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EX-31.1 - China Energy Recovery, Inc.v218376_ex31-1.htm
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EX-31.2 - China Energy Recovery, Inc.v218376_ex31-2.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 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
 
(I.R.S. Employer
Incorporation or Organization)
 
Identification No.)

7F, No. 267 Qu Yang Road
   
Hongkou District
   
Shanghai, China
 
200081
(Address of Principal Executive Offices)
 
(Zip Code)
 
+86 (0)21 5556-0020
(Registrant's Telephone Number, Including Area Code)
 

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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

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

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
 
 
 

 
 
TABLE OF CONTENTS

       
Page
Part I
 
Financial Information
   
         
 
Item 1.
Unaudited Consolidated Financial Statements
 
3
         
   
Consolidated Balance Sheets as of December 31, 2009 and September 30, 2010
 
3
         
   
Consolidated Statements of Operations and Other Comprehensive Income(Loss) for the Three and Nine Months Ended September 30, 2009 and 2010
 
4
         
   
Consolidated Statements of Shareholders' Equity for the Year Ended December 31, 2009 and Nine Months Ended September 30, 2010
 
5
         
   
Consolidated Statements of Cash Flow for the Nine Months Ended September 30, 2009 and 2010
 
6
         
   
Notes to the Consolidated Financial Statements
 
7
         
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
37
         
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
50
         
 
Item 4.
Controls and Procedures
 
50
         
Part II
 
Other Information
   
         
 
Item 1.
Legal Proceedings
 
50
         
 
Item 1A.  
Risk Factors
 
50
         
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
51
         
 
Item 3.
Defaults Upon Senior Securities
 
51
         
 
Item 4.
[Reserved]
 
51
         
 
Item 5.
Other Information
 
51
         
 
Item 6.
Exhibits
 
51
  
 
2

 
 
PART I
FINANCIAL INFORMATION

Item 1. Unaudited Consolidated Financial Statements
 
CHINA ENERGY RECOVERY, INC.  AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2009 AND SEPTEMBER 30, 2010
(UNAUDITED)
   
December 31,
   
September 30,
 
   
2009
   
2010
 
             
ASSETS
           
             
CURRENT ASSETS:
           
Cash
  $ 2,386,573     $ 780,509  
Notes receivable
    411,049       -  
Accounts receivable, net of allowance for doubtful accounts
    6,601,921       7,919,723  
Inventories
    8,574,775       8,033,415  
Other current assets and receivables
    892,657       884,720  
Deferred financial cost - current
    674,748       289,975  
Deferred tax assets - current
    67,276       -  
Advances on purchases
    4,271,054       8,186,270  
Total current assets
    23,880,053       26,094,612  
                 
NON-CURRENT ASSETS:
               
Property, plant and equipment, net
    758,888       5,040,492  
Deferred tax assets
    133,758       145,678  
Intangible assets
    2,439,022       2,469,786  
Deferred financial cost
    215,623       -  
Long-term accounts receivable
    6,830,615       5,163,359  
Total non-current assets
    10,377,906       12, 819,315  
Total assets
  $ 34,257,959     $ 38,913,927  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
                 
CURRENT LIABILITIES:
               
Accounts payable
  $ 4,188,205     $ 3,825,658  
Accrued expenses and other liabilities
    1,745,082       2,079,967  
Advances from customers
    11,226,273       13,859,605  
Taxes payable
    2,956,476       2,308,684  
Short-term bank loans
    880,200       -  
Convertible note, current
    2,023,720       4,659,381  
Derivative liability, current
    435,500       155,645  
Long-term loans ,current
    -       3,540,687  
Total current liabilities
    23,455,456       30,429,627  
                 
NON-CURRENT  LIABILITIES:
               
Warrant liability
    1,372,947       392,330  
Derivative liability
    435,500       -  
Convertible note
    1,938,408       -  
Long-term loans
    -       1,003,778  
Total  non-current liabilities
    3,746,855       1,396,108  
Total  Liabilities
    27,202,311       31,825,735  
                 
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 September 30,  2010, respectively)
    626       189  
Common stock(US$0.001 par value; 100,000,000  shares authorized, 30,638,720 and 30,883,818 shares issued and outstanding as of December 31, 2009 and September 30, 2010, respectively)
    30,639       30,884  
Additional paid-in-capital
    8,163,224       8,269,175  
Accumulated deficits
    (1,194,158 )     (1,588,263 )
Statutory reserves
    132,802       132,802  
Accumulated other comprehensive income (loss)
    (77,485 )     243,405  
Total shareholders' equity
    7,055,648       7,088,192  
Total liabilities and shareholders' equity
  $ 34,257,959     $ 38,913,927  

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

 
3

 
 
CHINA ENERGY RECOVERY, INC.  AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME (LOSS)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2010
(UNAUDITED)

   
Three months ended September 30,
   
Nine months ended September 30,
 
   
2009
   
2010
   
2009
   
2010
 
   
(Restated)
         
(Restated)
       
REVENUES
  $ 5,320,518     $ 6,147,651     $ 14,743,413     $ 17,447,570  
                                 
COST OF REVENUES
    (4,466,987 )     (4,752,909 )     (11,521,307 )     (14,444,768 )
                                 
GROSS PROFIT
    853,531       1,394,742       3,222,106       3,002,802  
                                 
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
    (1,759,236 )     (1,588,818 )     (4,027,167 )     (4,095,102 )
                                 
LOSS FROM  OPERATIONS
    (905,705 )     (194,076 )     (805,061 )     (1,092,300 )
                                 
OTHER INCOME/(EXPENSE), NET:
                               
Change in fair value of warrants
    685,611       (97,281 )     1,236,678       980,617  
Change in fair value of derivative liabilities
    -       28,920       -       847,825  
Non-operating income/(loss), net
    33,144       30,424       (44,994 )     1,001,780  
Interest expenses
    (210,550 )     (477,239 )     (296,247 )     (1,786,380 )
Total other income/(loss), net
    508,205       (515,176 )     895,437       1,043,842  
                                 
(LOSS)/INCOME FROM OPERATIONS BEFORE INCOME TAXES
    (397,500 )     (709,252 )     90,376       (48,458 )
                                 
BENEFIT/(PROVISION) FOR INCOME TAXES
    139,382       (144,497 )     (8,900 )     (345,647 )
                                 
NET (LOSS)/INCOME
    (258,118 )     (853,749 )     81,476       (394,105 )
                                 
OTHER COMPREHENSIVE (LOSS)/INCOME
                               
Foreign currency translation adjustment
    8,784       292,890       37,837       320,890  
COMPREHENSIVE INCOME/(LOSS)
  $ (249,334 )   $ (560,859 )   $ 119,313     $ (73,215 )
 (LOSS)/ EARNINGS PER COMMON SHARE:
                               
Basic
    (0.009 )     (0.028 )     0.003       (0.013 )
Diluted
    (0.009 )     (0.028 )     0.003       (0.013 )
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
                               
Basic
    29,936,405       30,883,916       29,931,858       30,834,537  
Diluted
    29,936,405       30,883,916       29,931,858       30,834,537  

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

 
4

 

 CHINA ENERGY RECOVERY, INC.  AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(UNAUDITED)
 
   
Preferred Stock
   
Common stock
   
Additional
paid-in
   
Statutory
   
Accumulated
   
Accumulated
other
comprehensive
       
   
Shares
   
Amount
   
Shares
   
Amount
   
capital
   
reserves
   
deficits
   
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
    -       -       -       -       105,759       -       -       -       105,759  
Net loss
    -       -       -       -       -       -       (394,105 )     -       (394,105 )
Foreign currency translation gain
    -       -       -       -       -       -       -       320,890       320,890  
                                                                         
BALANCE, at September 30, 2010
    200,000     $ 189       30,883,818     $ 30,884       8,269,175       132,802       (1,588,263 )     243,405       7,088,192  
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

 
5

 

CHINA ENERGY RECOVERY, INC.  AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2010
(UNAUDITED)

  
 
Nine months ended September 30,
 
   
2009
   
2010
 
   
(Restated)
       
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income (loss)
  $ 81,476     $ (394,105 )
Adjustments to reconcile net income (loss) to cash (used in) provided by operating activities:
               
