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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the fiscal year ended: December 31, 2011

 

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 000-50155

 

NF ENERGY SAVING CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware 02-0563302
(State of Incorporation) (I.R.S. Employer ID Number)
   
3106, Tower C, 390 Qingnian Avenue, Heping District  
Shenyang, P. R. China 110015
 (Address of Principal Executive Offices) (Zip Code)

 

(8624) 8563-1159

(Issuer’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class Name of Each Exchange on Which Registered
Common stock, $0.001 par value The NASDAQ Stock Market

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ¨ No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes ¨ No x

 

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

 

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 S No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of "accelerated filer", "large 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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.).

Yes ¨ No x

 

As of June 30, 2011, the aggregate market value of the common equity held by non-affiliates of the registrant was $4,613,136 based on the price of $1.6556 per share which the registrant’s common stock was last sold.

  

As of March 2, 2012 there were 5,326,501 shares of the registrant’s common stock outstanding.

 

 
 

 

NF ENERGY SAVING CORPORATION

FORM 10-K

 

TABLE OF CONTENTS

 

  Page No.
PART I    
Item 1 Business 5
Item 1A Risk Factors 21
Item 1B Unresolved Staff Comments 33
Item 2 Properties 33
Item 3 Legal Proceedings 34
Item 4 Mine Safety Disclosure 34
PART II    
Item 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 35
Item 6 Selected Financial Data 36
Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 36
Item 7A Quantitative and Qualitative Disclosures About Market Risk 48
Item 8 Financial Statements and supplementary data 48
Item 9 Changes In and Disagreements With Accountants on Accounting and Financial Disclosure 50
Item 9A Controls and Procedures 50
Item 9B Other Information 51
PART III    
Item 10 Directors, Executive Officers and Corporate Governance 51
Item 11 Executive Compensation 54
Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 55
Item 13 Certain Relationships and Related Transactions, and Director Independence 56
Item 14 Principal Accountant Fees and Services 57
PART IV    
Item 15 Exhibits and Financial Statement Schedules 58

 

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CAUTIONARY STATEMENT REGARDING FORWARD LOOKING INFORMATION

 

Certain statements in this Annual Report on Form 10-K (“Form 10-K”) pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including statements of our expectations, intentions, plans and beliefs, including those contained in or implied by “Management’s Discussion and Analysis” and the Notes to Consolidated Financial Statements, are “forward-looking statements”, within the meaning of Section 21E of the Exchange Act that are subject to certain events, risks and uncertainties that may be outside our control. The words “believe”, “expect”, “anticipate”, “optimistic”, “intend”, “will”, and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. The Company undertakes no obligation to update or revise any forward-looking statements. These forward-looking statements include statements of management’s plans and objectives for our future operations and statements of future economic performance, information regarding our expansion and possible results from expansion, our expected growth, our capital budget and future capital requirements, the availability of funds and our ability to meet future capital needs, the realization of our deferred tax assets, and the assumptions described in this report underlying such forward-looking statements, our expansion and acquisition strategy, our ability to achieve operating efficiencies, , industry pricing and technology trends, evolving industry standards, regulatory matters, general economic and business conditions, the strength and financial resources of our competitors, our ability to find and retain skilled personnel, the political and economic climate in which we conduct operations and the risk factors described from time to time in our other documents and reports filed with the Securities and Exchange Commission (the “Commission”). Additional factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to: 1) our ability to successfully develop, manufacture and deliver our products on a timely basis and in the prescribed condition; 2) our ability to compete effectively with other companies in the same industry; 3) our ability to raise sufficient capital in order to effectuate our business plan; and 4) our ability to retain our key executives.

 

Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business.

 

For further information about these and other risks, uncertainties and factors, please review the disclosure included in this report under “Part I, Item 1A - Risk Factors.”

