:
1) CER
continued to lack some policies/documentation for the specific implementation in
the area of sales, purchase and other business processes, resulting in some
important control activities moving to next step without required prior
approval.
2) Management
discovered that the accounting staff continues to lack sufficient accounting
skills and experience necessary to fulfill our public reporting obligations
according to accounting principles generally accepted in the United States and
the SEC's rules and regulations. During fiscal year 2009, the Company continued
to recruit several qualified staff persons familiar with US GAAP, which resulted
in a far better compilation of the necessary information and interpretation for
the proper presentation of the financial statements, however, management
understands that there must be continued improvement in this area.
3) There
continued to be insufficient controls for company information technology,
especially in the area of ERP. The Company does not have policies to
govern IT and the accounts in ERP, particularly in the access right for each
account, the access password and SOD in the accounting system.
4) The
Company continued to have insufficient qualified resources (employees and work
framework) to perform our internal audit functions properly.
5) CER
has not completed development of its policies for performance appraisal, and
also has no written documents left. The management has no data to analyze the
condition of human resources and to assess the related risks.
6) Some
controls tested as deficiencies during 2009 still remained un-remediated as of
the year end 2009, because most departments were short of resources, especially
due to the lack of human resources.
Our
management is in the process of implementing remediation procedures and
anticipates remediating these material weaknesses by the end of 2010. Management
is seeking to develop the overall scope and effectiveness of our internal audit
capabilities. To that end, management has taken the following actions
to improve internal controls over financial reporting:
1) The
Company signed a contract at the beginning of 2009 with a global business
consulting firm to assist management in strengthening our internal control of
financial reporting. As of the year end of 2009, management has outlined and
assessed all the major processes and all the key controls of the Company.
Although management has made steps to remedy many deficiencies, there continued
to be deficiencies in the areas of purchasing, inventory control, and GL, and
management is continuing on-going assessment and testing of the processes and
controls. The work with the consulting firm is still in progress.
2) Management
is establishing an internal audit function, and it has recruited one full-time
employee (we plan to recruit more in the future) to focus on internal controls.
The staff will directly report to the audit committee. Management also has
established some relevant policies and procedures to strengthen the fraud risk
assessment and anti-fraud system, while it is preparing detailed instructions
and guidance.
55
3) Management
has recruited some qualified employees (we are recruiting more persons in
connection with the Group’s expansion plan) for the key positions which relate
to financial reporting and has been providing more training courses for the
staff of the financial and internal audit departments.
4) Management
has developed policies and procedures to ensure that the preparation of
quarterly and annual financial statements, note disclosures, and related
information are in compliance with accounting standards and guidance, and we
have developed policies and procedures to review and document the resolution to
any abnormal balances and account relationship discrepancies on a monthly
basis. Specifically, management has established a policy that it
should (a) analyze the abnormal balances and account relationship discrepancies,
(b) document the review and resolution for any abnormal balances and account
relationship discrepancies that exist (i.e. journal entries prepared, etc.), and
(c) report significant abnormal balances and account relationship discrepancies
on a monthly basis including a status of researching and resolving the balances
and be required to report significant abnormal balances and account relationship
discrepancies on a monthly basis including a status of researching and resolving
the balances. In respect of the above processes, management will maintain
adequate documentation.
5) Management
is establishing, together with the consulting firm, more detailed policies and
procedures for the preparation of consolidated financial statements, and has
improved our formal contract review process to establish and document revenue
recognition events and methodologies at the inception of revenue generating
contracts.
6) Management
is developing policies and procedures to determine if any journal entries
processed in the current fiscal year have a prior period impact.
7) Management
is developing a enterprise resource planning (ERP) system to eliminated manual
processes in the area of supply chain, manufacturing, sales and financial
processes to avoid the mistakes that may result from manual entry.
8) Management
has established some and still establishing high level and detailed control
policies for all business departments, and management will continue to monitor
the implementation of these policies. These policies include, but are not
limited to, CER Examine and Approve Matrix, Guidance for Physical Count and
Variance Adjustment, IT Security Policy and so on.
9) Management
implemented more comprehensive documentation control policies and procedures to
allow it to evaluate whether our controls in this respect are effective and
implemented a more comprehensive information technology (including ERP) policies
and procedures.
10) For
IT security, management has developed formats to control the accounts and access
right to the data if there is any change. Management also periodically inspects
the physical room of the computer servers and the virtual system to check
whether there is any unusual phenomenon that may cause risks and keep written
documentation to support this activity.