Depreciation and amortization
    102,807       242,627  
Change in allowance for uncollectible accounts
    -       (68,049 )
Stock based compensation
    147,644       105,759  
Change in fair value of warrants
    (1,236,678 )     (980,617 )
Change in value of  derivative liabilities
    -       (847,825 )
Accretion of interest on the convertible note and long term loan
    -       731,233  
Amortization of deferred financing cost
    293,072       600,396  
Capitalized interest expenses
    -       (114,329 )
Deferred tax expense
    (117,814 )     55,356  
Change in operating assets and liabilities:
               
Notes receivable
    (395,342 )     411,049  
Accounts receivable
    1,126,540       (1,317,802 )
Inventories
    368,418       541,360  
Other current assets and receivables
    (630,504 )     7,937  
Advances on purchases
    (3,057,428 )     (2,821,431 )
Long term accounts receivable
    (5,056,994 )     1,725,146  
Accounts payable
    2,016,978       (453,572 )
Other payables and accrued liabilities
    387,588       334,885  
Advances from customers
    739,990       2,633,332  
Taxes payable
    (169,968 )     (647,792 )
Effects of exchange rate change in operating activities
    35,518       285,942  
Net cash provided by (used in) operating activities
    (5,364,697 )     29,500  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of property, plant and equipment
    (173,706 )     (5,361,821 )
Purchase intangible assets
    -       (38,958 )
Restricted cash
    106,286       -  
Net cash used in  investing activities
    (67,420 )     (5,400,779 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Cash proceeds from long term loans
    -       5,003,778  
Cash proceeds from convertible note
    5,000,000       -  
Cash proceeds from short term bank loans
    880,200       -  
Principal repayment of short term bank loans and long term loans
    (381,420 )     (1,241,023 )
Net cash provided by financing activities
    5,498,780       3,762,755  
                 
EFFECTS OF EXCHANGE RATE CHANGE IN CASH
    (25 )     2,460  
                 
INCREASE/(DECREASE) IN CASH
    66,638       (1,606,064 )
                 
CASH, beginning
  $ 6,136,403     $ 2,386,573  
                 
CASH, ending
  $ 6,203,041     $ 780,509  
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
               
Cash paid during the year for income taxes
    -       53,446  
Cash paid during the year for interest
    6,337       451,303  
                 
Supplemental schedule of non-cash investing and financing activities:
               
Accounts payable relating to purchase of property, plant and equipment
    -       91,025  

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

 
6

 
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)

Note 1 – Organization

China Energy Recovery, Inc. ("CER" or the "Company"), formerly known as MMA Media Inc. and Commerce Development Corporation Ltd., was incorporated under the laws of the State of Maryland in May, 1998. On April 7, 2006, the Company entered into an Agreement and Plan of Merger with its wholly-owned subsidiary, Commerce Development Corporation, Ltd., a Delaware corporation, which changed the Company's state of incorporation from Maryland to Delaware as a result. On February 5, 2008, the Company changed its name to China Energy Recovery, Inc.

On January 24, 2008, the Company entered into a Share Exchange Agreement with Poise Profit International, Ltd. ("Poise Profit"), a company incorporated on November 23, 2007, under the laws of the British Virgin Islands, and the shareholders of Poise Profit. The share exchange transaction (the "Share Exchange") was consummated on April 15, 2008 and Poise Profit became a wholly-owned subsidiary of the Company. On April 16, 2008, the Company conducted a 1-for-2 reverse stock split pursuant to which each two shares of CER's common stock, issued and outstanding on the record date of April 15, 2008, converted into one share of CER's common stock. Pursuant to the Share Exchange Agreement, the Company agreed to acquire all of the issued and outstanding shares of Poise Profit's common stock in exchange for the issuance of 20,757,090 shares, or 81.5% of the Company's common stock on a post 1-for-2 reverse stock split basis, to the shareholders of Poise Profit. Because the acquisition is treated as a reverse acquisition and recapitalization whereby Poise Profit is deemed to be the accounting acquirer (legal acquiree) and the Company to be the accounting acquiree (legal acquirer), the financial statements of the Company have been retroactively adjusted to reflect the acquisition from the beginning of the reported period. The historical financial statements for periods prior to April 15, 2008 are those of Poise Profit except that the equity section and earnings per share have been retroactively restated to reflect the reverse acquisition and recapitalization.

Poise Profit is an off-shore holding company and has no operating business activities. Poise Profit owns 100% of HAIE Hi-tech Engineering (Hong Kong) Company, Limited ("Hi-tech") and CER (Hong Kong) Holdings Limited (“CER Hong Kong”), which were incorporated in Hong Kong on January 4, 2002 and August 13, 2008, respectively.

Shanghai Hai Lu Kun Lun Hi-tech Engineering Co., Ltd ("Shanghai Engineering") was established in Shanghai, China in July 1999. Shanghai Xin Ye Environmental Protection Engineering Technology Co., Ltd ("Shanghai Environmental") was incorporated in Shanghai on May 23, 2007. Mr. Qinghuan Wu, the Company’s chairman and Chief Executive Officer, became the sole shareholder of Shanghai Environmental in November 2007. Shanghai Environmental is not an operating company but serves as a vehicle for arranging sales and maximizing tax benefits.

All of Shanghai Engineering’s manufacturing activities are conducted through a Leasing and Operation Agreement, a form of cooperative manufacturing agreement, originally effective as of May 1, 2003 and subsequently renewed and amended with a state-owned enterprise, Shanghai Si Fang.  Pursuant to the agreement, Shanghai Si Fang leases certain land use right, buildings and fixed assets (lease elements) in one of its subsidiaries, Vessel Works Division, and provides management services and licenses the “Si Fang” brand and manufacturing license (non-lease elements) of Vessel Works Division to Shanghai Engineering.  Because the arrangement contains both the lease and non-lease elements, the amount of quarterly payment is allocated between the lease and non-lease deliverables based on their fair values.  The lease elements are classified and accounted for as operating leases and the lease expense is recorded on a straight-line basis.  The non-lease elements are accounted for as prepayment for management and licensing fees and the payment is amortized on a straight-line basis over each contractual period.

 
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.

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 the Lease and Operation arrangement, Shanghai Engineering is not the primary beneficiary of Shanghai Si Fang.

Effective on January 1, 2006, Hi-tech executed a series of contractual arrangements with Shanghai Engineering and its shareholders, including a Consulting Services Agreement and an Operating Agreement, through which Hi-tech has the right to advise, consult, manage and operate Shanghai Engineering, and collect and own all of its net profits. Additionally, Shanghai Engineering's shareholders have assigned their voting rights over Shanghai Engineering to Hi-tech. In order to further reinforce Hi-tech's rights to control and operate Shanghai Engineering, Shanghai Engineering and its shareholders have granted Hi-tech the exclusive right and option to acquire all of their equity interests in Shanghai Engineering. Further, Shanghai Engineering shareholders have pledged all of their rights, titles and interests in Shanghai Engineering to Hi-tech.
 
Effective on May 23, 2007, Hi-tech executed a series of contractual arrangements with Shanghai Environmental and its shareholders, including a Consulting Services Agreement and an Operating Agreement, through which Hi-tech has the right to advise, consult, manage and operate Shanghai Environmental, and collect and own all of its net profits. Additionally, Mr. Qinghuan Wu, Shanghai Environmental's sole shareholder has assigned his voting rights over Shanghai Environmental to Hi-tech. In order to further reinforce Hi-tech's rights to control and operate Shanghai Environmental, Shanghai Environmental and Mr. Qinghuan Wu have granted Hi-tech the exclusive right and option to acquire all of his equity interest in Shanghai Environmental. Further, Mr. Wu has pledged all of his right, title and interests in Shanghai Environmental. Shanghai Environmental was dissolved on June 12, 2010 and the registered capital was transferred to Shanghai Engineering in 2010.

