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EX-32.1 - China Energy Recovery, Inc.v218935_ex32-1.htm
EX-21.1 - China Energy Recovery, Inc.v218935_ex21-1.htm
EX-31.2 - China Energy Recovery, Inc.v218935_ex31-2.htm
EX-31.1 - China Energy Recovery, Inc.v218935_ex31-1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 


FORM 10-K

(Mark One)

x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended              December 31, 2010
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 x                  No o

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

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 $11,983,530  [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 first fiscal quarter.]

Number of shares outstanding of the registrant's common stock as of March 31, 2011:
30,956,651 shares of Common Stock, $0.001 par value per share

DOCUMENTS INCORPORATED BY REFERENCE

None

 
 

 
 
Table of Content

PART I
      3  
           
Item 1
Business
    3  
           
Item 1A
Risk Factors
    18  
           
Item 1B
Unresolved Staff Comments
    29  
           
Item 2
Properties
    30  
           
Item 3
Legal Proceedings
    30  
           
Item 4
[Reserved]
    30  
           
PART II
      31  
           
Item 5
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    31  
           
Item 6
Selected Financial Data
    32  
           
Item 7
Management's Discussion and Analysis of Financial Condition and Results of Operations
    33  
           
Item 7A
Quantitative and Quantitative Disclosures about Market Risk
    49  
           
Item 8
Financial Statements and Supplementary Data
    50  
           
Item 9
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    84  
           
Item 9A
Controls and Procedures
    84  
           
Item 9B
Other Information
    86  
           
PART III
      87  
           
Item 10
Directors, Executive Officers and Corporate Governance
    87  
           
Item 11
Executive Compensation
    89  
           
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    91  
           
Item 13
Certain Relationships and Related Transactions, and Director Independence
    92  
           
Item 14
Principal Accountant Fees and Services
    92  
           
PART IV
      93  
           
Item 15
Exhibits and Financial Statement Schedules
    93  
 
 
2

 
 
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."
 
PART I
 
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. Since inception, the Company has installed over 122 energy recovery systems both in China and internationally. The Company mainly sells its energy recovery systems and services directly to customers.
 
 
3

 
 
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 were 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.
 
 
4

 
 
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.

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 were 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.

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.
 
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.
 
 
5

 
 
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 their respective 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 2010 fiscal year and do not intend to do so in the future, hence we dissolved 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.

On December 3, 2008, as a part of our reorganization, all of the material 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. These material contractual relationships consist of:

 
· 
Consulting Services Agreements - These agreements allow CER Hong Kong to manage and operate Shanghai Engineering and Shanghai Environmental, and collect the respective net profits of each company. Under the terms of the agreements, CER Hong Kong 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 CER Hong Kong such company's respective net profits. CER Hong Kong 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 CER Hong Kong. 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 CER Hong Kong 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 CER Hong Kong may assign its rights or obligations under the agreements to an affiliate.

 
·
Operating Agreements - The parties to each of these agreements are CER Hong Kong, Shanghai Engineering, Shanghai Environmental, respectively, and all of the shareholders of each of Shanghai Engineering and Shanghai Environmental, respectively. Under the agreements, CER Hong Kong 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. CER Hong Kong 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, CER Hong Kong has the right to recommend director candidates and appoint the senior executives of each company. The agreements expire 10 years from execution unless renewed. CER Hong Kong 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. CER Hong Kong 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 CER Hong Kong.

 
6

 
 
 
· 
Proxy Agreements - CER Hong Kong 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 CER Hong Kong and agreed to not transfer the shareholders' respective equity interests in the two companies to anyone but CER Hong Kong or its designee(s). The agreements do not have an expiration date. CER Hong Kong has the right to terminate each of the agreements upon 30 days' written notice but the shareholders may not terminate the agreements without CER Hong Kong's consent.

 
· 
Option Agreements - The parties to each of these agreements are CER Hong Kong, 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 CER Hong Kong 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 CER Hong Kong's rights under the respective agreement. The agreements expire 10 years from execution unless renewed. CER Hong Kong 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 CER Hong Kong.

 
· 
Equity Pledge Agreements - The parties to each of these agreements are CER Hong Kong, 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 CER Hong Kong 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. CER Hong Kong 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 CER Hong Kong's rights under the respective agreement. Upon an event of default under the agreements, CER Hong Kong 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 CER Hong Kong's rights under the respective agreement. CER Hong Kong 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 CER Hong Kong.

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 rights, 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 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.

 
7

 
 
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 a variable interest 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. Phase one construction of the plant was completed and began operating in January 2011. Phase two is under construction and anticipated to be completed in 2012. As a result, the company’s production function is now split between Vessel Works Division and CER Yangzhou. We are in the process of transferring the production function from Vessel Works Division to CER Yangzhou and expect to be finished by end of April 2011.

The following is an organizational chart setting forth the current status of the Company's subsidiaries and affiliated companies as of December 31, 2010:

 
 
8

 
 
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 usable 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, 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.
 
 
9

 
 
In March 2010, the Chinese People's Political Consultative Conference (“CPPCC”) and National People's Congress (“NPC”) convened, during which the number one 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 nine principal focuses 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 in growing 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 fuel 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 2010, China's total installed generating capacity reached 960GW, an increase of more than 10% over the capacity at the end of 2009. Due to the expansion of energy intensive industrial sectors such as steel, cement, coal, petrol 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, 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.

 
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In 2010, China's primary energy consumption was 3.25 billion tons of standard coal, an increase of 6% compared to that of 2009. China has become one of the world's major energy consumers. However, China has tried to reduce energy intensity to some extent. The energy consumption per GDP fell 4%. It is predicted that China will reach total electricity consumption of 4.6 trillion kwh, an increase of 9.5%; coal consumption of over 3.5 billion tons; crude oil consumption of 0.46 billion tons; natural gas consumption will maintain rapid growth and the total consumption is expected to reach 120-130 billion cubic meters.

The Chinese government principally encourages the setup of large-scale companies in energy intensive industries such as chemicals, petrol and coal.  Therefore we would expect a general decrease in the number of smaller-scale companies in  this related industry. We intend to develop the market opportunities to cooperate with these large companies for our future development.

In October 2010, the State Council announced that China will continue to focus on supporting and developing the strategic new industries, such as energy-saving, new energy, high-side equipment manufactory industries.  The government encourages energy recycling and recovery to increase the efficiency of energy utilization. The goal is to increase the GDP of such strategic new industries to 8% and 15% of the total GDP, for the years ending 2015 and 2020, respectively.

In November 2010, the State Council approved  development plans for energy-saving and environmental protection industries. The government addressed the support of development of high-efficiency energy-saving techniques and equipment, including our waste-heat energy recovery systems. We predicted that China will launch a series of technological and fiscal support policies to further promote the healthy growth of such industries.

In December 2010, a Chinese senior government official reiterated at the Cancun Conference that China intends to fulfill the goal of reducing 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. From 2001 to 2005, the 10th five year plan, China realized an annual increase of GDP by 9.8% with increase of energy by10.4%. From2006 to 2010, the 11th five years, China realized an annual increase of GDP by 10.2% with increase of energy by 6.8%, which represented China’s rapid growth in investment of new energy and great improvement in energy utilization efficiency.

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.

In February 2011, Ministry of Industry and Information Technology announced that China will continue to encourage the energy-saving industries, to accelerate the development of recycling economics, recovery industries and energy-saving equipments. The supporting measures will be launched in order to reduce energy utilization and mitigate the release of harmful emissions.
 
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.

 
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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
 
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 global players 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 100 highly trained engineers in our engineering team and are planning to hire more.

We have targeted our products at industrial sectors with significant amounts of waste heat. These sectors include:

 
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Chemical and Petrochemical Industries;
 
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Paper Manufacturing;
 
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Refining Industry; and
 
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Coking 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 that a customer requested such services. For example, we entered into three EPC contracts in 2007 and 2008. The number of EPC contracts increased to four and eight in 2009 and 2010, respectively. The revenue generated from EPC contracts increased from 43.6% to 56.2% of the total revenue in year 2010. 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.

By the end of 2010, phase one of our newly built first class manufacturing facility in Yangzhou, China was completed. Starting from 2011, our new facility will significantly boost our production capability, lower the production costs and provide us the opportunity to expand our participation as a supplier of high-performance energy recovery systems to industry located in China and around the world.
 
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.
 
 
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Manufacturing
 
We operated a manufacturing facility, owned by Shanghai Si Fang through Shanghai Engineering in Shanghai, China. The facility occupies approximately 10 acres (4 hectares) of land with approximately 9,000 square meters of manufacturing space and storage. We employed 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.