This
annual report does not include an attestation report of our company’s
independent registered public accounting firm regarding internal control over
financial reporting. Management’s report was not subject to attestation by our
independent registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit us to provide only management’s
report in this annual report.
c) Changes
in Internal Controls
During
the fourth quarter, the Company established certain internal audit functions and
recruited specific internal audit staff to focus internal controls, some of
which are described above. The Company also established relevant policies and
procedures to strengthen the fraud risk assessment and anti-fraud system. The
Company continually seeks to make other changes in the internal control over
financial reporting (as defined in Rule 13a-15(f) under the Exchange
Act). Some of such changes described above were initially implemented
during the fourth quarter ended December 31, 2009.
56
Item
9B Other Information
None
PART
III
Item
10 Directors, Executive Officers and Corporate Governance
Directors
and Executive Officers
The
following table sets forth certain information concerning the directors and
executive officers of our Company as of September 30, 2010:
Name
|
Age
|
Position
with the Company
|
||
Qinghuan
Wu
|
63
|
Chairman
of the Board, Chief Executive Officer and Acting Chief Financial
Officer
|
||
Qi
Chen
|
39
|
Chief
Operations Officer and Director
|
||
Jialing
Zhou
|
54
|
Director
|
||
Ye
Tian
|
30
|
Director
|
||
Estelle
Lau
|
43
|
Director
|
Qinghuan
Wu has been a director, the Chairman of our Board and our Chief Executive
Officer since April 2008 and our acting Chief Financial Officer since November
2009. Mr. Qinghuan Wu has devoted his 40-year career to the design and
production of waste heat boilers and energy recovery systems, and related
technological development. Mr. Qinghuan Wu has been the Executive Director of
our subsidiary Haie Hi-tech Engineering (Hong Kong) Company Limited (which we
refer to as Hi-tech), which was founded in January 2002, Shanghai Hai Lu Kun Lun
Hi-tech Engineering Co., Ltd. (which we refer to as Shanghai Engineering and
which has entered into a contractual relationship with Hi-tech and subsequently
with CER (Hong Kong) Holdings Limited (which we refer to as CER Hong Kong), a
wholly-owned subsidiary of the Company founded in August 2008), which was
founded in July 1999, and Shanghai Xin Ye Environmental Protection Engineering
Technology Co., Ltd. (which we refer to as Zhuyi and which has also entered into
a contractual relationship with Hi-tech and subsequently with CER Hong Kong),
which was founded in May 2007, since their inceptions. Between 1992 and 2004,
Mr. Qinghuan Wu founded or held positions with numerous companies and research
institutes whereby he developed significant expertise related to the energy
recovery business. Mr. Qinghuan Wu was the founder and President of Zhangjiagang
Hai Lu Waste Heat Boiler Research Institute between 1992 and 1998, the Executive
Director of Kunshan Kun Lun Hi-technology Engineering Co., Ltd. between 1996 and
2004 and the founder and Executive Director of Zhangjiagang Hai Lu Kun Lun
Hi-Technology Engineering Co., Ltd. between 1997 and 2001. Before that, Mr.
Qinghuan Wu worked for 23 years (from 1969 until 1992) as a research engineer at
the Nanjing Chemical Industry Research Institute, the largest research institute
under the Chinese Ministry of Chemical Industry. Mr. Qinghuan Wu has served as
the executive member of the Chinese Sulfur Industry Association since 1999 and
been responsible for waste heat recovery technology development for the
industry. Mr. Qinghuan Wu was granted the China National Science and Technology
Advancement Award and Technology Award of the Chinese Ministry of Chemical
Industry for his technological innovation in the waste heat recovery field. Mr.
Qinghuan Wu holds a bachelor degree in Process Equipment and Control Engineering
from Beijing University of Chemical Technology, Beijing, China. We believe Mr.
Qinghuan Wu’s qualifications to serve on our Board of Directors include his
intimate knowledge of our operations as a result of his day to day leadership as
our Chief Executive Officer.
Qi Chen
has been a director and our Chief Operations Officer since April 2008. He is
also the General Manager of our affiliated company Shanghai Engineering, a
position he has held since May 2007, and the General Manager of our wholly-owned
subsidiary, CER Energy Recovery (Shanghai) Co., Ltd. (which we refer to as CER
Shanghai), a position he has held since February 2009. Mr. Chen joined Shanghai
Engineering in 1997 as a member of its design, engineering, and sales
departments. Before joining Shanghai Engineering, he served as a trader for the
Xiamen Trading and Development Co. for six years. Mr. Chen holds a bachelor
degree in engineering from Xiamen University, Xiamen, China. We believe Mr.