In order to restructure the holding structure of the Company (the “Restructuring”), on December 2, 2008, 100% of the shares of CER Hong Kong were transferred to Poise Profit from Mr. Qinghuan Wu and his wife, Mrs. Zhou, and all the contracts between Hi-tech and Shanghai Engineering,  and between Hi-tech and Shanghai Environmental were transferred to CER Hong Kong.  Thereafter, CER Hong Kong, through its variable interest entities located in the People's Republic of China ("PRC"), designs, develops, manufactures and markets waste heat boilers and pressure vessels in the fields of chemical industry, petrochemical industry, oil refinery, fine chemicals, water and power conservancy, metallurgical, environmental protection, waste heat utilization and power generation from waste heat recovery.

On November 11, 2008, CER Energy Recovery (Shanghai) Co., Ltd. (“CER Shanghai”) was incorporated in Shanghai by CER Hong Kong. CER Shanghai’s registered capital is $5,000,000. As of September 30, 2010, CER Hong Kong has contributed approximately $3,380,000 capital in CER Shanghai, and the remaining amount has been injected at November 4, 2010. CER Shanghai is mainly engaged in the development of energy recovery and environmental protection technologies, and design, installation and servicing of waste heat recovery systems.

CER Energy Recovery (Yangzhou) Co., Ltd. (“CER Yangzhou”) was incorporated on August 28, 2009 in Yangzhou by CER Hong Kong. CER Yangzhou’s registered capital is $20,000,000 and the contributed capital was approximately $10,500,000 as of December 31, 2010. CER Yangzhou is mainly engaged in the development and manufacturing of waste heat recovery systems and other related energy efficiency equipment.

As all the above entities are under common control, the arrangements described above have been accounted for as a reorganization of entities and the financial statements have been prepared as if the reorganization had occurred retroactively. CER, Poise Profit, CER Hong Kong, Hi-tech, Shanghai Engineering, CER Shanghai, CER Yangzhou, and Shanghai Environmental, are collectively hereinafter referred to as the “Group”.

 
8

 

Note 2 Restatement of Consolidated Financial Statements for three and nine months ended September 30, 2009

Consolidated Statements of Income and other comprehensive income (loss) Impact:
 
The following table sets forth the effects of the restatement and reclassification adjustments on the Company’s consolidated statements of income and other comprehensive income (loss):

   
Three months ended September 30, 2009
 
   
Previously
             
   
Reported
   
Adjustments
   
Restated
 
                   
REVENUES (note(a))
  $ 6,064,800     $ (744,282 )   $ 5,320,518  
                         
COST OF REVENUES (note(b))
    (4,691,381 )     224,394       (4,466,987 )
                         
GROSS PROFIT
    1,373,419       (519,888 )     853,531  
                         
SELLING, GENERAL AND  ADMINISTRATIVE EXPENSES(note(c))
    (2,292,301 )     533,065       (1,759,236 )
                         
LOSS FROM  OPERATIONS
    (918,882 )     13,177       (905,705 )
                         
OTHER INCOME (EXPENSE), NET:
                       
Change in fair value of warrants(note(d))
    941,277       (255,666 )     685,611  
Non-operating income (expense), net(note(e))
    149,371       (116,227 )     33,144  
Interest expenses(note(f))
    (332,490 )     121,940       (210,550 )
Total other income (expense), net
    758,158       (249,953 )     508,205  
                         
LOSS FROM OPERATIONS BEFORE PROVISION FOR INCOME TAXES
    (160,724 )     (236,776 )     (397,500 )
                         
BENEFIT/(PROVISION) FOR INCOME TAXES(note(g))
    43,718       95,664       139,382  
                         
NET(LOSS)/INCOME
    (117,006 )     (141,112 )     (258,118 )
                         
OTHER COMPREHENSIVE INCOME
                       
Foreign currency translation adjustment
    8,784       -       8,784  
                         
COMPREHENSIVE LOSS
  $ (108,222 )   $ (141,112 )   $ (249,334 )
                         
(LOSS)/EARNINGS PER COMMON SHARE:
                       
Basic and diluted(note(h))
  $ (0.004 )     (0.005 )     (0.009 )
                         
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
                       
Basic
    29,936,493       (88 )     29,936,405  
Diluted
    30,287,473       (351,068 )     29,936,405  

(a)
The restated revenues decreased by $744,282 because the Company over recognized certain revenue by $862,075, offset by recognizing retainage of $117,793 as revenue for the three months ended September 30, 2009, since the recoverability of the retainage could be reasonably assured.

(b)
The restated cost of revenues decreased by $224,394, representing overcharged costs and sales taxes of $192,064 and $32,330, respectively.

(c)
The restated selling, general and administrative expenses decreased by $533,065, representing overcharged stock based compensation of $244,311, allowance of doubtful accounts of $187,883 and rental expenses of $117,331, offset by undercharged salary payable of $16,460.

(d)
The restated change in fair value of warrants decreased by $255,666, representing the underestimated value of the warrants.

(e)
The restated non-operating income decreased by $116,227, representing overcharged income between Si Fang and Shanghai Engineering.

(f)
The restated interest expenses decreased by $121,940, representing the over amortized value of warrants related to the convertible notes.

(g)
The adjustment to income tax expense has been calculated based on the above adjustments.

(h)
The number of weighted average common shares has been adjusted to correct a computational difference in the previously disclosed balance.
 
 
9

 
 
   
Nine months ended September 30, 2009
 
   
Previously
             
   
Reported
   
Adjustments
   
Restated
 
                   
REVENUES
  $ 14,942,533     $ (199,120 )   $ 14,743,413  
                         
COST OF REVENUES
    (11,936,853 )     415,546       (11,521,307 )
                         
GROSS PROFIT
    3,005,680       216,426       3,222,106  
                         
SELLING, GENERAL AND  ADMINISTRATIVE EXPENSES(note(c))
    (5,648,822 )     1,621,655       (4,027,167 )
                         
LOSS FROM  OPERATIONS
    (2,643,142 )     1,838,081       (805,061 )
                         
OTHER INCOME (EXPENSE), NET:
                       
Change in fair value of warrants(note(d))
    2,108,556       (871,878 )     1,236,678  
Non-operating expense, net(note(e))
    (1,148 )     (43,846 )     (44,994 )
Interest expenses(note(f))
    (329,584 )     33,337       (296,247 )
Total other income (expense), net
    1,777,824       (882,387 )     895,437  
                         
(LOSS)/INCOME FROM OPERATIONS BEFORE PROVISION FOR INCOME TAXES
    (865,318 )     955,694       90,376  
                         
BENEFIT/(PROVISION) FOR INCOME TAXES(note(g))
    119,210       (128,110 )     (8,900 )
                         
NET(LOSS)/INCOME
    (746,108 )     827,584       81,476  
                         
OTHER COMPREHENSIVE INCOME
                       
Foreign currency translation adjustment
    37,837       -       37,837  
                         
COMPREHENSIVE (LOSS)/INCOME
  $ (708,271 )   $ 827,584     $ 119,313  
                         
(LOSS)/ EARNINGS PER COMMON SHARE:
                       
Basic and diluted(note(h))
  $ (0.024 )     0.027       0.003  
                         
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
                       
Basic and diluted
    29,931,806       52       29,931,858  

(a)
The restated revenues decreased by $199,120 because the Company over recognized certain revenue by $862,075, offset by recognizing retainage of $662,955 as revenue for the nine months ended September 30, 2009, since the recoverability of the retainage could be reasonably assured.

(b)
The restated cost of revenues decreased by $415,546, representing overcharged costs and sales taxes of $344,987 and $70,559, respectively.

(c)
The restated selling, general and administrative expenses decreased by $1,621,655, representing overcharged stock based compensation of $999,483 and allowance of doubtful accounts of $671,553, offset by undercharged salary payable of $49,381.

(d)
The restated change in fair value of warrants decreased by $871,878, representing the under estimated value of the warrants.

(e)
The restated non-operating expense increased by $43,846, representing undercharged expense between Sifang and Shanghai Engineering.

(f)
The restated interest expenses decreased by $33,337, representing the over amortized value of warrants related to the convertible notes.

(g) 
The adjustment to income tax expense has been calculated based on the above adjustments.

(h) 
The number of weighted average common shares has been adjusted to correct a computational difference in the previously disclosed balance.
 