In August 2009, we started to build our new manufacturing base in Yangzhou Auto Industry Park, Jiangsu Province. The new factory will occupy approximately 37.5 acres (15 hectares) of land with approximately 90,000 square meters of manufacturing space and storage., with a total investment is about $60 million. Total registered capital of the Yangzhou Company is $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 a world-class international manufacturing facility of waste heat equipment, in both products and technology. We plan to make highly efficient energy-saving products, using advanced manufacturing processes and equipment, We intend for this manufacturing facility to embody a completely new look of a modern factory, thus making 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. In January 2011, phase one construction of the plant was completed. The phase one facility is about 14,000 square meters.  Many advanced pieces of equipment have been installed in the new factory. The new facility significantly expands our ability to accept new orders and will speed delivery of large-scale waste heat systems for new and retro-fitted industrial plants located in China and overseas.
 
As a result, our production facilities are currently contained in both Vessel Works Division and CER Yangzhou. We will complete the transfer of the production function from Vessel Works Division to CER Yangzhou at the end of April 2011. Phase two is under construction and anticipated to be complete in 2012.
 
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 plan 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.

 
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Products and Technology
 
We have four main service offerings available to our customers, of which the first three generate the majority of our revenue stream:

 
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Fabrication. We have highly-trained manufacturing teams capable of building high quality energy recovery systems in a timely fashion. All of our energy recovery systems are of modular design with a high degree of factory assembly. With modular construction, site welds on heat exchanger pressure parts are kept to a minimum. We design all energy recovery systems we manufacture to protect our brand. We collect a one-time fee for the fabrication of each of our units. Of the approximately 110 unique customers who have purchased energy recovery systems from us, more than 25% of them have also purchased some of the other three major services that we offer which are auxiliary to our fabrication services, or have returned to us for new projects.

 
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Design. Our primary product line of energy recovery systems can be designed to meet the specific needs of our customers. We typically focus on heavy industrial applications. In addition to the designing of energy recovery systems for our own customers, we occasionally are approached by and contract with third party manufacturers or engineering firms to design systems for their customers. This offers a peripheral revenue stream to supplement our core operations. We employ a flexible pricing scheme when designing for third parties that depends upon the size, application and deadline of the proposed energy recovery system.

 
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Implementation and EPC Projects. Similar to the revenue model employed for our design services, we either package the implementation (installation) of our energy recovery system with the design and fabrication of our units, or outsource this function to third party manufacturers for a service charge; this allows smaller third party manufacturers to convert fixed costs to variable costs, while offering us an ancillary revenue stream. We do not perform implementation services on a stand-alone basis. We also possess the resources, expertise and capabilities to act as the lead engineering procurement and construction contractor, overseeing the implementation of energy recovery systems for our customers. EPC services involve the whole process of the construction of projects from design, development, engineering, manufacturing up to installation.

 
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Maintenance. Our team is responsible for the overall maintenance of the energy recovery systems we install. In the event that major repairs are needed, the maintenance team is capable of rebuilding the equipment in order to repair or replace any necessary components. The maintenance team is contracted to service our own as well as other manufacturers' energy recovery systems. Our maintenance team charges an hourly fee for its services.

Our energy recovery systems represent a fully-customizable technology capable of meeting the varying needs of a diversified customer base. The systems are capable of recycling up to 70% of the energy that would otherwise be lost in customers' industrial processes, in many cases allowing our customers to recover their costs of the energy recovery system in energy savings within one to three years. The energy recovery systems can also capture and eliminate harmful particles, carbon dioxide, sulfur dioxide and other pollutants where the main industrial facilities release such harmful emissions.

Our energy recovery systems are suitable for use in a wide range of industries, including chemical processing, papermaking, and oil and ethanol refining. The core technology is easily adaptable to meet a variety of different size facilities and types of plant design. Below is an illustration of our technology as it is implemented in the sulfuric acid production industry.

 
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Traditional Sulfuric Acid Production Process. The production of sulfuric acid involves highly exothermic chemical reactions. Most of the heat is released into the atmosphere through cooling towers without capturing any of the energy contained therein. Some of the heat from the production process is captured as steam, which the manufacturer can use to, for example, generate electricity. Without the use of an energy recovery system, the production of one ton of sulfuric acid will produce approximately one ton of steam.
 
 
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Sulfuric Acid Production Process with Energy Recovery System. The incorporation of an energy recovery system increases the manufacturer's ability to extract energy from the production process such that the production of one ton of sulfuric acid can produce between 1.3 and 1.65 tons of steam. In so doing, 94% of the heat that would have otherwise been released to the atmosphere is utilized to provide a larger quantity of steam that can be used in industrial applications. The harnessed steam can be used for various applications, most commonly to drive generator turbines to produce electricity. Doing so decreases the manufacturer's demand for externally produced energy as the manufacturer instead can use internally produced energy resulting from the energy recovery system's increased production and utilization of steam.
 
Customers
 
We have provided approximately 110 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 Saudi Arabia, 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, 2009 and 2010, our five largest customers accounted for 69% and 60% of our sales, respectively. Receivables from these five customers were 66% and 5% of total accounts receivable at December 31, 2009 and 2010, respectively. Our large customers may not be the same from year to year. It represents the revenue recognized in excess of the amount billed based on the percentage of completion method. Therefore, we do not believe that we are dependent upon any specific major customer 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 and CER Shanghai 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
 
Spray pump synthesizing tower
 
8/30/2017
Invention
 
Chlorosulfonic acid preparation new craftwork and equipment
 
8/30/2017
Utility model
 
Cement kiln forced-circulated waste heat recovery boiler
 
4/2/2019
Utility model
 
The center pipe smoke double disc regulator
 
4/16/2019
Utility model
  
Steam air reactor
  
3/28/2020
 
 
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CER Shanghai has submitted the following patent applications to the Chinese State IPR Office, which are currently pending authorization:

Patent Type
 
Patent Name
 
Application Date
Utility model
 
Feed water type diluter
 
6/2/2010
Utility model
 
Inspection device for leaking
 
6/2/2010
Utility model
 
Steam drainage device
 
6/2/2010
 
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 highly trained engineers at our Shanghai, China facilities who are engaged in refining the core technology for our energy recovery systems, developing our intellectual property rights, enhancing energy efficiencies and decreasing environmental impact for our customers. Our engineers carry out development activities alongside with the design work for our customers’ projects and the expenses associated with our research and development activities are passed along to our customers as part of the price paid for our products and services. However, since expenses incurred in research and development are immaterial, we do not record research and development expenses as a separate line item in our financial statements. Shanghai Engineering has a portfolio of core Chinese patents on various components of our energy recovery systems as described above.
 
Our Business Strategy
 
We have established a three-phase growth strategy:

 
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Phase One. During the first phase of our growth strategy, we will continue to fulfill our current orders while growing our domestic Chinese business. During this time, we intend to establish long-term strategic purchasing agreements with suppliers that provide key raw materials.

 
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Phase Two. The second phase of our growth strategy involves increased expenditures that will support our growth. We have completed the first phase of the construction of our first owned manufacturing facility, which we believe will increase our profit margins and efficiency. We also intend to invest in specialized equipment to further increase the efficiency of our manufacturing process. While these capital expenditures are underway, we expect to incur separate (unrelated to any particular customer project) research and development expenditures to support an expansion into new sectors, such as coke refining and cement, including adding more specialized talents to our engineering and design team. We also anticipate recruiting an international sales and marketing team to assist in international market expansion.

 
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Phase Three. In the third phase of our growth strategy, we plan to complete the second phase of the construction of our first owned manufacturing facility to meet future demand. We also anticipate expanding our EPC business by continuing to increase the size of our engineering and design team. Finally, we intend to increase our international marketing efforts in the Middle East, Europe and the United States during this phase.
 
 
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Raw Materials and Principal Suppliers
 
We do not currently have any long-term supply agreements. We do not believe that we are reliant on our current suppliers. We believe that we could substitute other suppliers if needed. Our five largest suppliers (by value) supplied approximately 29% of our raw materials in 2010.
 
Employees
 
As of December 31, 2010, we had approximately 470 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 2011 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 conducted all our manufacturing operations before 2011 and obtained all required licenses. In January 2011, CER Yangzhou also obtained all required licenses and will take over all our manufacturing function starting approximately in May 2011. 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 which stipulates preventive and curative measures. The issuance of a building permit is conditioned on the approval of the environmental impact statement.

 
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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.
 
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. 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;
 
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Advances in the manufacturing processes of these sectors that could eliminate the economic feasibility of our technology; and
 
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Failure to successfully implement our systems for one or more customers within a particular sector could adversely affect the reputation of our products and services have as a viable option for other companies within that sector.