Chen’s qualifications to serve on our Board of Directors include his knowledge
of the industry in which we operate.
57
Jialing
Zhou has been a director since April 2008. She is also a director of
Hi-tech and has served in such position since Hi-tech’s inception in January
2002. Mrs. Zhou also serves as the controller of Shanghai Engineering, a
position she has held since Shanghai Engineering’s inception in July 1999. She
served as the controller for Zhangjiagang Hai Lu Waste Heat Boiler Research
Institute between 1992 and 1998 and for Zhangjiagang Hai Lu Kun Lun
Hi-Technology Engineering Co., Ltd. between 1997 and 2001. Between 1972 and
1992, she was a computer system analyst at the Nanjing Chemical Industry
Research Institute, the largest research institute under the Chinese Ministry of
Chemical Industry. We believe Ms. Zhou’s qualifications to serve on our Board of
Directors include her knowledge and experience in financial and accounting
matters.
Ye Tian
has been a director since June 2009. Mr. Tian is currently the CEO of Back In
Time Ltd. and its wholly-owned subsidiary JOVI, a retail chain and lifestyle
brand in China, the non-executive Chairman of Ying Dong Media, a movie/TV
production and distribution company in China, and a General Partner of Media
Plus, an investment company located in Beijing and focusing on Asia. Prior to
his current work, from 2006 to 2007, Mr. Tian was a Director at Loeb
Enterprises, an incubation company in New York, and from 2003 to 2005, he was an
Analyst at Appian Corporation, a software company in Virginia. Mr. Tian holds a
Bachelor of Arts degree in Applied Mathematics from Harvard University. We
believe Mr. Tian’s qualifications to serve on the Board of Directors include his
business experience as a chief executive officer.
Estelle
Lau has been a director since October 2009. Ms. Lau has been a consultant
for the past 10 years in the venture capital community focusing on cross-border
investments in Asia, mainly in Chinese-speaking countries. Ms. Lau has served as
General Counsel to pan-Asian venture funds, including CVM Capital and Crimson
Capital. Ms. has held the position of Vice President at 51Job, the leading
provider of HR services in China listed on NASDAQ, serving as internal counsel
and managing investor relations in the U.S. Ms. Lau also worked as an
independent consultant at Kmart Corporation as Acting VP of Global Sourcing and
Compliance. Most recently, she served as General Counsel and managed investor
relations for Shine Media Acquisition Corporation. Ms. Lau was an Associate
Professor of Law at SUNY Buffalo School of Law and has a B.A. in Sociology and
Philosophy from Wellesley College, an M.A. and Ph.D. in Sociology from the
University of Chicago and a J.D. from Harvard Law School. We believe Ms. Lau’s
qualifications to serve on the Board of Directors include her financial and
legal experience.
Family
Relationships
Mr. Qinghuan
Wu, our Chairman of the Board, Chief Executive Officer and Chief Financial
Officer, and one of our directors, Mrs. Jialing Zhou, are husband and
wife.
Section
16(a) Beneficial Ownership Reporting Compliance
Section
16(a) of the Securities Exchange Act of 1934, as amended, requires our officers,
directors and persons who beneficially own more than 10% of our common stock to
file reports of ownership and changes in ownership with the Securities and
Exchange Commission (SEC). Officers, directors and ten percent shareholders are
charged by SEC regulations to furnish us with copies of all Section 16(a) forms
they file. Based solely upon our review of the copies of such forms received by
us, or written representations from certain reporting persons that no Forms 5
were required for those persons, we believe that, during the fiscal year ended
December 31, 2009, all filing requirements applicable to our executive
officers, directors and ten percent shareholders were fulfilled.
Code of
Ethics
We do not
currently have a Code of Ethics in place for the Company. Our business
operations are not complex and we have a very limited shareholder base. The
Company seeks advice and counsel from outside experts such as our lawyers on
matters relating to corporate governance.
58
Audit
Committee
The
functions of the Audit Committee include oversight of the integrity of our
financial statements, compliance with legal and regulatory requirements, and the
performance, qualifications and independence of our independent auditors.
Estelle Lau (Chairman) and Ye Tian are the current members of our Audit
Committee.
The Board
of Directors, after making a qualitative assessment of each member of the Audit
Committee, has determined that both Estelle Lau and Ye Tian are financial
experts within the meaning of all applicable rules. In making this
determination, the Board of Directors considered their ability to understand
generally accepted accounting principles and financial statements, their ability
to assess the general application of generally accepted accounting principles in
connection with our financial statements, including estimates, accruals and
reserves, their experience in analyzing or evaluating financial statements of
similar breadth and complexity as our financial statements, their understanding
of internal controls and procedures for financial reporting, and their
understanding of the audit committee functions.