 

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PART I

 

ITEM 1. BUSINESS

 

The Company

 

As used herein the terms “we”, “us”, “our,” “NFEC” and the “Company” means, NF Energy Saving Corporation, a Delaware corporation, formerly known as NF Energy Saving Corporation of America, Diagnostic Corporation of America, Global Broadcast Group, Inc., and Galli Process, Inc. These terms also include our subsidiaries, Liaoning Nengfa Weiye Energy Technology Company Ltd., a corporation organized and existing under the laws of the Peoples’ Republic of China (“PRC”), and Liaoning Nengfa Weiye Tie Fa Sales Co., Ltd., a limited liability corporation organized and existing under the laws of the PRC.

 

NF Energy Saving Corporation was incorporated under the laws of the State of Delaware under the name of Galli Process, Inc. on October 31, 2000 for the purpose of seeking and consummating a merger or acquisition with a business entity organized as a private corporation, partnership, or sole proprietorship. On December 31, 2001, Galli Process, Inc. became a majority owned subsidiary of City View TV, Inc., a Florida corporation (“City View”). On February 7, 2002, Galli Process, Inc. changed its name to Global Broadcast Group, Inc. On March 1, 2002, City View merged into Global Broadcast Group, Inc., which was the surviving entity. On November 12, 2004, the Company changed its name to Diagnostic Corporation of America. On March 15, 2007, we changed our name to NF Energy Saving Corporation of America, and on August 24, 2009, the Company further changed its name to NF Energy Saving Corporation, in both instances to more accurately reflect our business after the Plan of Exchange (see below). Our principal place of business is 3106, Tower C, 390 Qingnian Avenue, Heping District, Shenyang, P. R. China 110015. Our telephone number is (8624) 8563-1159.

 

On November 15, 2006, we executed a Plan of Exchange (“Plan of Exchange”), among the Company, Liaoning Nengfa Weiye Pipe Network Construction and Operation Co. Ltd. (“Nengfa”), the shareholders of Nengfa (the "Nengfa Shareholders") and Gang Li, our Chairman and Chief Executive Officer (“Mr. Li”). At the closing of the Plan of Exchange, which occurred on November 30, 2006, we issued to the Nengfa Shareholders 12,000,000 shares of our common stock, or 89.4% of our then outstanding common stock, in exchange for all of the shares of capital stock of Nengfa owned by the Nengfa Shareholders. Immediately upon the closing, Nengfa became our 100% owned subsidiary, and the Company adopted and implemented the business plan of Nengfa.

 

On September 5, 2007, we established a new sales company, Liaoning Nengfa Weiye Tie Fa Sales Co., Ltd. (“Sales Company”). Sales Company is a subsidiary, which is 99% owned by Liaoning Nengfa Weiye Energy Technology Company Ltd. Sales Company engages in the sales and marketing of flow control equipment and products in PRC.

  

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On January 31, 2008, to better reflect our energy technology business, we changed the name of Nengfa to Liaoning Nengfa Weiye Energy Technology Company Ltd. (“Nengfa Energy”). Nengfa Energy’s area of business includes research and development, processing, manufacturing, marketing and distribution of energy saving flow control equipment; manufacturing, marketing and distribution of energy equipment, wind power equipment and fittings; energy saving technical reconstruction; and energy saving technology consulting services.

 

On August 26, 2009, the Company completed a 3 to 1 reverse share split of its common stock. As a result, the total number of shares of outstanding common stock changed from 39,872,704 pre-split to 13,291,387 post-split shares.

 

On September 15, 2010 the Company completed a 2.5 to 1 reverse share split of its common stock, the total number of shares of outstanding common stock changed from 13,315,486 pre-split to 5,326,501 post-split shares.

 

On October 4, 2010 our common stock commenced trading on the Nasdaq Global Market. On March 7, 2012, upon approval approved by Nasdaq , our common stock transferred from the Nasdaq Global Market to the Nasdaq Capital Market , Our common stocks trades on the Nasdaq Stock Market under the ticker symbol “NFEC”.

 

The structure of our corporate organization is as follows:

 

 

Business Description

 

NFEC is dedicated to energy efficiency enhancement in two fields: (1) manufacturing large diameter energy efficient intelligent flow control systems for thermal and nuclear power generation plants, major national and regional water supply projects and municipal water, gas and heat supply pipeline networks; and (2) energy saving technology consulting, optimization design services, energy saving reconstruction of pipeline networks and contractual energy management services for China’s electric power, petrochemical, coal, metallurgy, construction, and municipal infrastructure industries.