 
10

 

Consolidated Statement of Cash Flows Impact:
 
The following table presents selected unaudited consolidated statements of cash flows information for the Company showing previously reported and restated cash flows, for the nine months ended September 30, 2009:

         
Nine months ended September 30, 2009
 
   
Previously
Reported
   
Adjustments
   
Restated
 
Net cash used in operating activities
  $ (5,399,559 )   $ 34,862
(1)
  $ (5,364,697 )
Net cash used in investing activities
    (160,319 )     92,899 (1)     (67,420 )
Net cash provided by financing activities
    5,604,613       (105,833 )     5,498,780  
Subtract: Restricted cash - special use
    (5,000,000 )     5,000,000       -  
Effects of exchange rate  change in cash
  $ 21,903     $ (21,928 )   $ (25 )

(1) Included in the adjustments is a revision to restricted cash in the unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2009: The Company revised the net change in restricted cash during the first half of 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 certain 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 $106,286 and net cash used in investing activities has decreased accordingly. The revision had no effect on previously reported results of operations or accumulated deficit.

Note 3 – Summary of Significant Accounting Policies

The principal accounting policies adopted in the preparation of these consolidated financial statements are set out below:

(a)
Principal of consolidation

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”).  The consolidated financial statements  include the financial statements of the Company, its wholly-owned subsidiaries Poise Profit, CER Hong Kong, Hi-tech, CER Shanghai, CER Yangzhou, and its variable interest entities (“VIEs”), Shanghai Engineering, and Shanghai Environmental. All significant inter-company transactions and balances among the Company, its subsidiaries and VIEs are eliminated upon consolidation.
 
In accordance with the Accounting Standard Codification (“ASC”) 810-10, variable interest entities (VIEs) are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability. All VIEs with which the Company is involved must be evaluated to determine the primary beneficiary of the risks and rewards of the VIE. The primary beneficiary is required to consolidate the VIE for financial reporting purposes.
 
The Company has concluded that Shanghai Engineering, and Shanghai Environmental are VIEs and that the Company is the primary beneficiary. Under the requirements of US GAAP, the Company consolidated the financial statements of Shanghai Engineering and Shanghai Environmental.

 
11

 

(b) Use of estimates

In preparing financial statements in conformity with US GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reported periods. Significant estimates include useful lives of property, plant and equipment, allowance for doubtful accounts, deferred tax assets and the completion percentage of the construction contracts. Actual results could differ from those estimates.

(c) Concentration of risk

The Company maintains cash balances at financial institutions within the U.S. Hong Kong and PRC. Balances at financial institutions or state owned banks within the PRC are not covered by insurance. Balances at financial institutions within the United States are covered by the Federal Deposit Insurance Corporation for $250,000 per depositor per institution. Balances at financial institutions within Hong Kong are fully covered by the government provided insurance until the end of 2010.  The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risks on its cash in bank accounts.

For the three months ended September 30, 2009 and 2010, the Company’s five top customers accounted for 85% and 83% of the Company's sales, respectively. For the nine months ended September 30, 2009 and 2010, the Company’s five top customers accounted for 69% and 72% of the Company's sales, respectively.  Receivables from the five top customers were 16% and 5% of total accounts receivable ended September 30, 2009 and 2010, respectively.

For the three months ended September 30, 2009 and 2010, five top suppliers provided approximately13% and 43% of the Company's purchases of raw materials, respectively. For the nine months ended September 30, 2009 and 2010, five top suppliers provided approximately 41% and 36% of the Company's purchases of raw materials, respectively. Payables to the five suppliers were about 9% and 2% of total accounts payable as of September 30, 2009 and 2010, respectively.  

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

(d) Foreign currency translations
 
The reporting currency of the Company is the U.S. dollar. Shanghai Engineering, CER Shanghai, CER Yangzhou, Hi-tech and CER Hong Kong use Renminbi ("RMB") as their functional currency.  Results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the end of period exchange rates. Cash flows are also translated at average translation rates for the period, therefore, amounts reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet. Translation adjustments resulting from this process are included in accumulated other comprehensive income (loss) in stockholders' equity. Transaction gains and losses that arise from exchange rate fluctuations from transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. For the three months ended September 30, 2009 and 2010, foreign currency translation income amounted to $8,784 and income amounted to $292,890, respectively. For the nine months ended September 30, 2009 and 2010, foreign currency translation income amounted to $37,837 and loss amounted to $320,890, respectively.

 
12

 

The PRC government imposes significant exchange restrictions on fund transfers out of the PRC that are not related to business operations. These restrictions have not had a material impact on the Company because it has not engaged in any significant transactions that are subject to the restrictions.

Accumulated other comprehensive loss amounted to $77,485 and income amounted to $243,405 as of December 31, 2009 and September 30, 2010, respectively. The balance sheet accounts with the exception of equity at December 31, 2009 and September 30, 2010 were translated at RMB6.82 to $1.00, and were translated at RMB 6.70 to $1.00 respectively.

The average translation rates applied to income and cash flow statement amounts for the three months ended September 30, 2009 and 2010 were RMB6.82 to $1.00 and RMB6.80 to $1.00, respectively. For the nine months ended September 30, 2009 and 2010, the average translation rates were RMB6.82 to $1.00 and RMB6.80 to $1.00, respectively.

(e) Cash

Cash includes cash on hand and demand deposits with banks, which are unrestricted as to withdrawal and use, and which have original maturities less than three months.

(f) Notes receivable

Notes receivable represent trade accounts receivable due from various customers where the customers’ banks have guaranteed the payment of the receivables. The notes are non-interest bearing and normally paid within three to nine months. The Company has the ability to submit request for payment to the customer’s bank earlier than the scheduled payment date, but will incur an interest charge and a processing fee. There was no notes receivable as of September 30, 2010.
 
(g) Receivables and allowance for doubtful accounts

Receivables include trade accounts due from the customers, and other receivables from cash advances to employees or third parties. Management regularly reviews aging of receivables and changes in payment trends by its customers, and records a reserve when they believe collection of amounts due are at risk. 

Allowance for doubtful account, December 31, 2008
  $ 251,458  
Addition
    337,383  
Translation adjustment
    207  
Allowance for doubtful account, December 31, 2009
  $ 589,048  
Addition
    -  
Recovery
    (68,049 )
Translation adjustment
    10,159  
Allowance for doubtful accounts, September  30, 2010
  $ 531,158  

Accounts receivable which are expected to be collected after twelve months are reclassified as long-term accounts receivable. The Company reserved a provision for account receivable balances based on the nature of the business and accounts receivable collection history (further discussed in Note 4).
 
(h) Inventories

Inventories are comprised of raw materials, work in progress and finished goods and are stated at the lower of cost or market value. Costs of work in progress include direct labor, direct materials, and production overhead before the goods are ready for sale. Management reviews inventories for obsolescence or cost in excess of market value periodically. The obsolescence, if any, is recorded as a reserve against the inventory. The cost in excess of market value is written off and recorded as cost of revenues.

 
13

 

(i) Advances on purchase

Advances on purchases are monies advanced to outside vendors for inventory purchases and property, plant and equipment purchases. This amount is refundable and bears no interest.

(j) Property, plant and equipment, net

Property, plant and equipment are stated at cost. Depreciation is provided principally by use of the straight-line method over the estimated useful lives of the related assets. Expenditures for maintenance and repairs, which do not improve or extend the expected useful lives of the assets, are charged to operations as incurred, while renewals and betterments are capitalized.

Management established a 5% residual value for property, plant and equipment. The estimated useful lives of the property, plant and equipment are as follows:

Plant
20 years
Transportation equipment
3-10 years
Machinery equipment
5-10 years
Office equipment
3-5 years

The gain or loss on disposal of property, plant and equipment is the difference between the net sales proceeds and the carrying amount of the relevant assets; gains or losses, if any, are recognized in the statement of operations. There was no disposal of assets during the three and nine months ended September 30, 2009 and 2010.

(k) Impairment of assets

The Company assesses the carrying value of long-lived assets each reporting period, more often when factors indicating impairment are present, and reduces the carrying value of such assets by the amount of the impairment. The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted and without interest charges) and comparing such amount to the net asset carrying value. An impairment loss, if it exists, is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Fair value generally means based on either quoted market price, if available, or discounted cash flow analysis. There were no impairment of long lived assets recognized for the three and nine months ended September 30, 2009 and 2010.