Item
11 Executive Compensation
Summary
Compensation Table
The
following table sets forth information regarding compensation with respect to
our fiscal years ended December 31, 2009 and December 31, 2008, paid or accrued
by us to or on behalf of those persons who were our principal executive officer,
who we refer to as our “named executive officers.” There were no other executive
officers whose compensation exceeding $100,000 during those two fiscal
years.
Name
and
principal
position
|
Year
|
Salary
($)
|
All
Other
Compensation(1)
($)
|
Total
($)
|
||||||||||
Qinghuan
Wu, Chief
|
2009
|
70,373 | 4,000 | 74,373 | ||||||||||
Executive
Officer and
|
2008
|
53,373 | 4,000 | 57,373 | ||||||||||
Acting
Chief Financial Officer
|
||||||||||||||
Richard
Liu(2)
,
|
2009
|
145,033 | 145,033 | |||||||||||
Chief
Financial Officer
|
2008
|
39,567 | 39,567 |
(1)
Represents cost for automobile benefit.
(2)
Richard Liu resigned in November 2009.
Base
Salary
Our
executive officers receive base salaries that are determined based on their
responsibilities, skills and experience related to their respective positions
within the context of the Chinese market. The amount and timing of an increase
in base compensation depends upon, among other things, the individual’s
performance, and the time interval and any added responsibilities since his or
her last salary increase.
Outstanding
Equity Awards at Fiscal Year-End
There is
no equity award outstanding at December 31, 2009 for each of the named executive
officers:
Option
Exercises
None of
our named executive officers exercised any options during the year ended
December 31, 2009.
59
Employment
Contracts and Termination of Employment and Change-in-Control
Arrangements
We
currently do not have any employment contracts or termination of employment and
change-in-control arrangements with our named executive officers.
Retirement
Plans and Employee Benefits
Our
Chinese subsidiaries and our affiliated companies are required to provide
certain employee benefits to their respective employees under Chinese law as
described below.
|
¨
|
Employees
from outside of Shanghai, China. For employees who are not the
residents of Shanghai, as stipulated by the relevant laws and regulations
for companies operating in the Shanghai, the employer company is required
to contribute to a city-sponsored comprehensive insurance plan in an
amount equal to 12.5% of a benchmark number consisting of 60% of the last
year monthly average salary of the entire workforce in Shanghai (including
the employer’s employees).
|
|
¨
|
Outsourced
employees. We have
entered into an agreement with a human resource service company to
outsource the employees for manufacturing. The human resource service
company will be responsible for the comprehensive insurance for these
employees.
|
|
¨
|
Senior
management. Our
Chinese subsidiaries and our affiliated companies pay the premiums for
accident insurance for a few members of their respective senior
management.
|
Director
Compensation
Members
of our Board of Directors who are also executive officers do not receive equity
or cash compensation for their services as directors. Our policy is to reimburse
our non-executive directors for reasonable expenses incurred in attending board
of director or committee meetings or in connection with their services as
members of the Board.
We
entered into substantially similar Board of Directors - Retainer Agreements with
each of our independent directors, Estelle Lau and Ye Tian. Pursuant to the
terms of the Retainer Agreements, each director has agreed to serve as a
director until the earlier of the termination of the Retainer Agreement or the
two year anniversary of the effective date thereof. Each director will receive
compensation for service on the Company's Board of Directors in the form of
options to purchase the Company's common stock and, in some cases, cash retainer
payments. The term of the options is ten years and the options vest in eight
equal installments on each October 1, January 1, April 1 and July 1 during the
term. The retainers are paid on a quarterly basis during the term of the
Retainer Agreement. The Retainer Agreements automatically renew for successive
terms upon the director's re-election to the Board of Directors for the period
of such term, unless the Board of Directors determines not to renew a Retainer
Agreement in its sole discretion.
Each
Retainer Agreement automatically terminates upon the earlier to occur of (a) the
death of the director, (b) the director's resignation or removal from, or
failure to win election or re-election to, the Company's Board of Directors, or
(c) upon the approval of the Company's Board of Directors, in its sole
discretion. In the event of termination, the director is entitled to receive (i)
payment of the portion of the retainer for service on the Company's Board of
Directors which has accrued to such director through the date of termination,
and (ii) the number of options that are vested as of the date of termination.
The unaccrued portion of the retainer and any unvested options as of the date of
termination will be forfeited by the director upon termination of the Retainer
Agreement. Finally, each director has agreed not to compete with the Company
during the term of the Retainer Agreement and for a period of six months
thereafter.