 

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NFEC has received many awards and honors from China's regulators, professional associations and renowned international organizations, including the ISO 9001:20000 certification from Det Norske Veritas Management System, the Liaoning Provincial Government's Award of Innovative Enterprise with Best Investment Return Potentials, the Special Industrial Contribution Award of the ESCO Committee of China Energy Conservation Association, and the Grade A Tax Payer Enterprise Award by the Liaoning State Local Tax Administration.

 

NFEC enjoys a reputation as a leader and dedicated energy saving company in China for over 15 years. Its professional capacity as a provider of energy services is officially certified by China's National Development and Reform Commission (NDRC). It has been a corporate member on the Board of the ESCO Committee of China Energy Conservation Association and a founding member of China Standardization and Technical Consortium for Energy Conservation and Emission.

 

As a certified energy service provider , NFEC is entitled to various tax breaks and energy saving awards created by Chinese governments at national, provincial and local levels. The major tax incentives by the central government includes two-year corporate income tax exemption plus a three-year reduction of corporation income tax for all energy performance based, profit sharing energy service projects. The government policy also incentivizes NFEC's clients with tax refunds on goods and properties of the energy saving projects when NFEC transfers to them at the end of energy service contracts.

 

The current principal development focus of NFEC is to complete the on-going construction project of the new manufacturing facility which will triple the company's capacity to produce large intelligent flow control systems and to provide our company with more advanced technology to supply upper grade energy efficient and safety reliant products for high end markets such as nuclear power plants and super critical power generation plants.

 

Our corporate goal is to maintain our established position as a leading provider of energy efficiency flow control systems, an cutting edge innovator with clean energy and energy efficiency technologies, and a total energy efficiency solution and service provider dedicated to maximum returns to our investors, partners, clients and environment.

 

Products and Services

 

Our products and services include the manufacturing and sales of energy-saving flow control equipment, energy saving technology consulting, optimization design services, energy saving reconstruction of pipeline networks and contractual energy management services for China’s electric power, water power, petrochemical, coal, metallurgy, construction, and municipal infrastructure development industries. Examples of contracts entered into by the Company or its subsidiaries are:

 

·In 2007, Nengfa Energy received contracts for our products and services to be used in three sub-sections of the prominent “South to North Water Transfer and Supply Project." The subsections were completed and passed inspection in 2008.

 

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·In 2008, the Company received flow control equipment contracts from seven cities in Liaoning Province for their water supply systems.

 

·In 2009, the Company was awarded several flow control equipment supply contracts, including one for the Xijiang diversion project of Guandong Province, and one for Phase 1 of Guangdong Yuedian Huilai Power Plant.

 

·In 2010, the Company received contracts for our products and services to be used in over 50 companies, including Chongqing Water Turbine Company, Chongqing Fangneng Electricity Power Company, Zhejiang Zheneng Jiahua Electricity Power Co. Ltd, and Shaoxing Binhai Thermal Power Company, and a project contract with a Fuxin inner-Mongolian county.

 

·In 2011, the Company received contracts for our products, including from Jiangsu Changshu Electricity Power Ltd, India RODA Supercritical Coal Fired Power Station, India KAWAI Supercritical Coal Fired Power Station, Zhejiang Zheneng Zhongmei Zhoushan Coal and Electricity Company, Shenzhen Qinglinjing Water diversion project, Chongqing Yunneng Electricity Power Ltd, and Shenyang Mining Machinery Ltd .

 

Production and Sales of Energy Saving Flow Control Equipment

 

The Company’s current principal business is the production and sales of energy-saving flow control equipment, and intelligent flow control equipment. This business currently accounts for the majority of the Company’s revenues.

 

Pipeline transport is one of the basic modes of transportation together with rail transport, road transport, air transport and water transport. Water, gas, oil, and heat rely on various kinds of pipelines and pipe networks to be transported to end users. In the case of water pipelines, such systems are also used for public health and safety, and waste and flood control.