 (l) Advances from customers

Advances from customers represent amounts advanced by customers on product or service orders. The product (service) normally is shipped (rendered) within one year after receipt of the advance payment, and the related sales are recognized in accordance with the Company’s revenue recognition policy.

(m) Income taxes

Income taxes are accounted for under the asset and liability method. Deferred income taxes are recognized for temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements, net operating loss carry forwards and credits, by applying enacted statutory tax rate in the year in which those temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Current income taxes are provided for in accordance with the laws of the relevant taxing authorities.

(n) Value added tax
 
Sales revenue represents the invoiced value of goods, net of a value-added tax ("VAT"). All of the Company's products that are sold in the PRC are subject to a Chinese value-added tax at a rate of 17% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing its finished product. The Company recorded VAT payable and VAT receivable net of payments in the financial statements. The VAT tax return is filed offsetting the payables against the receivables.


 
14

 

(o) Operation leases

Leases where substantial all the rewards and risks of ownership of assets remain with the leasing company are accounted for as operating leases. Payments made under operating leases are charged to the statement of operation on a straight line basis over the lease periods.

(p) Stock based compensation

In accordance with ASC 718, Compensation-Stock Compensation, the Company measures the cost of employee services received in exchange for stock based compensation at the grant date fair value of the award.
 
The Group recognizes the stock based compensation costs, net of a forfeiture rate, on a straight-line basis over the requisite service period for each award.
 
ASC 718 requires forfeitures to be estimated at the time of grant and revised in subsequent periods if actual forfeitures differ from those estimates.  
 
Cost of goods acquired or services received from non-employees is measured based on the fair value of the awards issued on the measurement date as defined in ASC 505. Awards granted to non-employees are remeasured at each reporting date using the fair value as at each period end. Changes in fair values between the interim reporting dates are attributed consistent with the method used in recognizing the original stock based compensation costs.

(q) Shipping and handling costs

Shipping and handling costs are included in selling, general and administrative expenses which totaled $83,013 and $82,453 for the three months period ended September 30, 2009 and 2010, respectively, $346,090 and $192,369 for the nine months period ended September 30, 2009 and 2010, respectively.

(r) Revenue recognition

The Company derives revenues principally from

 
(a)
Sales of energy recovery systems, and

 
(b)
Provision of design services, and

 
(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 the three and nine months ended September 30, 2009 and 2010 are summarized as follows:

   
Three months ended September 30,
 
   
2009
   
2010
 
Revenue:
           
Product
  $ 2,845,939     $ 3,067,962  
EPC contracts
    2,474,579       3,079,689  
Totals
  $ 5,320,518     $ 6,147,651  
 
 
15

 

 
   
Nine months ended September 30,
 
   
2009
   
2010
 
Revenue:
           
Product
  $ 10,147,408     $ 6,058,268  
EPC contracts
    4,596,005       11,389,302  
Totals
  $ 14,743,413     $ 17,447,570  

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. There were no service revenue for the three and nine months ended September 30, 2009 and 2010. 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 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.

In accordance with the accounting standard 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.

 (s) Fair value of financial instruments

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:

 
16

 

 
Level 1
Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Fair valued assets and liabilities that are generally included in this category are assets comprised of cash, restricted cash, accounts and notes receivable, and liabilities comprised of bank loans, accounts payable, accrued liabilities and other payables. As of December 31, 2009 and September 30, 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 September 30, 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 September 30, 2010 and December 31, 2009.

         
Balance as of September 30, 2010
 
   
Carrying
   
Fair Value Measurements
 
   
Value
   
Using Fair Value Hierarchy
 
         
Level 1
   
Level 2
   
Level 3
 
Derivative liability, current (Note 14)
  $ 155,645       -       -     $ 155,645  
Warrant liability (Note 14)
  $ 392,330       -       -     $ 392,330  
 
         
Balance as of December 31, 2009
 
   
Carrying
   
Fair Value Measurements
 
   
Value
   
Using Fair Value Hierarchy
 
         
Level 1
   
Level 2
   
Level 3
 
Derivative liability, current (Note 14)
  $ 435,500                 $ 435,500  
Derivative liability (Note 14)
  $ 435,500       -       -     $ 435,500  
Warrant liability (Note 14)
  $ 1,372,947       -       -     $ 1,372,947  

A summary of changes in Level 3 derivative and warrant liabilities for the years ended December 31, 2009 and for the nine months ended September 30, 2010 were as follows:

Balance at January 1, 2009
  $ 1,524,268  
Warrants issued at issuance of convertible notes (Note 14)
    1,387,912  
Derivative liability at issuance of convertible notes (Note 14)
    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 9)
    132,470  
Change in fair value of warrant liability recognized in earnings
    (980,617 )
Change in fair value of derivative liability recognized in earnings
    (847,825 )
Balance at September 30, 2010
  $ 547,975  

 
17

 

The following presents the carrying value and the estimated value of the Company’s convertible note at September 30, 2010:

   
Carrying Value
   
Fair Value
 
             
Convertible note
  $ 4,659,381     $ 4,448,399  

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 September 30, 2010 and December 31, 2009.

(t) Segment reporting

The group has adopted ASC 280, Segment Reporting, for its Segment reporting. The group mainly operates in China and measures its business as a single segment.

(u) Recent accounting pronouncements

In January 2010, the FASB issued new accounting guidance related to the disclosure requirements for fair value measurements and provides 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 rollforward activity of Level 3 fair value measurements. Those disclosure requirements are effective for fiscal years ending after December 31, 2010. The Company does not expect the adoption of the updated guidance will have a material impact on its consolidated financial position, results of operations and cash flows.
 
In February 2010, the FASB issued accounting standards update which amends the accounting standard on subsequent event. 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.
 
In April 2010, the FASB issued an authoritative pronouncement on 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 Company does not expect the adoption of this pronouncement to 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, and do not anticipate that this adoption will have a significant impact on our financial position or results of operations.
 
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.
 
 
18

 
 
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.
 
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.
 
Note 4 – Accounts Receivable

(a)
Accounts Receivable
 
   
December 31,
   
September 30,
 
   
2009
   
2010
 
             
Current accounts receivable
  $ 6,601,921     $ 7,919,723  
Subtract: Allowance for doubtful accounts
    -       -  
Current accounts receivable, net
  $ 6,601,921     $ 7,919,723  

The Company reclassified accounts receivable which are expected to be collected after one year as long- term assets.

Current accounts receivable also consisted revenue recognized in excess of amounts billed for the EPC contracts recognized using the percentage of completion method.  As of December 31, 2009 and September 30, 2010, the revenue recognized in excess of amounts billed amounted to approximately $2,382,315 and $2,301,126, respectively.

(b)
Long-term Accounts Receivable
 
   
December 31,
   
September 30,
 
   
2009
   
2010
 
Long-term accounts receivable
  $ 7,419,663     $ 5,694,517  
Subtract: Allowance for doubtful accounts
    (589,048 )     (531,158 )
Long-term accounts  receivable, net
  $ 6,830,615     $ 5,163,359  

Long-term accounts receivable consisted revenue recognized in excess of amounts billed of approximately $6,220,710 and $5,163,359 as of December 31, 2009 and September 30, 2010, respectively.

 
19

 

Note 5 – Inventories

As of December 31, 2009 and September 30, 2010, inventories consist of the following:

   
December 31,
   
September 30,
 
   
2009
   
2010
 
             
Raw materials
  $ 1,539,322     $ 1,563,281  
Work in progress
    6,988,199       6,408,355  
Finished goods
    47,254       61,779  
Total inventories
  $ 8,574,775     $ 8,033,415  

For the three and nine months ended September 30, 2010 and 2009, management determined that no additional provisions to inventory balances were required.

Note 6 – Property, plant and equipment, Net

As of December 31, 2009 and September 30, 2010, property, plant and equipment consist of the following:

  
 
December 31,
   
September 30,
 
   
2009
   
2010
 
             
Machinery equipment
  $ 626,485     $ 668,282  
Transportation equipment
    270,419       346,789  
Office equipment
    431,905       483,602  
Construction in progress
    -       4,303,526  
Subtotal
    1,328,809       5,802,199  
Accumulated depreciation
    (569,921 )     (761,707 )
Property, plant and equipment, net
  $ 758,888     $ 5,040,492  

Depreciation expense for the three months ended September 30, 2009 and 2010 was $50,383 and $88,979, respectively. Depreciation expense for the nine months ended September 30, 2009 and 2010 was $139,862 and $191,786, respectively.