We face risks associated with the marketing, distribution and sale of our energy recovery systems, and if we are unable to effectively manage these risks, they could impair our ability to expand our business.

The marketing, distribution and sale of our products expose us to a number of risks, including, but not limited to:

 
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Increased costs associated with maintaining marketing efforts in various parts of China and various countries;
 
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Marketing campaigns that are either ineffective or negatively perceived in one or more countries and/or across one or more industry sectors;
 
¨
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
 
 
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Trade barriers such as export requirements, tariffs, taxes and other restrictions and expenses, which could increase the prices of our products and make us less competitive in some countries.

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.

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.
 
We do not have currently any employment agreements with our key personnel, including our chief Executive Officer; therefore such key personnel 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. The higher gearing ratio may make us more difficult to perform debt finance in the future. Raising external capital in the form of debt could also 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. On December 31, 2010, the Company entered into a loan agreement with the lender to replace and continue the prior lending arrangement which was entered into on May 21, 2009, to extend the term until which the principal amount of $5,000,000 is due to September 29, 2012, and to change certain of the terms of the loan. The aggregate principal amount of the loan extension is $5,000,000, and bears interest at the annual rate of 15.1%, calculated on a monthly compounded basis.  The principal and accrued interests are due September 29, 2012.
 
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 for future expansion is subject to significant risks and uncertainties on funding. We may be unable to raise the necessary capital to complete the remaining phase of construction of our manufacturing base in Yangzhou or further initiate a new manufacturing facility. We may be unable to 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.
 
 
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We may not be able to manage our expansion of operations effectively and if we are unable to do so, our profits may decrease.

The trend towards mitigating the effect of global warming and the enactment of new environmental protection policy greatly increased the demand for our products and services. As we continue to grow, we must continue to improve our operational and financial systems, procedures and controls, increase our 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, we held a total of ten 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 charge 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.

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 25% appreciation of the Renminbi against the U.S. dollar as of December 31, 2010 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. 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.

 
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Fluctuation in steel price may continue to increase the level of our earnings volatility and reduce our profitability.

Steel is a major raw material of our products. Fluctuation in the price of steel may greatly affect the cost of goods sold. If we are unable to increase our selling price, to the same extent as the price of steel increases, the level of our earnings volatility would increase and our profitability would decline, which would materially and adversely affect our business, financial condition and results of operations.

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. Since Shanghai Environmental was dissolved in year 2010 and we will transfer our production function to CER Yangzhou from Vessel Works Division, which was controlled by Shanghai Engineering, we no longer need to enforce, retain or renew these contracts with Shanghai Environmental and Shanghai Engineering. The risk of conducting business by means of contractual agreements will be remote from year 2011.

Our contractual arrangements with Shanghai Engineering 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 company, Shanghai Engineering. We have no equity ownership interest in Shanghai Engineering and rely on contractual arrangements to control and operate such entity and its business. This contractual arrangement may not be as effective in providing control as direct ownership. For example, Shanghai Engineering could fail to take actions required for our business despite their contractual obligation to do so. If Shanghai Engineering fails to perform under its agreement with us, we may have to rely on legal remedies under Chinese law to enforce it, which may not be effective. In addition, we cannot assure you that Shanghai Engineering's respective shareholders would always act in our best interests.

 
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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.

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.
 
 
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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.

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.

 
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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.

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.
 
 
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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 December 31, 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 3,357,450 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. Conflicts of interest may arise between his duties to our company and his duties to Shanghai Engineering, or his interest as an owner of Shanghai Engineering. 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.

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, Chief Executive Officer and Acting Chief Financial 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

 
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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,.

In 2010, we strengthened our internal control and reviewed corporation governance and financial related issues and have improved the financial reporting systems as we have previously restate the financials for fiscal 2008 and 2009. During our assessment of the effectiveness of our disclosure controls and procedures and internal controls over financial reporting as of December 31, 2009, we found that some of 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. However, we did take some actions to remediate these weaknesses in 2010.

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 the management team have limited or no experience operating a publicly-traded company, we are continuously 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.
 
Item 1B   Unresolved Staff Comments
 
Not applicable.

 
29

 
 
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 ended on February 28, 2011. The Company is also required to make a security deposit of approximately $292,613 in addition to the annual lease payments. The rental expense is recorded on a straight-line basis.CER Shanghai also has an option to purchase the office space. If CER Shanghai exercises the purchase option, all the lease payments and the deposit payment made can be credited against the purchase price and counted as a partial purchase payment. The Company has paid the first year’s rental fee in the amount of $146,304 and the security deposit of $292,613 in April 2009, and has also paid the second year’s rental fee in the amount of $851,525 in February 2010.The Company has amortized the total rental fee using straight-line method over the 2-year lease period.

On March 30, 2011, CER Shanghai exercised the purchase option with Shanghai Zhangjiang Integrated Circuit Industrial Zone Development Co., Ltd. The total purchase price of the building is $7,392,770 (RMB 48,486,224), which represents the price of the building and related land use right. CER Shanghai paid cash of $1,174,226 (RMB 7,698,697) and bank acceptance of $747,361 (RMB 4,900,000) on March 31, 2011. The maturity date of the bank acceptance shall be no later than October 10, 2011. The remaining payment will be made after March 30, 2011, by means of cash or bank acceptance according to the contract.

Through a contractual arrangement with Shanghai Engineering, our subsidiary Shanghai Engineering 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.

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 one construction of the plant was completed in January 2011. Phase two is under construction and anticipated to be complete in 2012.
 
Our production facilities are currently held in both Vessel Works Division and CER Yangzhou. We will complete the transfer of the production function from Vessel Works Division to CER Yangzhou by end of April 2011.
 
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]

 
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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 trading was terminated because of the delinquency in the Company’s SEC reporting obligations. 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
 
2011
           
First Quarter
  $ 1.25     $ 0.80  
2010
               
Fourth Quarter
  $ 1.40     $ 0.32  
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  

As of March 31, 2011, the last reported sales price on the Pink Sheets for our common stock was $1.07 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 March 31, 2011, we had approximately 91 shareholders of record of our common stock. However, we currently believe that there are approximately an additional 200 shareholders who beneficially hold their shares through street name.

 
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Dividends

We have not declared any 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.
 
Recent Sales of Unregistered Securities
 
None
 
Securities Authorized for Issuance under Equity Compensation Plans
 
The following table sets forth, as of December 31, 2010, 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
   
6,422,728
   
$
2.03
     
272,500
 
Total
   
6,422,728
   
$
2.03
     
272,500
 
 
Item 6   Selected Financial Data
 
Not applicable.

 
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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, 2009 and 2010 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 the Share Exchange, our business operations consist of those of Poise Profit's Chinese subsidiary, Hi-tech, which was 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, CER Yangzhou 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 saleable 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 122 energy recovery systems throughout China and in a variety of international markets.
 
In October 2010, the State Council announced that China will continue to focus on supporting and developing the strategic new industries, such as energy-saving, new energy, high-side equipment manufacturing industries.  The government encourages energy recycling and recovery to increase the efficiency of energy utilization. The goal is to increase the GDP of such strategic new industries to 8% and 15% of the total GDP, for the years 2015 and 2020, respectively. In February 2011, Ministry of Industry and Information Technology announced that China will continue to encourage energy-saving industries, to accelerate the development of recycling economics, recovery industries and energy-saving equipment. The supporting measures will be launched to achieve reductions in energy utilization and to mitigate the release of harmful emissions.


 
33

 

Facing a possible large market opportunity and potential government supports, we decided to enlarge our production capacity by setting up new production base. Our plan is to establish CER Yangzhou as a world-class international manufacturing facility of waste heat equipment, in both products and technology. We plan to make highly efficient energy-saving products, make using advanced manufacturing processes and equipment. We intend, for this manufacturing facility to embody a completely new look of a modern factory, thus making 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. During the last years, production constraints limited our growth and affected our financial profitability. Thus in 2010, we focused much of our energies on the construction of our new manufacturing facility in,  Yangzhou, China, and completed the first phase of construction of the plant by January 2011. As a result, our production facilities are currently held in both Vessel Works Division and CER Yangzhou. We will complete the transfer of the remaining production function from Vessel Works Division to CER Yangzhou by end of April 2011. Phase two of the facility is still under construction and is anticipated to be complete in 2012.
 
In order to close down our existing manufacturing facility at Vessel Works Division in Shanghai, we deliberately accepted fewer product orders beginning in June 2010. However, with the factors mentioned above and the world economy beginning to recover, we took more orders than anticipated from existing and new customers. In year 2010, the Company doubled the amount of sales contracts to $65 million. The main reason is that we focused more attention and efforts on EPC contracts, which consolidated our leadership position in these sectors and contributed to higher revenue. All the EPC contracts are signed for projects with HRS techniques, which have been developed into the mature period in China. These techniques have been fully accepted by most of our customers. With the upward trend in energy price, we expect HRS techniques will have a bright future in the next five to ten years. Besides, with our widely recognized brand name and reputation for quality goods in the sulfuric acid industry, we believe we will benefit from this advantage and will have more opportunities in the future to put our expertise to good use.
 