 

The key to the efficiency and energy conservation of the pipeline transportation process is the valve and the flow control equipment. Having unique technology in this field, the Company has obtained four patents and holds twelve utilization model patents in China for flow control devices, especially in the area of the bidirectional seal zero revelation installation system with its special characteristics. Using valves of this type can result in reduced energy consumption by 20% for customers compared to traditional valves. The reduced energy consumption thereby increases the efficiency of the pipeline system. It is widely used in the fields of electric power, hydro power, petroleum, and natural gas. The Company’s super intelligent flow-control device was awarded “Number One Energy Saving Valve of China” by the Chinese Energy Conservation Association. Our products currently are exported to the United States, Russia, Turkey, Japan, South Korea, Vietnam, India, Iraq, and Afghanistan.

 

Once the Company’s new manufacturing facility is completed, the newly installed numerical controlled machines will allow the Company to manufacture and process technologically advanced flow control equipment with greater precision. This will enable the Company to expand its markets into nuclear power station equipment and new high precision energy related equipment.

 

8
 

 

Because improved manufacturing and use of sophisticated technologies are important revenue drivers for the Company and represent an important part of its energy efficiency focus, the Company will continue to develop comprehensive energy conservation and energy reduction equipment and services, and to pursue research development and improved manufacturing of flow control and clean energy related equipment.

 

Energy Saving Reconstruction Projects

 

1.Energy Efficiency Retrofitting Projects on Industrial Boilers and Furnaces

 

Our business also focuses on the reconstruction of various industrial boiler/furnace systems with the objective of modernization and improvement in the overall efficiency of existing systems. Efficiency can be expressed in several ways, such as lower operating costs, reduced energy consumption, recapture of by-products which can be used for other purposes, and pollution reduction.

 

China’s industrial boilers and furnaces are used mainly in the iron and steel, metallurgy, building materials, machinery manufacturing, chemical industry and other similar energy consumption industries. Their energy consumption accounts for about 10% of China’s total energy consumption. It is estimated that as many as half of the enterprises have outdated technology and equipment, and experience a significant waste of energy. Using our existing technology, we can reconstruct the boiler’s or furnace’s structure, its heat source system, combustion system, and control system, and thereby both improve the overall efficiency of the system and yield important conservation and pollution control benefits.

 

One of the most important opportunities for the Company is to undertake projects that refurbish or reconstruct industrial boilers and create cogeneration opportunities for coal fired boilers. It is estimated that as many as 95% of the industrial boilers in China are coal fired. These types of industrial boilers are very inefficient because: (i) most industrial coal burning boilers use traditional traveling grate boilers, only a small portion of the coal fired boilers are equipped with advanced technology, such as the pulverized coal combustion or circulating fluidized bed. The traveling grate boilers are smaller in capacity than required for the purpose for which they are employed, their output is not matched to the auxiliary equipment used by the boilers, because of their low combustion and thermal efficiency the traditional coal fired boilers emit more CO2 and NOx, and the boilers are typically at or beyond their estimated useful life. Overall, it is estimated that these types of boilers are operating at about 60-70% of their efficiency, which is about 20% below that of international best practice. The inefficiency, in part, results from their use of mixed sizes of coal particles in layer combustion. Among these types of boilers, about 60% of them are clockwise rotation boilers. The use of the differing sizes of the coal particles results in a highly inefficient combustion, due to the poor ventilation for the effective combustion and the accumulation of dust which chokes the combustion. Therefore, the coal is not totally burned and there is a loss of potential energy. The current methods of coal feed to the boilers and the current combustion cannot solve this problem. Given the large quantities of these types of industrial boilers, approximately 0.3~0.4 million sets of traveling grate boilers currently in-use Company sees a significant opportunity to focus on boiler transformation technology and projects.

 

9
 

 

The Company’s solution is to redesign and reconstruct elements of an existing boiler or boiler system to improve its overall performance and increase its optimization rates. This is done in a number of different ways, such as the following:

 

a) Boilers using a pulverized coal fired or a clockwise rotation chain grate system can be refitted with a circulating fluidized bed combustion technology. This change has the benefit of allowing the boiler to use a lower grade of coal but improve the thermal efficiency. The ash from the fluidized bed combustion system can be used in building materials, which is a valuable by-product and reduces pollution output.