Note 7 – Intangible Assets

Intangible assets mainly represent purchase for usage of a parcel of land in Yangzhou where the manufacturing plant is located.  The Company has obtained the legal usage title of the land in November 2009.  The land use right is recorded at cost of $2,438,632 and is amortized over the lease term of 50 years starting from November 2009 when it is acquired. The amortization expense recorded for the three and nine months ended September 30, 2010 amounted to $16,740 and $50,841, respectively. The remaining balance represents the net value of purchased software.

Note 8 – Short Term Bank Loans

On September 1, 2009, the Company borrowed $880,200 a short-term loan from one bank in China which matured on August 31, 2010 with a 5.841% annual interest rate. The bank loan was collateralized by Shanghai Engineering’s leased office space, which is owned jointly by Mr. Qinghuan Wu, the Chairman of the Board and Chief Executive Officer of the Company, and his son. The full amount of $880,200 was repaid on January 5, 2010.

 
20

 

 
Interest expenses of short-term bank loans for the three months ended September 30, 2009 and 2010 was $4,282 and $0. Interest expenses of short-term bank loans for the nine months ended September 30, 2009 and 2010 was $6,337 and $1,571, respectively.

Note 9 – Long Term Loans

On February 1, 2010, the Company, through its subsidiaries, CER Shanghai (“Borrower”) and CER Hong Kong (“Paying Agent”) entered into a series of agreements for a loan arrangement with two lenders (the “Loan Agreements”). The proceeds of this loan are for construction of the new plant in China for the production of the Company’s products.

The aggregate principal amount of the loan under the two Loan Agreements is $4,000,000. The principal is due January 15, 2013, and bears interest at the annual rate of 15.1%.  The loan repayments are to be made three times a year starting May 15, 2010, and are fully amortizing, such that the principal and interest will be fully repaid at maturity. The Company will pay the sum of US$ 566,023 at the end of every four calendar months, commencing May 15, 2010. The Company has entered into other agreements to provide that moneys due from a certain sale and service contract and related guarantee will be directed to pay the amounts due under the Loan Agreements, with the balance paid to the Company or its affiliates. The loan agreement between the lender and the Company and related agreements have been registered with State Administration of Foreign Exchange (SAFE) for the inflow of funds and the repayment of the loan obligations. The loans may be prepaid at any time with a premium of 1.25% of the principal amount being paid. The Loan Agreements provide for the typical events of default, including a cross default clause, and the Company has made various representations and given various covenants to the lenders as are typical of such arrangements.

As a guarantor of the payments under the Loan Agreements, Mr. Qinghuan Wu, the Chief Executive Officer of the Company and the principal officer of the Borrower, Paying Agent and other affiliates, has pledged 8,000,006 shares for the repayment of the obligations under the Loan Agreements.

As a result of the Company not filing its periodic reports with the Securities and Exchange Commission ("SEC") under the Securities Exchange Act of 1934, as amended, on a timely basis for the fiscal year ended December 31, 2009 and the quarters ended March 31, 2010, June 30, 2010 and September 30, 2010, the Company was in violation of various loan covenants and default terms with respect its obligation to file SEC reports and comply with applicable laws under the terms of the loan for $4,000,000 in principal amount due January 15, 2013. The violation of the covenants and default permit the note holders to accelerate the repayment of the full amount of the principal and interest due on the loan. To date, the lenders have not delivered any notice of acceleration and have not indicated that they intend to give such a notice. One of the lenders representing $2,000,000 in principal amount of the loans provided to the Company on November 1, 2010, a waiver of the covenant and default terms and also provided the Company sufficient time to make the necessary past due filings, before a covenant violation or default would result again concerning these issues.

According to the loan agreement provisions, as an additional inducement to the Lender to make the Loan, which payment will not be considered interest hereunder, CER will issue to the Lender or its designee, on each date that an amount of principal of the Loan is paid, shares of common stock of CER, on a restricted basis, without registration rights, as follows:  If the RMB exchange rate between the RMB and United States Dollar (“USD”) is less than RMB 6.8271(the agreed upon exchange rate on the date of the making of the Loan), such that the value of the RMB is greater than the USD, then the difference in the principal installment calculated at the rate of RMB and calculated at the rate of RMB to USD on such repayment date will be converted into a US dollar amount and divided by the closing price of one share of common stock of CER on the OTC or stock exchange, the result of which will represent that number of shares to be issued to the Lender as of such date, in restricted stock. As of September 30, 2010, the derivative liabilities amounted to $133,299.The change in fair value of the derivative liability income amounted to $3,095 and loss amounted to $829 was recorded in the consolidated statements of operations for the three and nine months ended September 30, 2010, respectively. The interest expenses recognized for accretion to the redemption value of the long term loan was $16,951 and $33,980 for the three and nine months ended September 30, 2010.

 
21

 

Since the lenders have right to request early repayment, thus the long term loans and the derivative liabilities were reclassified to current liabilities as of September 30, 2010.

Contemporaneously with the funding of the Loan Agreements, on February 1, 2010, Mr. Qinghuan Wu, arranged for a loan from Haide Engineering (Hong Kong) Limited (“Haide”),a company controlled by Mr. Qinghuan Wu, to lend to the Company the sum of $1,000,000.  The proceeds of this loan will be forwarded to CER Yangzhou for additional paid-in capital which will help fund the new plant being built in China.  The loan bears interest at the annual rate of 9.5%, and is unsecured; the Company will pay the interest $23,750 at the end of every three calendar months. 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.

Note 10 – Convertible Notes

On May 21, 2009, the Company entered into a term loan agreement (“Convertible Notes Agreement”) with an investment company (the “Lender”). Pursuant to the Convertible Notes Agreement, the lender provides term loan financing (“Convertible Notes”) to the Company in an amount of up to $5,000,000 within 6 months, which may be drawn from time to time, in whole or in installments, upon notice, but once repaid shall not be subject to reborrowing. The proceeds from this Convertible Note are for the construction of a new plant located in China for the production of the products, including, but not limited to, the purchase of land for the plant, buildings, equipment and for the facilitating of financing loans from one or more in-China banks and other institutional lenders. Any amount borrowed will bear interest at 9.5%, payable every six months, calculated and compounded quarterly. Each draw is due twenty-four (24) months after the draw down date, together with any accrued and unpaid interest. The Company drew down $5,000,000 on September 29, 2009. For the three months ended September 30, 2010, interest expense of $565,170 was incurred. The Convertible Notes could be converted to 2,777,778 shares of common stock at the conversion price of $1.80. In addition, the Company has issued the Lender a five-year common stock purchase warrant (“Warrants”) to purchase up to 1,388,889 shares of the Company’s common stock, which is that number of shares of the Company’s common stock equal to 50% of the principal sum of this Convertible Note divided by the conversion price of $1.80. In connection with these Convertible Notes, the Company issued to the Lender one hundred shares of Series B preferred stock, that provides for voting rights and the ability to appoint directors in the event of defaults equal to or exceeding $1,000,000 in the aggregate amount.

The Lender may recall a Convertible Note after the first anniversary of the draw down at a redemption price equal to the outstanding principal plus any accrued and unpaid interest upon the closing by the Company of any debt and/or equity financing (except for debt financings with banks or institutional lenders in China), in an amount up to 50% of the amount financed.  Additionally, upon occurrence of certain events, the Lender can demand the entire outstanding principal, together with any accrued and unpaid interest to be immediately repaid in full or in part.  The Company can also prepay the Convertible Note at any time it desires with accrued interest and unpaid interest. On September 13, 2010, the Lender agreed not to exercise its right to request an early repayment prior to January 1, 2011.