With phase one of the new facility complete, we are prepared to expand our customer base and enter into more sectors. 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 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 and we intend to enter these markets through partnerships.

 
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Critical Accounting Policies and Estimates
 
While our significant accounting policies are more fully described in Note 2 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

              The accounting standard regarding fair value of financial instruments and related fair value measurements defines financial instruments and requires fair value disclosures of those financial instruments. On January 1, 2008, the Company adopted accounting standard regarding 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 qualify as financial instruments. Management concluded the carrying values of these 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. Fair valued assets and liabilities that are generally included in this category are assets comprised of cash, accounts and notes receivable, and liabilities comprised of bank loans, accounts payable, accrued liabilities and other payables. As of December 31, 2009 and December 31, 2010, the carrying values of these assets and liabilities approximated their fair values.

Level 2
Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments. At December 31, 2009 and December 31, 2010, the Company did not have any fair value assets or liabilities classified as Level 2.

Level 3
Inputs to the valuation methodology are unobservable and significant to the fair value. Inputs reflected management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.
 
The following table presents information about the company’s financial liabilities classified as Level 3 as of December 31, 2010.

          
Balance as of December 31, 2010
 
   
Carrying
   
Fair Value Measurements
 
   
Value
   
Using Fair Value Hierarchy
 
   
    
   
Level 1
   
Level 2
   
Level 3
 
Derivative liability, current (Note 13)
  $ 374,846       -       -     $ 374,846  
Derivative liability (Note 13)
  $ 48,461       -       -     $ 48,461  
Warrant liability (Note 13)
  $ 1,332,760       -       -     $ 1,332,760  
 
 
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A summary of changes in Level 3 derivative and warrant liabilities for the years ended December 31, 2009 and 2010 were as follows:

 
Balance at January 1, 2009
  $ 1,524,268  
Warrants issued at issuance of convertible notes (Note 13)
    1,387,912  
Derivative liability at issuance of convertible notes (Note 13)
    1,270,500  
Change in fair value of warrant liability recognized in earnings
    (1,539,233 )
Change in fair value of derivative liability recognized in earnings
    (399,500 )
Balance at December 31, 2009
  $ 2,243,947  
Derivative liability of long term loan, current (Note 8)
    132,470  
Derivative liability of convertible notes (Note 9)
    48,461  
Change in fair value of warrant liability recognized in earnings
    (40,187 )
Change in fair value of derivative liability recognized in earnings
    (628,624 )
Balance at December 31, 2010
  $ 1,756,067  

The following presents the carry value and the estimated value of the Company’s convertible note at December 31, 2010:
 
   
Carry Value
   
Fair Value
 
                 
Convertible note
  $ 4,691,582     $ 4,580,314  

The fair value of the convertible note is based on the market interest rate for debt with similar terms and maturity.

The long term account receivable is recorded at cost, which is discounted from the contractual balance. The carrying value of the long term account receivable, which is estimated based upon future cash flows, approximates fair value at December 31, 2010 and 2009.

In July 2010, the FASB issued an accounting standard update to provide guidance to enhance disclosure related to the credit quality of a company’s financing receivables portfolio and the associated allowance for credit loss. Pursuant to this accounting update, a company is required to provide a greater level of disaggregated information about its financing receivables portfolio and its allowance for credit loss with the objective of facilitating users’ evaluation of the nature of credit risk inherent in the company’s portfolio of financing receivables, how that risk is analyzed and assessed in arriving at the allowance for credit loss, and the changes and reasons for those changes in the allowance for credit loss. The Company has included in Note 3 the expanded disclosure related to both the year end balances and activities during the reporting period.

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.

 
36

 

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 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 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.

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

The Company derives revenues principally from

 
37

 

 
(a)
Sales of energy recovery systems;

 
(b)
Provision of design services;

 
(c)
Provision of Engineering, Procurement and Construction ("EPC") services, which are essentially turnkey contracts where the Company provides all services in the whole construction process from design, development, engineering, manufacturing, procurement to installation.

Revenue by the above categories for years ended December 31, 2009 and 2010 are summarized as follows:
 
   
Year ended December 31,
 
   
2009
   
2010
 
Revenue:
           
Product
  $ 12,413,075       8,555,323  
Service
    260,815       -  
EPC contracts
    9,520,553       12,527,330  
Totals
  $ 22,194,443       21,082,653  
 
In providing design services, the Company designs energy recovery systems and other related systems based on a customer's requirements and the deliverable consists of engineering drawings. The customer may elect to engage the Company to manufacture the designed system or choose to present the Company's drawings to other manufacturers for manufacturing and installation. In contrast, when providing EPC services, the customer is purchasing a turnkey energy recovery system and the Company is involved throughout the entire process from design to installation.

Sales of the Company's energy recovery systems and related products are essentially product sales. The products consist mainly of waste heat boilers and other related equipment manufactured according to specific customers' specifications. Once manufactured, the Company ships the products to its customers in their entirety in one batch.  The Company’s service arrangement also includes a limited warranty to its customers pursuant to which the customers retain between 5% and 10% of the particular contract price as retainage during the limited warranty period (usually 12-18 months). The Company generally recognizes revenues including retainage from product sales when (i) persuasive evidence of an arrangement exists, which is generally represented by a contract between the Company and the customer; (ii) products are shipped; (iii) title and risk of ownership have passed to the customer, which generally occurs at the time of delivery; (iv) the customer accepts the products upon quality inspection performed by them; (v) the purchase price is agreed to between the Company and the customer; and (vi) collectability is reasonably assured. Net revenues represent the invoiced value of products, less returns and discounts, and net of value-added tax.

The Company recognizes revenues from design services when the services are provided, the design drawings are delivered, invoices are issued and collectability is reasonably assured. The Company generally delivers the drawings in one batch.

 
38

 

In accordance with the accounting standards regarding performance of construction-type and certain production-type contracts, and long-term construction-type contracts, the Company adopted the percentage of completion method to recognize revenues and cost of sales for EPC contracts. EPC contracts are long-term, complex contracts involving multiple elements, such as design, manufacturing and installation, which all form one integral EPC project. The energy recovery system involved in an EPC project is highly customized to the specific customer's facilities and essentially not transferable to any other facilities without significant modification and cost. It would be difficult, if not impossible, to beneficially use a single element of a specific EPC project on a standalone basis other than in connection with the facilities for which it was intended. EPC contracts are by nature long-term construction-type contracts, usually lasting more than one accounting period, and the Company is able to reasonably estimate the progress toward completion, including contracts revenues and contracts costs. EPC contacts specify the customers' rights to the goods, the consideration to be paid and received, and the terms of payment. Specifically, the Company has the right to require a customer to make progress payments upon completion of determined stages of the project which serve as evidence of the customer's approval and acceptance of the work completed to date as complying with the terms of the particular EPC contract and upon which the Company recognizes the revenue.

Classification of Current/Non-Current Receivables

We have reviewed our receivable balances and reassessed each balance and its collectability during the forthcoming 12 months. Upon assessment, we have reclassified certain of these outstanding balances to non-current assets where we have arrangements with the customers to bill and collect a portion of the receivable after 12 months. We intend to closely monitor our receivables and focus on increasing collections over the next quarter.

Recent Accounting Pronouncements

In January 2010, the FASB issued new accounting guidance related to the disclosure requirements for fair value measurements and provided clarification for existing disclosures requirements. More specifically, this update will require (a) an entity to disclose separately the amounts of significant transfers in and out of Levels 1 and 2 fair value measurements and to describe the reasons for the transfers; and (b) information about purchases, sales, issuances and settlements to be presented separately (i.e. present the activity on a gross basis rather than net) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3 inputs). This guidance clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at fair value and require disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. The new disclosures and clarifications of existing disclosure are effective for fiscal years beginning after December 15, 2009, except for the disclosure requirements for related to the purchases, sales, issuances and settlements in the roll forward activity of Level 3 fair value measurements. Those disclosure requirements are effective for fiscal years ending after December 31, 2010. The adoption of the updated guidance does not have a material impact on the Company’s consolidated financial position, results of operations and cash flows.

In February 2010, the FASB issued an accounting standards update which amends the accounting standard on subsequent events. The accounting update provides guidance on events that occur after the balance sheet date but prior to the issuance of the financial statements. The accounting standard distinguishes events requiring recognition in the financial statements and those that may require disclosure in the financial statements. As a result of the accounting update, 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. The accounting standard was effective for interim and annual periods ending after June 15, 2009, and the accounting update is effective immediately. We have evaluated subsequent events in accordance with the accounting update.
  