 

b) The control system of a boiler can be either reconstructed or modified to improve the operations of the unit and system.

 

c) The coal feed system of a boiler system can be altered to provide more efficient coal layer arrangement according to different volume and nature of the coal , with the effect that the boiler will fully combust the coal. This improves the operating cost and fuel optimization.

 

d) Another change that can be made to boilers is to improve the ventilation system, which can result in increased fuel combustion efficiency and hence reducing the operating costs.

 

e) One of the most important improvements that the Company seeks to introduce into existing and into new boiler systems are methods to reclaim discharged water. The Company designs recovery equipment which permits recovery of significant amounts of the waste water used in a traditional boiler. This recovery can also improve the capture of pollutants by the boiler system.

 

f) A boiler’s heat recovery can be improved, whether it is coal, natural gas or petroleum fueled. By-product heat can be used in a number of different ways, such as to create steam for other uses or localized heating of the factory. The capture and use of the residual heat reduces its emission into the atmosphere thereby reducing heat pollution. This can be an additional source of income or help reduce operating costs and pollution.

 

The Company is capable of designing and introducing steam thermal systems into existing systems with the effect of recovering the condensed water, eliminating the leakage losses due to faulty or worn steam trap valves and improving the heat preservation systems.

 

2. Motor Drive Reconstruction

In China, motor drive systems use about two thirds of the total electricity consumption of the country. About 90% of these motors are AC asynchronous motors. Nengfa Energy redesigns such systems to convert them so that they can be used for variable load fans and pumps through frequency conversion and speed regulation technology. NF Energy focuses on the reconstruction and energy conservation of the fans of power station boilers, industrial furnaces and kilns, and the energy-saving pumps in the cold/hot water pipe system. As we analyze the whole industrial reconstruction projects, we can also provide power conservation reconstruction in solid material conveyor systems used in the mining, metallurgy, iron and steel industries.

 

10
 

 

It is estimated that approximately 12% of China’s electric power consumption is for lighting. As one of the most important energy-saving projects, the Chinese government plans to distribute 150 million energy-saving lamps throughout the country during the "Eleventh Five Year Plan" period through a fiscal subsidy in an effort to replace inefficient incandescent lamps and other lighting products. The government also plans to reduce the consumption of power by changing the use of lighting through a rational distribution of public lighting, improving the quality of power consumption and introducing on-demand controls. Between 2008 and 2009, the Company, as one of the companies assigned by the National Development and Reform Commission, has distributed 2.5 million green lighting products in Liaoning Province China.

 

3.Energy-Saving and Reconstruction of Steam Heat Energy System

 

As a high quality source of secondary energy, steam is widely used in petroleum, petrochemical, chemical, paper making, brewing, tobacco, steel, pharmaceutical, packaging, machinery, and electronics among other industries. The total energy efficiency of steam is directly determined by the system’s energy efficiency. The characteristics of the steam and condensation system are highly complex, due to factors such as the need for a condensation traps and vacuum breakers, the damage from water hammer, corrosion of the heat exchanger and leakage, condensation, pollution and purification, steam consumption’s imbalance in winter and summer, steam consumption’s mismatching between high and low pressures, the flash steam problem, and steam leakage. For a long time, due to the irrationality of system design, the complexity of the system itself, the negligence of owners, the imprecision of management, and the deficiency of maintenance, the overall energy efficiency of steam systems in China is very low. Therefore, the Company believes there is a significant opportunity for energy savings in steam systems:

 

1)     Approximately 0.5 billion tons of standard coal is consumed annually, which is above 1/3 of the total national consumption of fossil fuels.

 

2)     The overall energy efficiency of steam systems in China is only approximately 30%, which is 25% lower than well developed countries.

 

3)     The annual energy waste due to the low energy efficiency of steam systems is approximately 120 million tce, which is estimated to be worth over 120 billion RMB.

 

4)     The annual waste due to inefficient transportation and distribution of steam systems is approximately 180 million tce.