60
The
following table sets forth compensation information for the Company’s directors
who are not named executive officers for the year ended December 31,
2009:
Name
|
Fees Earned or
Paid in cash
|
Option Awards(1)
|
All Other
Compensation
|
Total
|
||||||||||||
($)
|
($)
|
($)
|
($)
|
|||||||||||||
Roger
Ballentine(2)
|
60,000 | 41,913 | 101,913 | |||||||||||||
Mengjiao
Jiang(3)
|
29,938 | 29,938 | ||||||||||||||
Fred
Krupica(4)
|
30,000 | 83,815 | 113,815 | |||||||||||||
Ye
Tian
|
61,775 | 61,775 | ||||||||||||||
Estelle
Lau
|
7,500 | 4,366 | 11,866 |
(1) Option
award amounts reflect compensation cost for our directors for the year ended
December 31, 2009, calculated in accordance with FASB ASC Topic 718 and using a
Black-Scholes valuation model.
(2) Mr.
Ballentine resigned from the Board of Directors effective January 1,
2010.
(3) Ms.
Jiang resigned from the Board of Directors effective October 1,
2009.
(4) Mr.
Krupica resigned from the Board of Directors effective January 1,
2010.
Item
12 Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
Our
common stock and Series A Convertible Preferred Stock constitute our only voting
securities. Holders of our common stock and Series A Convertible Preferred Stock
vote together as a single class. As of September 30, 2010, we
had 30,934,203 shares of common stock and 200,000 shares of Series A
Convertible Preferred Stock issued and outstanding. Each holder of Series A
Convertible Preferred Stock is entitled to that number of votes equal to the
number of shares of common stock into which such holder’s aggregate number of
shares of Series A Convertible Preferred Stock is convertible immediately after
the close of business on the applicable record date. Currently, the Series A
Convertible Preferred Stock is convertible into an aggregate of 105,882
shares.
The
following table sets forth, as of September30, 2010, the beneficial ownership of
our common stock by (a) each person or group of persons known to us to
beneficially own more than 5% of our outstanding shares of common stock, (b)
each of our directors and named executive officers and (c) all of our directors
and executive officers as a group. None of the foregoing persons hold any shares
of our Series A Convertible Preferred Stock. Except as indicated in the
footnotes to the table below, each stockholder named in the table has sole
voting and investment power with respect to the shares shown as beneficially
owned by such stockholder.
Beneficial
ownership is determined in accordance with Rule 13d-3 under the Exchange Act. In
computing the number of shares beneficially owned by a person or a group and the
percentage ownership of that person or group, shares of our common stock subject
to options or warrants currently exercisable or exercisable within 60 days after
September30, 2010 are deemed outstanding, but are not deemed outstanding for the
purpose of computing the percentage ownership of any other person. Except as
indicated in the table below, the address of each individual named below is 7F,
No. 267 Qu Yang Road, Hongkou District, Shanghai, China 200081.
61
Name
of Beneficial
Owner
|
Number
of Shares of
Common
Stock Beneficially
Owned
|
Percentage
of Class(1)
|
||||||
Qinghuan
Wu
|
11,454,254 | 37.03 | % | |||||
Qi
Chen
|
- | - | ||||||
Jialing
Zhou
|
8,302,836 | 26.84 | % | |||||
Ye
Tian
|
250,000 | (2) | * | |||||
Estelle
Lau
|
30,000 | (3) | * | |||||
All
directors and officers as a group (5 persons)
|
20,037,090 | 64.77 | % |
(1)
|
Based
upon 30,934,203 shares of common stock issued and outstanding as of
September 30, 2010. Does not include 200,000 shares of Series A
Convertible Preferred Stock currently exercisable into 105,882 shares of
common stock.
|
(2)
|
Includes
250,000 shares of common stock issuable upon exercise of outstanding
options.
|
(3)
|
Includes
30,000 shares of common stock issuable upon exercise of outstanding
options.
|
*
|
Less
than 1%
|
Item
13 Certain Relationships and Related Transactions, and Director
Independence
Transactions
with Related Persons
In 2005,
Shanghai Engineering entered into agreements with the son of Mr. Qinghuan Wu,
our Chairman and Chief Executive Officer, to lease office space. For the years
ended December 31, 2008 and 2009, the Company incurred $8,649 and $52,776 as
rental expense to Mr. Qinghuan Wu's son.