 
39

 

In April 2010, the FASB issued an authoritative pronouncement on the effect of denominating the exercise price of a share-based payment award in the currency of the market in which the underlying equity securities trades and that currency is different from (1) entity’s functional currency, (2) functional currency of the foreign operation for which the employee provides services, and (3) payroll currency of the employee. The guidance clarifies that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should be considered an equity award assuming all other criteria for equity classification are met. The pronouncement will be effective for interim and annual periods beginning on or after December 15, 2010, and will be applied prospectively. Affected entities will be required to record a cumulative catch-up adjustment for all awards outstanding as of the beginning of the annual period in which the guidance is adopted. The adoption of this pronouncement does not have a significant impact on its consolidated financial position or results of operations.

In July 2010, the FASB issued new disclosure guidance related to the credit quality of financing receivables and the allowance for credit losses. The guidance will require companies to provide more information about the credit quality of their financing receivables in the disclosures to financial statements including, but not limited to, significant purchases and sales of financing receivables, aging information and credit quality indicators. We will adopt this accounting standard upon its effective date for periods ending on or after December 15, 2010. The Company has evaluated the new disclosure requirement in accordance with the accounting guidance

In October 2009, the Financial Accounting Standards Board (“FASB”) issued new guidance on “revenue recognition for arrangements with multiple deliverables and certain revenue arrangements that include software elements.” By providing another alternative for determining the selling price of deliverables, the guidance for arrangements with multiple deliverables will allow companies to allocate consideration in multiple deliverable arrangements in a manner that better reflects the transaction’s economics and will often result in earlier revenue recognition. The new guidance modifies the fair value requirements of previous guidance by allowing “best estimate of selling price” in addition to vendor-specific objective evidence (“VSOE”) and other vendor objective evidence (“VOE,” now referred to as “TPE,” standing for third-party evidence) for determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when VSOE or TPE of the selling price cannot be determined. In addition, the residual method of allocating arrangement consideration is no longer permitted under the new guidance. The new guidance for certain revenue arrangements that include software elements removes non-software components of tangible products and certain software components of tangible products from the scope of existing software revenue guidance, resulting in the recognition of revenue similar to that for other tangible products. The new guidance is effective for fiscal years beginning on or after June 15, 2010. However, companies may adopt the guidance as early as interim periods ended September 30, 2009. The guidance may be applied either prospectively from the beginning of the fiscal year for new or materially modified arrangements or retrospectively. The Company has not early adopted the new guidance and the adoption of the new guidance does not have a significant impact on our financial position or results of operations.
 
 
40

 
 
In December 2010, FASB issued revised guidance on “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” The revised guidance specifies that an entity with reporting units that have carrying amounts that are zero or negative is required to assess whether it is more likely than not that the reporting units’ goodwill is impaired. If the entity determines that it is more likely than not that the goodwill of one or more of its reporting units is impaired, the entity should perform Step 2 of the goodwill impairment test for those reporting unit(s). Any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings in the period of adoption. Any goodwill impairments occurring after the initial adoption of the revised guidance should be included in earnings as required by Section 350-20-35. The revised guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption does not have a significant impact on our financial position or results of operations.

In December 2010, FASB issued revised guidance on the “Disclosure of Supplementary Pro Forma Information for Business Combinations.” The revised guidance specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The revised guidance also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The revised guidance is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company has not early adopted the new guidance and the adoption  does not have a significant impact on our financial position or results of operations.
 
 
41

 
 
Results of Operations
 
Comparison of the Fiscal Years Ended December 31, 2009 and December 31, 2010

The following table sets forth the results of our operations for the years indicated as a percentage of revenues:

   
Fiscal Year ended December 31,
 
   
2009
   
2010
 
                         
REVENUES
  $ 22,194,443       100.0 %   $ 21,082,653       100.0 %
                                 
COST OF REVENUES
    (18,842,557 )     (84.9 )%     (17,898,955 )     (84.9 )%
                                 
GROSS PROFIT
    3,351,886       15.1 %     3,183,698       15.1 %
                                 
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
    (5,746,743 )     (25.9 )%     (6,440,852 )     (30.6 )%
                                 
LOSS FROM  OPERATIONS
    (2,394,857 )     (10.8 )%     (3,257,154 )     (15.5 )%
                                 
OTHER INCOME(LOSS), NET:
                               
Change in fair value of warrant liability
    1,539,233       6.9 %     40,187       0.2 %
Change in fair value of derivative liability
    399,500       1.8 %     628,624       3.0 %
Non-operating income, net
    80,692       0.4 %     1,186,603       5.6 %
Interest expenses
    (868,388 )     (3.9 )%     (1,928,955 )     (9.1 )%
Total other income(loss) , net
    1,151,037       5.2 %     (73,541 )     (0.3 )%
                                 
LOSS FROM OPERATIONS BEFORE INCOME TAXES
    (1,243,820 )     (5.6 )%     (3,330,695 )     (15.8 )%
                                 
INCOME TAXES BENEFITS/(EXPENSES)
    357,340       1.6 %     (188,688 )     (0.9 )%
                                 
NET LOSS
    (886,480 )     (4.0 )%     (3,519,383 )     (16.7 )%
                                 
OTHER COMPREHENSIVE INCOME
                               
Foreign currency translation adjustment
    29,152       0.1 %     488,131       2.3 %
                                 
COMPREHENSIVE LOSS
  $ (857,328 )     (3.9 )%   $ (3,031,252 )     (14.4 )%

Revenues. Our revenues include revenues from sales of energy recovery systems, provision of design services and EPC contracts. Revenues decreased to $21,082,653 for the year ended December 31, 2010 as compared to $22,194,443 for the year ended December 31, 2009, a decrease of $1,111,790 or 5.0%. The decrease is mainly attributable to the decrease in number of product contracts.  Although the average sales revenue recognized per product contract increased by $15,553 from $326,660 for the year ended December 31, 2009 to $342,213 for the year ended December 31, 2010, the number of completed product contracts decreased from 38 to 25 due to following 2 reasons: (a) Our strategic decision to focus our business more on EPC contracts and less on single product contracts; and (b) the fact we purposely accepted less product contracts during 2010  due to a temporary decrease in our production capacity as a result of moving resources from our Vessel Woks Division, which we plan to close, to plant in Yangzhou, China.
 
Since we began to focus more on EPC contracts, we have completed 8 EPC contracts in 2010 while the amount completed was only 4 in 2009. However, due to  many new orders are signed in late 2010, the revenue on these EPC contracts recognized on percentage-of-completion basis was rather small. Accordingly, the average revenue recognized from each EPC contract decreased by $814,222 in fiscal 2010 as compared to 2009.
 
Furthermore, we completed two design service contracts during 2009, while no such design service contracts were completed in 2010. The detailed changes are as follows:
 
 
42

 
 
  
 
2009
   
2010
   
Change ($)
   
%
 
Average Revenue per Contract
                       
Products
  $ 326,660     $ 342,213     $ 15,553       5 %
Design Services
  $ 130,408     $ -     $ (130,408 )     (100 )%
EPC
  $ 2,380,138     $ 1,565,916     $ (814,222 )     (34 )%
Average Revenue per Contract
  $ 504,419     $ 638,868     $ 134,449       27 %
Number of Contracts Completed
                               
Products
    38       25       (13 )     (34 )%
Design Services
    2       -       (2 )     (100 )%
EPC
    4       8       4       100 %
Total Number of Contracts Completed
    44       33       (11 )     (25 )%

Cost of Revenues. Cost of revenues decreased to $17,898,955 for the year ended December 31, 2010, as compared to $18,842,557 for the year ended December 31, 2009, a decrease of $943,602, or 5.0%. As a percentage of revenues, cost of revenues remained 84.9% for the year ended December 31, 2010 compared to that of 2009. The absolute decrease is consistent with the decrease of revenue.

