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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
 
5
     
Item 1 Business
 
5
     
Overview of Our Business
 
5
Our History
 
6
Organizational Structure and Subsidiaries
 
7
Industry Overview
 
11
Global Market Overview
 
12
Competitive Markets and Competition
 
13
Design and Engineering
 
14
Manufacturing
 
14
Marketing and Sales
 
15
Products and Technology
 
15
Customers
 
17
Intellectual Property and Other Proprietary Rights
 
17
Our Business Strategy
 
18
Raw Materials and Principal Suppliers
 
18
Employees
 
19
Governmental Regulation
 
19
Compliance with Environmental Laws
 
19
     
Item 1A Risk Factors
 
19
     
Risks Related to Our Business
 
20
Risks Related to Our Corporate Structure
 
25
Risks Related to Doing Business in China
 
26
Risks Related to our Common Stock
 
28
Risks Related to Our Company
 
30
     
Item 1B Unresolved Staff Comments
 
32
     
Item 2 Properties
 
32
     
Item 3 Legal Proceedings
 
32
     
Item 4 [Reserved]
 
32
     
PART II
 
33
     
Item 5 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
33
     
Market Information
 
33
Dividends
 
33
Recent Sales of Unregistered Securities
 
34
Securities Authorized for Issuance under Equity Compensation Plans
 
34
     
Item 6 Selected Financial Data
 
35
 
2

 
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations
 
35
     
Overview
 
35
Critical Accounting Policies and Estimates
 
39
Results of Operations
 
44
Liquidity and Capital Resources
 
47
Table Disclosure of Contractual Obligations
 
50
Off-Balance Sheet Arrangements
 
52
     
Item 7A Quantitative and Quantitative Disclosures about Market Risk
 
52
     
Item 8 Financial Statements and Supplementary Data
 
52
     
Report of Independent Registered Public Accounting Firm
 
F-1
Note 1 – Organization
 
F-6
Note 2 Restatement of Consolidated Financial Statements for Year ended December 31, 2008
 
F-8
Note 3 – Summary of Significant Accounting Policies
 
F-11
Note 4 – Accounts Receivable
 
F-17
Note 5– Inventories
 
F-18
Note 6 – Equipment, Net
 
F-18
Note 7 – Intangible Assets
 
F-18
Note 8 – Short-term Bank Loans
 
F-19
Note 9 – Convertible Notes
 
F-19
Note 10 – Taxation
 
F-20
Note 11 – Earnings/(Loss) per Share
 
F-22
Note 12 – Convertible Preferred Stocks
 
F-23
Note 13 – Warrant and Derivative Liabilities
 
F-24
Note 14 - Stock-Based Compensation
 
F-25
Note 15 – Interest Expenses
 
F-28
Note 16 – Related Party Transactions
 
F-28
Note 17 – Retirement Benefits
 
F-28
Note 18 – Statutory Reserve
 
F-28
Note 19 – Commitments and Contingencies
 
F-29
Note 20 – Subsequent events
 
F-30
Note 21 – Restricted Net Assets
 
F-31
     
Item 9 Change in and Disagreements with Accountants on Accounting and Financial Disclosure
 
53
     
Item 9A (T) Controls and Procedures
 
54
Item 9B Other Information
 
57
     
PART III
 
57
     
Item 10 Directors, Executive Officers and Corporate Governance
 
57
     
Directors and Executive Officers
 
57
Family Relationships
 
58
Section 16(a) Beneficial Ownership Reporting Compliance
 
58
 
3

 
Audit Committee
 
59
     
Item 11 Executive Compensation
 
59
     
Outstanding Equity Awards at Fiscal Year-End
 
59
Option Exercises
 
59
     
Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
61
     
Item 13 Certain Relationships and Related Transactions, and Director Independence
 
62
     
Transactions with Related Persons
 
62
Director Independence
 
62
     
Item 14  Principal Accountant Fees and Services
 
62
     
PART IV
 
63
 
   
Item 15 Exhibits and Financial Statement Schedules
  
63
 
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.

 
·
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.

 
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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.

 
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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:

 
1
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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2
Major equipment manufacturers for which energy recovery systems are not a key focus but which have the necessary resources to build effective systems.

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:

 
Chemical and Petrochemical Industries;
 
Paper Manufacturing;
 
Refining Industry; and
 
Metallurgical Industry.

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.

 
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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:

 
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.

 
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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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.

 
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.

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.

 
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.
 

 
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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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
 
5/6/2013
Utility model
 
Double drum-type fire tube exhaust-heat boiler which shares one steam dome
 
11/6/2013
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
Utility model
  
Cement kiln forced-circulated waste heat recovery boiler
  
4/2/2019

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.

 
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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:

 
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.

 
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.

 
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.
 
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.

 
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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.

 
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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:

 
Decreased demand for the products of these manufacturing sectors;
 
Advances in the manufacturing processes of these sectors that could eliminate the economic feasibility of our technology; and
 
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.

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:

 
Increased costs associated with maintaining marketing efforts in various parts of China and various countries;
 
Marketing campaigns that are either ineffective or negatively perceived in one or more countries and/or across one or more industry sectors;
 
Difficulty and cost relating to compliance with the different commercial and legal requirements of the overseas markets in which we offer our products;
 
Inability to obtain, maintain or enforce intellectual property rights; and
 
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.
 
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.

 
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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.

 
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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.

 
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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.

 
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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.
 
 
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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.

 
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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.

 
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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.

 
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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.

 
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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.
 
 
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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 Companys 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 Companys change of valuation (Note 12). The previously reported amounts allocated to preferred stocks and warrants were $3,017,296 and $3,626,982.
 
 
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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. 
 
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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.

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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.

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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.
 
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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.
 
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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:
 
 
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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.

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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%.

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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.
 
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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.

 
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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 Developme