Director
Independence
We
undertook a review of the independence of our directors and, using the
definitions and independence standards for directors provided in the rules of
The Nasdaq Stock Market, considered whether any director has a material
relationship with us that could interfere with their ability to exercise
independent judgment in carrying out their responsibilities. As a result of this
review, we determined that Estelle Lau and Ye Tian are “independent directors”
as defined under the rules of The Nasdaq Stock Market.
Item
14 Principal Accountant Fees and Services
Principal
Accountant Fees and Services
PwC, our
current auditor, performed the audit of our annual consolidated financial
statements for the year ended December 31, 2009 and 2008. Moore
Stephens Wurth Frazer and Torbet, LLP, our previous
auditor, performed an audit of our annual
financial statements for the year ended December 31,
2008, which has been withdrawn upon
the issuance of the audit report by PwC, and performed the review of
our quarterly financial statements for the
first, second and third quarters ended March
31, 2009, June 30, 2009 and September 30, 2009, respectively.
The
following is a summary of fees billed by the principal accountant for services
rendered during each of the years ended December 31, 2008 and 2009.
62
Audit Fees.
For the years ended December 31, 2008 and December 31, 2009, the
aggregate fees billed for professional services rendered for the audit of our
annual financial statements, the review of our financial statements included in
our quarterly reports, and services provided in connection with regulatory
filings were approximately $247,694 and $242,388, respectively.
Audit Related
Fees. For the years ended December 31, 2008 and December 31, 2009, there
were no fees billed for professional services by our independent auditors for
assurance and related services.
Tax Fees.
For the years ended December 31, 2008 and December 31, 2009, there were
no fees billed for professional services rendered by our independent auditors
for tax compliance, tax advice or tax planning.
All Other Fees.
For the years ended December 31, 2008 and December 31, 2009, there were
no other fees billed for other professional services by our independent
auditors.
Pre-Approval
Policy
The Audit
Committee pre-approves the services to be provided by its independent auditors.
During the year ended December 31, 2009, the Audit Committee reviewed in advance
the scope of the annual audit to be performed by the independent auditors and
the independent auditors’ audit fees and approved them.
PART
IV
Item
15 Exhibits and Financial Statement Schedules
(a) We
have filed the following documents as part of this Annual Report on Form
10-K:
1. Financial
Statements
Included under Item 8 of this
Form 10-K.
2. Financial
Statement Schedules
Not
applicable.
63
3. Exhibits
Exhibit #
|
Description
|
|
2.1
|
Agreement
and Plan of Merger dated as of April 7, 2006 by and between the Registrant
and its wholly-owned subsidiary Commerce Development Corporation, Ltd.
(1)
|
|
2.2
|
Share
Exchange Agreement made effective as of January 24, 2008 by and among the
Registrant, Poise Profit International, Ltd. and the selling stockholders
of Poise Profit International, Ltd. as set out in the Share Exchange
Agreement (2)
|
|
2.3
|
Asset
Purchase Agreement dated as of January 25, 2008 between the Registrant and
MMA Acquisition Company (2)
|
|
2.4
|
First
Amendment to Share Exchange Agreement, dated as of April 15, 2008, by and
among the Registrant, Poise Profit International, Ltd. and the undersigned
shareholders of Poise Profit International, Ltd. (3)
|
|
3.1
|
Amended
and Restated Certificate of Incorporation (13)
|
|
3.2
|
Corrected
Certificate of Designation of the Preferences, Rights, Limitations,
Qualifications and Restrictions of the Series A Convertible Preferred
Stock of China Energy Recovery, Inc. (14)
|
|
3.3
|
Bylaws
(15)
|
|
3.4
|
First
Amendment to the Bylaws (16)
|
|
3.5
|
Certificate
of Designation, Preferences and Rights of Series B Preferred Stock
of
China
Energy Recovery, Inc. (17)
|
|
4.1
|
Form
of Warrant issued under the Consulting Agreement (2)
|
|
4.2
|
Form
of Warrant issued in the Financing (3)
|
|
4.3
|
Registration
Rights Agreement dated as of January 18, 2008 by and among the Registrant
and certain stockholders signatory thereto (3)
|
|
4.4
|
Form
of Registration Rights Agreement dated as of April 15, 2008 by and among
the Registrant and the investors in the Financing (3)
|
|
4.5
|
Warrant
issued under the Consulting Agreement between China Energy Recovery, Inc.