Gross Profit. Gross profit was $3,183,698 for the year ended December 31, 2010 as compared to $3,351,886 for the year ended December 31, 2009, a decrease of $168,188 or 5.0%. The gross margins are 15.1% for both the years ended December 31, 2010 and 2009. The lower gross profit is mainly due to the decrease in number of our products delivered in 2010.  The gross profit margin remained the same for year 2009 and 2010, mainly due to the lower profit margin from EPC contracts and higher profit margin from product contracts of 2010 compared to that of 2009. Firstly, we realized a profit margin of 17.9% from EPC contracts in 2009, while we only realized a profit margin of 13.9% in 2010, a decrease of 4%. In 2009, our EPC profit is derived mainly from the Sopo project, which contributed a higher margin based on its completion percentage, with a profit margin of 16%. In 2010, since many new orders are signed in late 2010, the revenue for these EPC contracts recognized on percentage-of-completion basis was rather small with lower profit margin of approximately 10%. Secondly, the profit margin of product increased by 3.8% from 13.0% in 2009 to 16.8% in 2010.  In order to focus our attention on construction of Yangzhou factory and EPC projects, we accepted fewer product orders in 2010 but with higher margin. In summary, the increase in the margin in the product sales is offset by the decrease in the margin for EPC contracts, which resulted in a constant gross profit margin for fiscal 2009 and 2010.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $6,440,852 for the year ended December 31, 2010, as compared to $5,746,743 for the year ended December 31, 2009, an increase of $694,109 or 12.1%. Selling, general and administrative expenses, as a percentage of revenue, increased from 25.9% for the year ended December 31, 2009 to 30.6% for the year ended December 31, 2010, an increase of 4.7%. The increase is the net result of increase of salaries, depreciation and amortization costs, and audit fees, offset by a decrease in consulting fees. Firstly, salary expenses increased by $1,179,778 or 79.6% for the year ended December 31, 2010 as compared to the year ended December 31, 2009, as a result of  additional of staff (staff increased by 100 headcounts to substantialize the Yangzhou team in 2010 as compared to 2009) to cater for the needs of new plant in Yangzhou, the addition of top and middle level management, and the gradual increase in personnel salary. Secondly, the depreciation and amortization expenses increased by $107,319 to $206,487 for the year ended December 31, 2010 due to the setup and the amortized land use right of CER Yangzhou. Thirdly, we changed our auditor at the end of year 2009 and incurred expenses for the reaudit of the financial statements for fiscal 2008, resulting in an increase in professional and related fees by $211,714. Fourthly, other administration expenses such as conference fees, entertainment fees and traveling fees also increased due to more business negotiations with EPC customers and more exhibitions around the world. The increase in SG&A expenses was offset by a decrease in consulting service fees of $923,955 for the year ended December 31, 2010 as compared to the year ended December 31, 2009, which occurred because the Company signed an agreement with a consulting company which provided financing and marketing advisory service for the Company’s international development in the last half of 2009. There is no such arrangement in fiscal year 2010.
 
 
43

 
 
Loss from Operations. As a result of the above, loss from operations totaled $3,257,154 for the year ended December 31, 2010 as compared to $2,394,857 for the year ended December 31, 2009, an increase of $862,297 or 36.0%. As a percentage of revenues, loss from operations increased from 10.8% for the year ended December 31, 2009 to 15.5% for the year ended December 31, 2010, an increase of 4.7%.  The increase is mainly attributable to increase in operating expenses and decrease in operation profit.
 
Other Income(loss), net. Other expense was $73,541 for the year ended December 31, 2010, as compared to income of $1,151,037 for the year ended December 31, 2009, an absolute difference of $1,224,578.  The difference consisted primary of $1,269,922 of change in fair value of warrants and derivative liabilities, and $1,060,567 of interest expenses, offset by $1,105,911 of non-operating income, all as further described below.

Change in fair value of warrants and derivative liabilities. This resulted from the valuation of warrants and derivative liabilities. The $668,811 absolute gain of year 2010 is mainly due to the higher risk-free rate and lower expected volatility as a result of reduced holding period of the conversion feature as compared to 2009.

Non-operating Income, net. Non-operating income increased to $1,186,603 for the year ended December 31, 2010, as compared to $80,692 for the year ended December 31, 2009, an increase of $1,105,911, mainly resulted from subsidy income received for Shanghai Engineering on technology support fund from Shanghai Yangpu Science and Technology Commission and the subsidy income for CER Yangzhou on research and development fund from Yizheng Industrial Park in 2010. There was no such subsidy income in 2009.

Interest Expense. Interest expense increased to $1,928,955 for the year ended December 31, 2010, as compared to $868,388 for the year ended December 31, 2009, an increase of $1,060,567 or 122.1%. Although we capitalized interest of $253,825 for the construction of the Yangzhou plant and recognized interest income from the long term receivable from the Sopo project of $407,287, according to the collection schedule starting from June 2010, interest expense increased significantly as the net result of increases of loan interest, deferred financing costs and a decrease of accretion of convertible notes. Firstly, due to the longer borrowing period of the convertible note and newly-borrowed long-term loans, interest expense increased dramatically by $951,586 to $1,070,336 for the year ended December 31, 2010. Secondly, the amortization of deferred financing costs increased by $177,207 due to a full year of amortization in fiscal 2010 as compared to 2009.  Lastly, the accretion interest of convertible notes increased by $545,287 to$777, 915 for the year ended December 31, 2010.

Loss before Provision for Income Taxes. As a result of the foregoing, loss before provision for income taxes was $3,330,695 for the year ended December 31, 2010, as compared to $1,243,820 for the year ended December, 2009, an increase of $2,086,875 or 167.8%.
 
 
44

 
 
Income Taxes Benefits/(Expenses). The normal applicable income tax rate for the operating entities in China is 25%. Pursuant to the PRC income tax laws, Shanghai Engineering is subject to enterprise income tax at a statutory rate of 15% as a high technology entity. For the year ended December 31, 2010, the Company incurred $188,688 of income tax provision, as compared to benefit of $357,340 for the year ended December 31, 2009, an absolute change of $546,028.  The change is mainly because we have provided a 100% valuation allowance for deferred tax asset of Shanghai Engineering for the year ended December 31, 2010 as we do not expect Shanghai Engineering will generate sufficient profit to realize the deferred tax asset in the future.

Net Loss. As a result of the foregoing, we incurred a net loss of $3, 519,383, for the year ended December 31, 2010 as compared to a net loss of $886,480 for the year ended December 31, 2009, an increase of $2,632,903 or 297.0%. The increase in net loss is mainly due to the increase in operating expenses, interest expense, provision for income tax and change in fair value of the warrants and derivative liability, offset by the non-operating income. The production constraints limited our growth and the condition persisted through fiscal 2010 while our new manufacturing facility was under construction. With the opening of our new facility in the fourth quarter of 2010 and the world economy recovering, we are able to take on new contracts at an increased rate and management anticipates better operating results in 2011.
 
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. Worldwide economic conditions seemed to be better but may be further deteriorating in the future. 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. Additionally, based on the forecast of the operation and the finance condition over the next few years, we anticipate that we will continue to generate positive cash flows from the business operations, which will enable us to develop our company in a sustainable manner. However, with the expansion of energy recycle and environment protection under the vigorous policy and support from the government, we believe that there will be an increasing growth and expansion opportunities in the future, which may in turn require an expansion of our manufacturing base, including Phase 2 construction of our Yangzhou factory.

To improve our existing cash and cash requirement position, we are continuing our efforts 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. Notwithstanding our existing resources for operations on a going forward basis at current operating levels, we will continue to need capital for our expansion plans, including funding for the building and the expansion of the existing factory which we may pursue.  If these sources are insufficient to satisfy our cash requirements, we may seek to issue debt securities or additional equity or to obtain bank borrowings. The issuance of convertible debt securities or additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financial covenants that would restrict our operations and the placement of liens over some or all of our assets. We cannot assure that financing will be available in amounts or on terms acceptable to us, if at all.
 
 
45

 
 
Cash Flows
 
The following table sets forth a summary of our cash flows for the periods indicated below:

   
Year ended December, 31
 
   
2009
   
2010
 
       
Net cash provided by (used in) operating activities
  $ (5,799,655 ) (1)   $ 3,863,563  
Net cash used in investing activities
    (3,478,370 ) (1)     (10,559,841 )
Net cash provided by financing activities
    5,498,780       7,257,121  
Effect of exchange rate changes on cash and cash equivalents
    29,415       48,660  
Net increase/(decrease) in cash and cash equivalents
    (3,749,830 )     609,503  
Cash and cash equivalents at the beginning of period
    6,136,403       2,386,573  
Cash and cash equivalents at the end of period
  $ 2,386,573     $ 2,996,076  

(1) Revision to Consolidated Statements of Cash Flows for the year ended December 31, 2009: The Company revised the net change in restricted cash during 2009 from operating activities to investing activities because of a contractual requirement to maintain a certain amount of cash on deposit with a bank to support the completion of projects. Since the restricted cash is deposited in a bank account for specific purposes, such activity is deemed to be an investing activity and as a result, net cash used in operating activities has been increased by $597,949 and net cash used in investing activities has decreased accordingly. The revision had no effect on previously reported results of operations or accumulated deficit.