As of September 30, 2010, all of the convertible notes are classified as a current liability. The embedded conversion feature is accounted for as a derivative liability separately in the balance sheet in accordance with ASC 815, Derivatives and Hedging, because the conversion price is denominated in USD, which is a currency other than the Company’s functional currency, RMB. All of the derivative liability is classified as current liability based on the timing of the cash flows derived from the Convertible Notes.  The Convertible Notes were recorded with a discount equal to the fair value of the conversion feature at the transaction date and were accreted to the redemption value of the Convertible Notes from the draw down date to the earliest redemption date using interest method. The change in fair value of the derivative liability of $25,825 and $848,654 was recorded in the consolidated statements of operations for the three and nine months ended September 30, 2010, respectively. The interest expenses recognized for accretion to the redemption value of the Convertible Notes was $231,997 and $697,253 for the three and nine months ended September 30, 2010, respectively.

 
22

 

 The grant value of the warrants issued in conjunction with the Convertible Notes was treated as a commitment fee for obtaining the Convertible Notes, and therefore the value was recorded as deferred financing cost to be amortized over the period from grant date to the earliest redemption date of the Convertible Notes. For the three and nine months ended September 30, 2010, $ 191,458 and $600,396 of deferred financing cost was amortized and charged to financial expenses, respectively. The Commitment Warrants were recorded as derivative liabilities in accordance with ASC 815, Derivatives and Hedging, because the exercise price of the Commitment Warrant is denominated in USD, which is a currency other than the Company’s functional currency, RMB.  Changes in fair value of the Commitment Warrants (Note 14) for the three months ended September 30, 2010 was recorded in the consolidated statements of operations.

 
23

 

Note 11 – Taxation

USA
CER, the Delaware holding company, was subject to US income tax at a rate of 34% on its assessable profits. No such tax has been assessed as the Group did not have assessable profit that was earned in or derived in the US during the years presented.

Hong Kong
CER Hong Kong subsidiaries were subject to Hong Kong profit tax at a rate of 16.5% on their assessable profits. No Hong Kong profit tax has been provided as the Group did not have assessable profit that was earned in or derived from Hong Kong subsidiaries during the years presented.

PRC
The New Enterprise Income Tax ("EIT") law was effective January 1, 2008 and the standard EIT rate is 25%. Pursuant to the PRC tax law, net operating loss can be carried forward 5 years to offset future taxable income.

Pursuant to the PRC income tax laws, Shanghai Engineering is subject to enterprise income tax at a statutory rate of 15% as a high technology entity. Shanghai Environmental, CER Shanghai and CER Yangzhou are subject to enterprise income tax at a statutory rate of 25%.  

   
Three months ended September 30,
 
   
2009
(Restated)
   
2010
 
Statutory CIT rate
    34.00 %     34.00 %
Tax differential from statutory rate applicable to entities in the PRC
    (12.24 )%     0.30 %
Permanent difference
    57.47 %     (9.60 )%
Allowance for deferred income tax assets
    (44.16 )%     (45.07 )%
Effective CIT rate
    35.07 %     (20.37 )%

   
Nine months ended September 30,
 
   
2009
(Restated)
   
2010
 
Statutory CIT rate
    34.00 %     34.00 %
Tax differential from statutory rate applicable to entities in the PRC
    (57.04 )%     6.82 %
Permanent difference
    (455.65 )%     1,098.86 %
Allowance for deferred income tax assets
    488.54 %     (1,852.97 )%
Effective CIT rate
    9.85 %     (713.29 )%
 
 
24

 

Deferred tax assets and liabilities without taking into consideration the offsetting of balances are as follows:

   
December 31,
   
September 30,
 
   
2009
   
2010
 
Deferred tax assets, current
           
Rental expenses
    67,276       -  
                 
Deferred tax assets, non-current:
               
Tax loss carry forwards
    2,178,667       2,892,892  
-Allowance for doubtful accounts and provision for inventory
    130,192       122,229  
Valuation allowance
    (1,822,225 )     (2,720,145 )
      486,634       294,976  
Total deferred tax assets
    553,910       294,976  
                 
Deferred tax liabilities, non-current:
               
Taxable temporary difference related to derivative liabilities
    (352,876 )     (149,298 )
Total deferred tax liabilities
    (352,876 )     (149,298 )

The net balances of deferred tax assets and liabilities after offsetting are as follows:

   
December 31,
   
September 30,
 
   
2009
   
2010
 
Deferred tax assets, current, net
    67,276       -  
Deferred tax assets, non-current net
    133,758       145,678  
Deferred tax liabilities, net
    -       -  

On February 22, 2008, the Ministry of Finance (“MOF”) and the State Administration of Taxation (“SAT”) jointly issued Cai Shui [2008] Circular 1 (“Circular 1”). According to Article 4 of Circular 1, distributions of accumulated profits earned by a foreign investment enterprise (“FIE”) prior to January 1, 2008 to foreign investor(s) in 2008 or after will be exempt from withholding tax (“WHT”) while distribution of the profit earned by an FIE after January 1, 2008 to its foreign investor(s) shall be subject to WHT at a rate up to 10% (lower rate is available under the protection of tax treaties). Since the Company intends to indefinitely reinvest its earnings to further expand the businesses in mainland China, the foreign invested enterprises do not intend to declare dividends to their immediate foreign holding companies in the foreseeable future. As a result, if any dividends are declared out of the cumulative retained earnings as of December 31, 2007, they should be exempt from WHT. Accumulated profit of foreign subsidiaries as of December 31, 2009 and September 31, 2010 were approximately $1,059,500 (RMB 7,844,000) and $1,006,928(RMB 7,485,886), respectively, and they are considered to be indefinitely reinvested.  Accordingly, no provision has been made.  No dividend was declared out of the cumulative retained earnings as of December 31, 2009 and September 30, 2010.

No provision for taxation has been made for CER Hong Kong, and CER Yangzhou for the three months ended September 30, 2009 and 2010, as those subsidiaries did not generate any taxable profits during the periods.

   
Three months ended September 30,
 
  
 
2009
 (Restated)
   
2010
 
US income tax benefit
  $ -     $ -  
HK income tax expense
    -       -  
PRC income tax (benefit)/expense
    (139,382 )     144,497  
Total  provision for income taxes expense
  $ (139,382 )   $ 144,497  
 
 
25

 
 
   
Nine months ended September 30,
 
  
 
2009
 (Restated)
   
2010
 
US income tax expense
  $ -     $ -  
HK income tax expense
    -       -  
PRC income tax expense
    8,900       345,647  
Total  provision for income taxes (benefit)/expense
  $ 8,900     $ 345,647  
 
The Company is incorporated in the U.S. and incurred a net operating loss for income tax purposes for the nine months ended September 30, 2009 and 2010. The net operating loss carry forwards for the U.S. income tax purposes is approximately $5,735,965  and $6,615,870  as of September 30, 2009 and 2010, respectively, which may be available to reduce future years' taxable income. These carry forwards will expire, if not utilized, in 20 years. Management believes that the realization of the benefits arising from this loss are uncertain due to Company's limited operating history and continuing losses for United States income tax purposes. In the year ended 31 December 2009, the Company accrued deferred tax liability due to convertible note of $431,970 of which the balance as of December 31, 2009 and September 30, 2010 was $352,876 and $149,298 respectively. Therefore the Company offset equivalent deferred tax asset and deferred tax liability. Except for the above mentioned deferred tax asset, the Company has provided a 100% valuation allowance of deferred tax asset at December 31, 2009 and September 30 2010. Management reviews this valuation allowance periodically and makes adjustments as warranted.
 
The valuation allowances as of December 31, 2009 and September 30, 2010 were as follows:

   
Amount
 
Balance of December 31, 2008
    1,173,146  
Increase
    649,079  
Balance of December 31, 2009
  $ 1,822,225  
Increase
    897,920  
Balance of September  30, 2010
  $ 2,720,145  

Note 12 – (Loss)/Earnings per Share

The Company reports earnings per share in accordance with the provisions of ASC 260, “Earnings Per Share”. This standard requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings(losses) per share excludes dilution and is computed by dividing net income(losses) available to common stockholders by the weighted average common shares outstanding during the period under the two-class method. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. In computing the dilutive effect of convertible securities, the number of shares is adjusted for the additional common stock to be issued as if the convertible securities are converted at the beginning of the period (or at the time of issuance, if later). In computing the dilutive effect of options and warrants, the treasury method is used. Under this method, options and warrants are assumed to be exercised at the beginning of the period and as if funds obtained thereby were used to purchase common stock at the average market price during the period. 