and ARC China, Inc. (6)
|
|
10.1
|
Securities
Purchase Agreement dated as of January 9, 2006 by and among the Registrant
and the purchasers signatory thereto (7)
|
|
10.2
|
Securities
Purchase Agreement dated as of April 13, 2006 by and among the Registrant
and the purchasers signatory thereto (8)
|
|
10.3
|
Stock
Purchase Agreement dated as of April 18, 2006 by and among the selling
stockholders and purchasers signatory thereto (8)
|
|
10.4
|
Form
of Securities Purchase Agreement dated as of April 15, 2008 by and among
the Registrant and the purchasers signatory thereto (3)
|
|
10.5
|
Amended
and Restated Senior Secured Promissory Note dated as of January 9, 2008
(9)
|
|
10.6
|
Escrow
Agreement dated as of April 15, 2008 by and among the Registrant, Poise
Profit International, Ltd., Qinghuan Wu and Jialing Zhou
(3)
|
|
10.7
|
Loan
and Transaction Expenses Agreement dated as of December 18, 2007 between
Shanghai Hai Lu Kun Lun Hi-tech Engineering Co., Ltd. and RMK Emerging
Markets, LLC (3)
|
|
10.8
|
Loan
Conversion Agreement dated as of April 15, 2008 between RMK Emerging
Markets, LLC, Shanghai Hai Lu Kun Lun Hi-tech Engineering Co., Ltd. and
China Energy Recovery, Inc. (3)
|
|
10.9
|
Leasing
and Operating Agreement dated as of April 22, 2004 between Shanghai Hai Lu
Kun Lun Hi-tech Engineering Co., Ltd. and Shanghai Si Fang Boiler Factory,
together with Amendment dated as of November 21, 2005, Amendment dated as
of December 28, 2006 and Amendment dates as of June 25, 2007
(3)
|
|
10.10
|
Consulting
Services Agreement dated as of December 28, 2005 between Haie Hi-tech
Engineering (Hong Kong) Company Limited and Shanghai Hai Lu Kun Lun
Hi-tech Engineering Co., Ltd. (3)
|
|
10.11
|
Operating
Agreement dated as of December 28, 2005 among Haie Hi-tech Engineering
(Hong Kong) Company Limited, Shanghai Hai Lu Kun Lun Hi-tech Engineering
Co., Ltd. and the shareholders of Shanghai Hai Lu Kun Lun Hi-tech
Engineering Co., Ltd. (3)
|
|
10.12
|
Proxy
Agreement dated as of December 28, 2005 between Haie Hi-tech Engineering
(Hong Kong) Company Limited and the shareholders of Shanghai Hai Lu Kun
Lun Hi-tech Engineering Co., Ltd. (3)
|
|
10.13
|
Option
Agreement dated as of December 28, 2005 among Haie Hi-tech Engineering
(Hong Kong) Company Limited, Shanghai Hai Lu Kun Lun Hi-tech Engineering
Co., Ltd. and the shareholders of Shanghai Hai Lu Kun Lun Hi-tech
Engineering Co., Ltd. (3)
|
|
10.14
|
Equity
Pledge Agreement dated as of December 28, 2005 among Haie Hi-tech
Engineering (Hong Kong) Company Limited, Shanghai Hai Lu Kun Lun Hi-tech
Engineering Co., Ltd. and the shareholders of Shanghai Hai Lu Kun Lun
Hi-tech Engineering Co., Ltd.
(3)
|
64
10.15
|
Consulting
Services Agreement dated as of December 28, 2005 between Haie Hi-tech
Engineering (Hong Kong) Company Limited and Shanghai Xin Ye Environmental
Protection Engineering Co., Ltd. (3)
|
|
10.16
|
Operating
Agreement dated as of December 28, 2005 among Haie Hi-tech Engineering
(Hong Kong) Company Limited, Shanghai Xin Ye Environmental Protection
Engineering Co., Ltd. and the sole shareholder of Shanghai Xin Ye
Environmental Protection Engineering Co., Ltd. (3)
|
|
10.17
|
Proxy
Agreement dated as of December 28, 2005 between Haie Hi-tech Engineering
(Hong Kong) Company Limited and the sole shareholder of Shanghai Xin Ye
Environmental Protection Engineering Co., Ltd. (3)
|
|
10.18
|
Option
Agreement dated as of December 28, 2005 among Haie Hi-tech Engineering
(Hong Kong) Company Limited, Shanghai Xin Ye Environmental Protection
Engineering Co., Ltd. and the sole shareholder of Shanghai Hai Lu Kun Lun
Hi-tech Engineering Co., Ltd. (3)
|
|
10.19
|
Equity
Pledge Agreement dated as of December 28, 2005 among Haie Hi-tech
Engineering (Hong Kong) Company Limited, Shanghai Xin Ye Environmental
Protection Engineering Co., Ltd. and the sole shareholder of Shanghai Xin
Ye Environmental Protection Engineering Co., Ltd. (3)
|
|
10.20*
|
Employment
Contract dated as of January 1, 2006 between Shanghai Hai Lu Kun Lun,
Hi-Tech Engineering Co., Ltd. and Qinghuan Wu (3)
|
|
10.21
|
Consulting
Agreement dated as of June 20, 2008 between China Energy Recovery, Inc.