Operating Activities

Net cash provided by operating activities was $3,863,563 for the year ended December 31, 2010 compared with net cash used in operating activities of $5,799,655 for the year ended December 31, 2009. The change of cash flow in operating activities was due to the net impact of cash inflow from customer payment and deposit, offset by cash outflow for advances made out for purchases.
 
Firstly, the Company took some new EPC orders in late 2010 and received more advance deposits from its customers in 2010 than that received in 2009.
 
Secondly, the Company did a build and transfer project for one customer, which we paid most of the cost during the production while we received money only when the project was finished in May 2010.
 
To procure the materials for orders to be completed in 2011, we also made cash advance payment to our suppliers. However, the cash outflow required was lower than the cash inflow, leading to the net cash provided by operating activities.

Investing Activities

Net cash used in investing activities was $10,559,841 for the year ended December 31, 2010 compared to net cash used in investing activities of $3,478,370 for the year ended December 31, 2009. The change was mainly due to the expenditure incurred for the construction of CER Yangzhou. As of December 31, 2009 and 2010, we have invested $0 and $ 10,107,858 on construction, $2,439,071 and $0 on land purchase, $1,637,248 and $192,795 on property, plant and equipment purchases, respectively, leading to the increase of cash expenditure of $ 7,081,471.
 
 
46

 
 
Financing Activities

Net cash provided by financing activities was $7,257,121 for the year ended December 31, 2010 compared to net cash provided by financing activities of $5,498,780 for the year ended December 31, 2009, an increase of $1,758,341. The increase is due to the Company still needing capital other than operation cash flows for the construction of the Yangzhou facility. In 2010, the Company borrowed approximately $4.4 million in a short-term bank loan and drew down long-term loans of $5 million from individual lenders. The Company also repaid 2.2 million loans in principal according to the loan repayment schedule.

Capital Resources

We obtained the following loans during the years ended December 31, 2009 and 2010, respectively:
 
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 (CB holder). In connection with this financing, we agreed to issue a two-year 9.5% Unsecured Convertible Promissory Note in the principal amount of $5 million, which may be converted into common stock at a conversion price of $1.80 per share. The Convertible Note Agreement permitted the Company to draw down up to $5,000,000 in principal amount, within six months. Any amount borrowed bears interest at 9.5%, payable every six months, calculated and compounded quarterly.  Each down is due twenty-four months after the draw down date, together with any accrued and unpaid interest.  The Company may pre-pay the note at any time, at its option. On September 28, 2009, the Company drew down $5,000,000, the full amount available. The proceeds of this loan are restricted to only the expenses related to the acquisition and construction of the company's new in Yangzhou, China in order to expand our production capacity. On December 31, 2010, the Company entered into a loan agreement with the CB holder to modify and continue the prior lending arrangement which was entered into on May 21, 2009, to extend the term until which the principal amount of $5,000,000 is due to September 29, 2012, and to change certain of the terms of the loan. The aggregate principal amount of the loan extension is $5,000,000, and bears interest at the annual rate of 15.1%, calculated on a monthly compounded basis.  The principal and accrued interests are due September 29, 2012. The loan may be prepaid by the Company, without penalty. As a guarantee of the payments under the loan extension, Mr. Wu, the Chief Executive Officer of the Company, pledged 8,000,006 shares for the repayment of the principal due under the loan agreement.  The pledge will only take effect when the shares are released from the current pledge under another loan entered into by the Company.  Additionally, since the loan is fixed in United States dollars, the lender will receive compensation for the value of the difference in the Renmenbi/US Dollar exchange rate between September 29, 2011, and the payment date, provided the Renminbi exchange rate increases against the US dollar, times the amount of being paid.
 
On September 1, 2009, we borrowed a short-term loan of RMB 6,000,000 (approximately $879, 660) for working capital purpose from Shanghai Pudong Development Bank, Luwan Branch. The term of the loan is one year. The loan agreement provides for monthly interest payments at an annual interest rate of 5.841%, maturing on August 31, 2010. The loan was repaid on January 5, 2010.
 
 
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On February 1, 2010, the Company entered into a series of agreements for a loan arrangement with two lenders (the “Loan Agreements”). The proceeds of this loan are generally for construction of the Company’s new plant in Yangzhou, China. The aggregate principal amount of the loan under the two Loan Agreements is $4,000,000.  The principal is due January 15, 2013, and bears interest at the annual rate of 15.1%. As security for this Loan Agreement and the other loan agreements of all the lenders, Mr. Qinghuan Wu, the Chairman and Chief Executive Officer of CER pledged 8,000,006 shares of common stock of CER, which shares will be held in escrow for the benefit of all the lenders.

Contemporaneously with the funding of the Loan Agreements, on February 1, 2010, Mr. Qinghuan Wu, arranged for Haide Engineering (Hong Kong) Limited (“Haide”), a company that Mr. Qinghuan Wu controls, to lend to CER Hong Kong the sum of $1,000,000.  The loan bears interest at the annual rate of 9.5%, interest payable quarterly.  The principal is due in full on January 30, 2012.  The loan is unsecured and there are no guarantees of the interest or principal.  CER Hong Kong has subordinated its loan to those under the Loan Agreements.

On November 18, 2010, CER Shanghai borrowed a short-term bank loan of RMB 8,400,000 (approximately $1,260,000) for working capital purpose from Shanghai Pudong Development Bank, Shanghai Branch. The term of the loan is one year. The loan agreement permitted the Company to draw down up to RMB 8,400,000 in principal amount, before the end of 2010. The loan agreement provides for quarterly interest payments at an annual interest rate of 6.116%. As of December 31, 2010, the Company drew down RMB 8,400,000, the full amount and paid back RMB 700,000 as planned, leaving the short-term loan balance of RMB 7,700,000.
 
On December 9, 2010, CER Yangzhou entered into a three-year, loan facility with the Bank of China, Yizheng Branch.  The facility is RMB 30,000,000 (approximately $4,500,000).  The funds may be used either as a short term loan or for trade financing or other purposes.  Any amounts due under the loan are repayable on November 24, 2013.  The loan has been guaranteed by each of Mr Wu, the Company’s Chief Executive Officer and a director, two of the Group’s companies, CER Shanghai, and Shanghai Engineering and Yizheng Auto Industrial Park Investment and Development Co., Ltd. The Company has also pledged the land use right in Yizheng. The Company has drawn RMB 21,000,000 (approximately $3,171,000) under the facility as a short-term loan, due in one year, which amount carries an annual interest rate of 5.838%.  These funds will be used for working capital.
 
Table Disclosure of Contractual Obligations
 
The following table sets forth our contractual obligations as of December 31, 2010:

   
Payment Due by Period
 
   
Total
   
Less than 1 year
   
1-3 years
 
                   
Investment capital commitments
  $ 9,500,000     $ 9,500,000     $ -  
Short-term loans
    4,333,700       4,333,700       -  
Long-term loans
    3,721,751       3,177,973       543,778  
Convertible notes
    4,691,582       -       4,691,582  
Purchasing obligations
    5,672,101       5,099,557       572,544  
Total
  $    27,919,134     $    22,111,230     $    5,807,904  
 
 
48

 
 
Off-Balance Sheet Arrangements
 
We have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as stockholder's equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
 
Item 7A Quantitative and Quantitative Disclosures about Market Risk
 
Not applicable.
 
 
49

 
 
Item 8 Financial Statements and Supplementary Data
 
CHINA ENERGY RECOVERY, INC.