 
26

 

The following is a reconciliation of the basic and diluted earnings per share computations for the three and nine months ended September 30, 2009 and 2010:

   
Three months ended September 30,
 
   
2009
   
2010
 
   
(Restated)
       
             
Numerator:
 
 
       
Net loss for the period
    (258,118 )     (853,749 )
Amount allocated to preferred stockholders
    -       -  
Net loss available to common stock holders – Basic and diluted
    (258,118 )     (853,749 )
                 
Denominator:
               
Denominator for basic earnings per share -weighted average common stocks outstanding
    29,936,405       30,883,916  
Dilutive effect of series A preferred shares
    -       -  
Denominator for diluted earnings per share
    29,936,405       30,883,916  
Basic loss per share
    (0.009 )     (0.028 )
Diluted loss per share
    (0.009 )     (0.028 )


   
Nine months ended September 30,
 
   
2009
   
2010
 
   
(Restated)
       
             
Numerator:
 
 
       
Net income/(loss)  for the period
    81,476       (394,105 )
Amount allocated to preferred stockholders
    (936 )     -  
Net income (loss) available to common stock holders – Basic and diluted
    80,540       (394,105 )
Denominator:
               
Denominator for basic earnings per share -weighted average common stocks outstanding
    29,931,858       30,834,537  
Dilutive effect of series A preferred shares
    -       -  
Denominator for diluted earnings per share
    29,931,858       30,834,537  
Basic (loss)/earnings per share
    0.003       (0.013 )
Diluted (loss)/earnings per share
    0.003       (0.013 )

For the three and nine months ended September 30, 2009, there was no diluted effect to loss per share due to the anti-dilutive effect. Warrants to purchase 3,357,450 shares of common stock and options to purchase 760,000 shares of common stock as of September 30, 2009 were not included in the calculation of dilutive earnings/(loss) per share because of the anti-dilutive effect.

For the three and nine months ended September 30, 2010, there was no diluted effect to earnings per share due to loss position. Warrants to purchase 3,357,450 shares of common stock and options to purchase 560,000 shares of common stock as of September 30, 2010 were not included in the calculation of dilutive loss per share because of their loss effect.

 
27

 

Note 13 – Convertible Preferred Stock

Series A Convertible Preferred Stock

On April 15, 2008 and as a condition to closing of the Share Exchange, CER entered into Securities Purchase Agreements with 25 accredited investors pursuant to which CER issued and sold an aggregate of 7,874,241 units at a unit price of $1.08 (the "Financing"). Each unit consisted of one share of CER's Series A convertible preferred stock, par value of $0.001, and one warrant to purchase one-half of one share of CER's common stock at an exercise price of $1.29 per share. After the 1-for-2 reverse stock split conducted on April 16, 2008, the 7,874,241 shares of the Company’s Series A convertible preferred stock are convertible into 3,937,121 shares of common stock and the warrants are exercisable into 1,968,561 shares of the Company's common stock at an exercise price of $2.58 per share. The issuance costs of $1,859,902, including commissions, legal fees and transaction expenses were taken from the gross proceeds received. The net proceeds were allocated between the shares of Series A convertible preferred stock and warrants based on their relative fair values. As of the closing date, the fair value of Series A convertible preferred stock is estimated at $1.68 where as the fair value of the warrants is estimated at $0.85.  As a result, an aggregate amount of $5,307,539 was allocated to shares of Series A convertible preferred stock and $1,336,739 was allocated to the warrants. The fair value of the warrants was initially valued using the binomial model with assumptions such as, stock price, volatility, expected term, dividend, risk-free interest rate, etc.
 
The rights, preferences and privileges with respect to the convertible preferred stock are as follows:
 
Voting
 
Holders of Series A convertible preferred stock are entitled to the number of votes equal to the number of shares of common stock into which such shares of preferred stock could be converted and to vote as a single class.
 
Dividends
 
Holders of Series A convertible preferred stock are entitled to dividends when dividends are declared for common stockholders.  There have been no dividends declared to date.
 
Liquidation
 
In the event of any liquidation, dissolution or winding up of the Company, the holders of Series A convertible preferred stock shall be entitled to receive the amount of the original issue price per share (as adjusted for the 1-for-2 reverse stock split) for each Series A convertible preferred stock, plus all declared and unpaid dividends.
 
Conversion
 
Each share of Series A convertible preferred stock is convertible into common stock on a one-for-one basis, anytime at the option of the holder. The initial conversion price is $2.16 after taking into effect the 1-for-2 reverse stock split, and the conversion price is subject to adjustment in accordance with the anti-dilution clause.
 
There was no beneficial conversion feature recognized for the issuance of the shares of Series A convertible preferred stock on the issuance date as the estimated fair value of the common stock is less than the conversion price on the date of issuance.  The Company’s common stock was quoted on the OTCBB and has been publicly traded.  However, with the high volatility and extremely low volume traded during the time when the Company entered into this Financing transaction, the fair value of the Company’s common stock as of April 15, 2008 was determined based on the Company’s estimate relied in part on a valuation report prepared by an  independent valuer. The estimated fair value of the common stock was $1.55 per share.

 
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Adjustment of Series A Convertible Preferred Stock Conversion Price and Warrant Exercise Price

In accordance to the anti-dilution clause of the afore-mentioned Financing, if the Company shall issue additional shares without consideration or for consideration per share less than the conversion price and/or the warrant exercise price immediately prior to the issuance, such conversion price and exercise price shall be adjusted.  

For the three months ended September 30, 2010, no Series A convertible preferred stock was converted to common stock. For the nine months ended September 30, 2010, 462,963 shares of Series A convertible preferred stock were converted to 245,098 shares of common stock.

As of December 31, 2009 and September 30, 2010, the Company had 662,963 and 200,000 shares of Series A convertible preferred stock issued and outstanding, respectively.

Series B Convertible Preferred Stock

In connection with the Convertible Notes Agreement discussed in Note 10, the Company was required to issue to the Lender one hundred shares of Series B Preferred Stock, par value at $0.001. The Series B preferred stock provides voting rights and the right to appoint directors only in the event of defaults which equal or exceed $1,000,000 in the aggregate. The Series B preferred stock is senior to all other capital stock of the Company. The holder of the Series B preferred stock will not be entitled to any dividends, any liquidation preference of any kind, or any conversion right to convert the Series B preferred stock into the Company’s common stock.  

Note 14 – Warrant and Derivative Liabilities

In June 2008, the FASB issued authoritative guidance on determining whether an instrument (or embedded feature) is indexed to an entity’s own stock.  Under the authoritative guidance, effective January 1, 2009, instruments, which do not have fixed settlement provisions, are deemed to be derivative instruments.  The conversion feature of the Company’s convertible note (described in Note 10), the related warrants and the warrants issued in connection with the Series A convertible preferred stock, do not have fixed settlement provisions because their conversion and exercise prices are denominated in US dollars, which is a currency other than the Company’s functional currency.  Additionally, the Company was required to include the reset provision in order to protect the holders from potential dilution associated with future financings. In accordance with the FASB authoritative guidance, the conversion feature of the Convertible Notes was separated from the host contract (i.e. the Convertible Notes) and recognized as a derivative liability in the balance sheet, and the warrants issued in connection with the Convertible Notes and Series A preferred stock have been recorded as warranty liabilities in the balance sheet to be re-measured at the end of every reporting period with changes in fair values reported in the consolidated statements of income and other comprehensive income. 

The derivative liabilities were valued using both the Black-Scholes and Binomial valuation techniques with the following assumptions:

 
September 29,
2009
   
December 31,
2009
   
September30,
2010
 
 
(Issuance date)
             
Conversion feature of Convertible Note:
               
Risk-free interest rate
    0.95     1.14 %     1.05 %
Expected volatility
    79.86     83.32 %     60.0 %
Expected life (in years)
2.00 years
   
1.75years
   
1.00year
 
Expected dividend yield
    -       -       -  
 
                       
Fair Value:
                       
Conversion feature
  $ 1,270,500     $ 871,000     $ 22,346  
 
 
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We calculated the derivative liability on exchange rate based on the following key assumptions:

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September 30, 2010