and ARC China, Inc.(6)
|
|
10.22
|
Amendment
dated as of August 20, 2008 to Leasing and Operating Agreement dated as of
April 22, 2004 between Shanghai Hai Lu Kun Lun Hi-tech Engineering Co.,
Ltd. and Shanghai Si Fang Boiler Factory, as amended
(10)
|
|
10.23
|
First
Amendment to Consulting Agreement dated as of August 11, 2008 between
China Energy Recovery, Inc. and ARC China, Inc. (10)
|
|
10.24*
|
Stock
Option Plan (12)
|
|
10.25
|
Loan
Agreement dated as of May 21, 2009 between Registrant and Hold And Opt
Investments Limited (18)
|
|
10.26
|
Registration
Rights Agreement dated as of May 21, 2009 between Registrant and Hold And
Opt Investments Limited (18)
|
|
10.27
|
Form
of Loan Agreement dated February 1, 2010, between investors and CER
Holdings (Hong Kong) Limited (19)
|
|
10.28
|
Loan
Agreement between Haide Engineering (Hong Kong) Limited and CER (Hong
Kong) Holdings Limited dated February 1, 2010 (19)
|
|
21.1
|
List
of Subsidiaries (+)
|
|
31.1
|
Certification
Pursuant To Section 302 Of The Sarbanes-Oxley Act Of 2002
(+)
|
|
31.2
|
Certification
Pursuant To Section 302 Of The Sarbanes-Oxley Act Of 2002
(+)
|
|
32.1
|
Certification
Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of
The Sarbanes-Oxley Act Of 2002
(+)
|
* Indicates
management contract, compensatory plan or arrangement.
1.
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on April
13, 2006.
|
2.
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on
January 30, 2008.
|
3.
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on April
21, 2008.
|
4.
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on
February 7, 2008.
|
5.
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on May
9, 2008.
|
6.
|
Incorporated
by reference to Amendment No. 2 to the Registrant's Registration Statement
on Form S-1 filed on July 31, 2008.
|
7.
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on
January 13, 2006.
|
8.
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on April
18, 2006.
|
9.
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on
January 15, 2008.
|
10.
|
Incorporated
by reference to Amendment No. 3 to the Registrant’s Registration Statement
on Form S-1 filed on August 25, 2008.
|
11.
|
Incorporated
by reference to the Registrant's Current Report on Form 8-K filed on
September 24, 2008.
|
12.
|
Incorporated
by reference to the Registrant's Current Report on Form 8-K filed on
November 4, 2008.
|
65
13.
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on
February 7, 2008.
|
14.
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on May
9, 2008.
|
15.
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on April
13, 2006.
|
16.
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on
September 24, 2008
|
17.
|
Incorporated
by reference to the Registrant's Current Report on Form 8-K filed on June
5, 2009.
|
18.
|
Incorporated
by reference to the Registrant's Current Report on Form 8-K filed on May
26, 2009.
|
19.
|
Incorporated
by reference to the Registrant's Current Report on Form 8-K filed on
February 4, 2010.
|
+
|
Filed
herewith.
|
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
CHINA
ENERGY RECOVERY, INC.
|
|||
November
3, 2010
|
By:
|
/s/ Qinghuan
Wu
|
|
Qinghuan
Wu
|
|||
Chief
Executive Officer
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
/s/ Qinghuan
Wu
|
Chief
Executive Officer and Director
|
|
Qinghuan
Wu
|
3-November-2010
|
|
Principal
Financial and Accounting Officer
|
||
/s/ Qinghuan
Wu
|
Acting
Chief Financial Officer
|
|
Qinghuan
Wu
|
3-November-2010
|
|
Directors:
|
||
/s/ Qi
Chen
|
Chief
Operation Officer and Director
|
|
Qi
Chen
|
3-November-2010
|
|
/s/ Jialing
Zhou
|
Director
|
|
Jialing
Zhou
|
3-November-2010
|
|
/s/ Ye
Tian
|
Director
|
|
Ye
Tian
|
3-November-2010
|
|
/s/ Estelle
Lau
|
Director
|
|
Estelle
Lau
|
3-November-2010
|
66