Index to Consolidated Financial Statements

  
Page No.
Report of Independent Registered Public Accounting Firm
51
   
Consolidated Balance Sheets as of December 31, 2009 and 2010
52
  
 
Consolidated Statements of Income and Other Comprehensive Income for the Years Ended December 31, 2009 and 2010
53
   
Consolidated Statements of Shareholders' Equity for the Years ended December 31,2009 and 2010
54
   
Consolidated Statements of Cash Flows for the Years Ended December 31, 2009 and 2010
55
   
Notes to the Consolidated Financial Statements
56
 
 
50

 
 
   
 
普华永道中天会计师事务所有限公司
 
11th Floor
 
PricewaterhouseCoopers Center
 
2 Corporate Avenue
 
202 Hu Bin Road, Luwan District
 
Shanghai 200021, PRC
 
Telephone +86 (21) 2323 8888
 
Facsimile +86 (21) 2323 8800
www.pwccn.com
 
Report of Independent Registered Public Accounting Firm
 
To the Board of Directors and Shareholders of
China Energy Recovery, Inc.:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income and other comprehensive loss, of shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of China Energy Recovery, Inc. and its subsidiaries (collectively, the “Company”) at December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.  We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers Zhong Tian CPAs Limited Company
April 18, 2011
 
 
51

 
 
CHINA ENERGY RECOVERY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2009 AND 2010

   
December 31
2009
   
December 31
2010
 
ASSETS
           
             
CURRENT ASSETS:
           
Cash
  $ 2,386,573     $ 2,996,076  
Restricted cash
    -       218,346  
Notes receivable
    411,049       1,341,359  
Accounts receivable, net of allowance for doubtful accounts
    6,601,921       7,059,935  
Inventories
    8,574,775       8,661,800  
Other current assets and receivables
    892,657       1,185,032  
Deferred financial cost - current
    674,748       215,623  
Deferred tax assets - current
    67,276       -  
Advances on purchases
    4,271,054       15,200,669  
Total current assets
    23,880,053       36,878,840  
                 
PROPERTY, PLANT AND EQUIPMENT, net
    758,888       10,101,755  
                 
OTHER ASSETS:
               
Deferred tax assets
    133,758       171,776  
Intangible assets
    2,439,022       2,477,959  
Deferred financial cost
    215,623       -  
Long-term accounts receivable
    6,830,615       4,679,121  
Total other assets
    9,619,018       7,328,856  
                 
Total assets
  $ 34,257,959     $ 54,309,451  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
                 
CURRENT LIABILITIES:
               
Accounts payable
  $ 4,188,205     $ 4,557,848  
Accrued expenses and other liabilities
    1,745,082       1,912,544  
Advances from customers
    11,226,273       27,530,065  
Taxes payable
    2,956,476       1,631,507  
Long-term loans, current
    -       3,177,973  
Short-term bank loans
    880,200       4,333,700  
Derivative liability, current
    435,500       374,846  
Convertible note, current
    2,023,720       -  
Total current liabilities
    23,455,456       43,518,483  
                 
NON-CURRENT LIABILITIES:
               
Warrant liability
    1,372,947       1,332,760  
Derivative liability
    435,500       48,461  
Convertible note
    1,938,408       4,691,582  
Long-term loan from related party
    -       543,778  
Total non-current liabilities
    3,746,855       6,616,581  
Total  Liabilities
    27,202,311       50,135,064  
                 
Commitment and contingency
    -       -  
                 
SHAREHOLDERS' EQUITY:
               
Preferred stock(US$0.001 par value; 50,000,000 shares authorized, 662,963 and 200,000 shares issued and outstanding as of December 31, 2009 and 2010, respectively)
    626       189  
Common stock(US$0.001 par value; 100,000,000  shares authorized, 30,638,720 and 30,906,266 shares issued and outstanding as of December 31, 2009 and 2010, respectively)
    30,639       30,906  
Additional paid-in-capital
    8,163,224       8,313,385  
Accumulated deficits
    (1,194,158 )     (4,713,541 )
Statutory reserves
    132,802       132,802  
Accumulated other comprehensive loss/(gain)
    (77,485 )     410,646  
Total shareholders' equity
    7,055,648       4,174,387  
                 
Total liabilities and shareholders' equity
  $ 34,257,959     $ 54,309,451  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
52

 
 
CHINA ENERGY RECOVERY, INC.

CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE LOSS
FOR YEARS ENDED DECEMBER 31, 2009 AND 2010
 
   
Year ended December 31,
 
   
2009
   
2010
 
             
REVENUES
  $ 22,194,443     $ 21,082,653  
                 
COST OF REVENUES
    (18,842,557 )     (17,898,955 )
                 
GROSS PROFIT
    3,351,886       3,183,698  
                 
SELLING, GENERAL AND  ADMINISTRATIVE EXPENSES
    (5,746,743 )     (6,440,852 )
                 
LOSS FROM  OPERATIONS
    (2,394,857 )     (3,257,154 )
                 
OTHER INCOME/(EXPENSE), NET:
               
Change in fair value of warrant liability
    1,539,233       40,187  
Change in fair value of derivative liability
    399,500       628,624  
Non-operating income, net
    80,692       1,186,603  
Interest expenses
    (868,388 )     (1,928,955 )
Total other income/(expense), net
    1,151,037       (73,541 )
                 
LOSS FROM OPERATIONS BEFORE INCOME TAXES
    (1,243,820 )     (3,330,695 )
                 
INCOME TAXES (EXPENSES)/BENEFITS
    357,340       (188,688 )
                 
NET LOSS
    (886,480 )     (3,519,383 )
                 
OTHER COMPREHENSIVE INCOME
               
Foreign currency translation adjustment
    29,152       488,131  
                 
COMPREHENSIVE LOSS
  $ (857,328 )   $ (3,031,252 )
                 
Loss per share
               
Basic
  $ (0.03 )   $ (0.11 )
Diluted
  $ (0.03 )   $ (0.11 )
Weighted average ordinary shares outstanding
               
Basic
    29,952,798       30,850,058  
Diluted
    29,952,798       30,850,058  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
53

 
 
CHINA ENERGY RECOVERY, INC. 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

    
Preferred Stock
   
Common stock
   
Additional
paid-in
   
Statutory
   
Accumulated
   
Accumulated
other
comprehensive
       
   
Shares
   
Amount
   
Shares
   
Amount
   
capital
   
reserves
   
deficits
   
income/(loss)
   
Total
 
                                                       
BALANCE, at January 1, 2009
    714,963     $ 715       29,912,573     $ 29,913       7,534,015       132,802       (307,678 )     (106,637 )     7,283,130  
                                                                         
Common stock for consulting services
    -       -       700,000       700       839,300       -       -       -       840,000  
Change of convertible rate
    -       (37 )     -       -       37       -       -       -       -  
Stock based compensation
    -       -       -       -       221,816       -       -       -       221,816  
Conversion of preferred stock
    (52,000 )     (52 )     26,147       26       26       -       -       -       -  
Deferred tax liability due to discount unconvertible notes
    -       -       -       -       (431,970 )     -       -       -       (431,970 )
Net loss
    -       -       -       -       -       -       (886,480 )     -       (886,480 )
Foreign currency translation gain
    -       -       -       -       -       -       -       29,152       29,152  
                                                                         
BALANCE, at December 31, 2009
    662,963       626       30,638,720       30,639       8,163,224       132,802       (1,194,158 )     (77,485 )     7,055,648  
                                                                         
Conversion of preferred stock
    (462,963 )     (437 )     245,098       245       192       -       -       -       -  
Stock based compensation
    -       -       -       -       141,012       -       -       -       141,012  
Common stock issued related to long-term loan
    -       -       22,448       22       8,957       -       -       -       8,979  
Net loss
    -       -       -       -       -       -       (3,519,383 )     -       (3,519,383 )
Foreign currency translation gain
    -       -       -       -       -       -       -       488,131       488,131  
                                                                         
BALANCE, at December 31, 2010
    200,000       189       30,906,266       30,906       8,313,385       132,802       (4,713,541 )     410,646       4,174,387  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
54

 
 
CHINA ENERGY RECOVERY, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR YEARS ENDED DECEMBER 31, 2009 AND 2010

   
Year Ended December 31,
 
   
2009
   
2010
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net loss
  $ (886,480 )   $ (3,519,383 )
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
               
Depreciation and amortization
    178,446       273,215  
Change in allowance for doubtful accounts
    337,383       152,960  
Change in provision for inventory
    40,248       47,281  
Common stock issued for services
    840,000       -  
Common stock issued for long-term loan
    -       8,979  
Stock based compensation
    221,816       141,012  
Change in fair value of warrant and derivative liabilities
    (1,938,733 )     (668,811 )
Accretion of interest on convertible note and long term loan
    232,628       828,515  
Amortization of deferred financing cost
    497,541       674,748  
Deferred income taxes
    (569,763 )     29,258  
Capitalized interest
    -       (253,825 )
Notes receivable
    (290,300 )     (930,310 )
Accounts receivable
    (1,830,055 )     (458,014 )
Accounts receivable - related party
    1,006,060       -  
Inventories
    (840,248 )     (134,306 )
Other current assets and receivables
    (794,386 )     (292,375 )
Advances on inventory purchases
    (1,675,452 )     (9,822,856 )
Long-term accounts receivable
    (6,727,925 )     1,980,890  
Accounts payable
    761,279       296,102  
Accrued expenses and other liabilities
    1,257,462       167,462  
Other payables - related party
    (65,078 )     -  
Advances from customers
    4,182,039       16,303,792  
Taxes payable
    263,863       (1,324,969 )
Effects of exchange rate change in operating activities
    -       364,198  
Net cash (used in)/provided by operating activities
    (5,799,655 )     3,863,563  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of property, plant and equipment
    (1,637,248 )     (10,300,653 )
Restricted cash
    597,949       (218,346 )
Purchase of intangible assets
    (2,439,071 )     (40,842