 

5)     Of the more than 1 million traps being used in steam systems in China, 60% of them have above average leakage, 30% of them have serious leakage, and only less than 10% work normally. The waste due to trap leakage is significant.

 

6)     Current condensation systems are generally designed in such a way as to be inappropriate to the system, resulting in the average recovery rate being less than 30% thus causing large waste of heat energy and water. 

      

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Working with energy saving experts in steam systems in China, the Company has built a steam system department. This department has an R&D and design team, which can provide energy conservation solutions for efficient and the long lasting energy saving results. Under normal conditions, the reduction of steam energy cost is generally between 10% to 25%.

 

Our energy conservation solutions improve energy efficiency in steam systems in five principal ways, covering the entire process of the steam and condensation system: steam generation, steam transportation and distribution, steam consumption, and condensation recovery and condensation purification.

 

1)    Steam generation stage

 

Our energy saving measures include: using the boiler’s long-term stable heat sink resources to fully absorb low temperature waste heat and reduce fuel consumption; correctly designing the generator in order to reduce the steam consumption of the deoxygenizing process and increasing the efficiency of the boiler; controlling boiler blowdown and fully utilizing the waste heat of blowdown water; adjusting the steam load with steam accumulator; and improving the quality of steam.

 

2)    Steam transportation and distribution stage

 

Our energy saving measures include: designing the most economical  flow speed of steam, reducing leakage, draining condensation correctly, filtering dirt and debris, reducing pressure drop loss, improving steam quality, and avoiding water hammer. The most serious problems to be addressed are water hammer, big drops in steam pressure, high steam humidity and low steam quality caused by errors in the design of the condensation trapping system.

 

3)    Steam consumption stage

 

In this stage, we improve the energy efficiency of the steam system by studying the difference in details between designed and actual steam consumption of each heat exchanger, and looking for the root causes of excessive energy consumption; consuming lower pressure steam as far as possible when meeting the process's demands; equipping the system with a vacuum breaker and air valve in beehive heat exchangers; designing a condensation trapping system correctly to avoid waterlogging;controlling temperatures automatically in the heating process; installing a separator for steam and vaporous water in the inlet of important equipment to ensure steam quality; optimizing the condensation pipe system according to the residual pressure of each heat exchanger; and enhancing daily inspection and maintenance.

 

4)    Condensation recovery stage

 

In this stage, we improve steam efficiency by optimizing the overall condensation piping system and deploying decentralized, cutting-edge pressure pump recovery technology; comprehensive treatment on flash steam; comprehensive utilization of heat sink resources; and limit water hammer. The key to optimizing the overall condensation piping system is to identify different condensations according to the residual pressure as “strong”, “mainstream” and “weak”, thus minimizing the mutual interference between different residual pressures.

 

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5)    Condensation purification stage

 

The Company’s “solvent impregnated resin oil desorption technology” can separate emulsified oil molecules and dissolved oil molecules from high temperature condensation directly through the resin’s lipophilicity and hydrophobicity. Before separation, “emulsification breaking”, “capturing” and “enriching” are completed automatically. When the oil molecules adsorbed in the face of the resin reaches a certain saturation level, the enriched oil will be separated from the resin as large oil-drops through the flow impact of condensation water inside the tank. After separation the oil-drops float into an oil-water separator and the off-oil resin will start to work automatically. In the oil-water separator the oils will separate from water automatically.

 

NF Energy’s condensation iron deprivation technology is called “Powder Ion Exchange Resin Coverage and Filtration Technology”. We utilize this technology to separate excessive metal oxides, colloids and iron ion (Fe3+ & Fe2+) from high temperature condensation. The technical principles are filtration, adsorption, and ion replacement; the processes are film formation, operating, toggling, back-washing and film formation again.

 

We estimate the energy saving market for steam systems is very large in China. We believe the annual consumption of steam systems is approximately 0.5 billion tce. The overall energy efficiency of steam systems in China is only approximately 30%, which is 25% lower than well developed countries. The annual energy waste due to low energy efficiency of steam systems is approximately 120 million tce, which is worth over 120 billion RMB. If all the energy saving projects in steam systems were operated under a EPC (Energy Performance Contract) model, and the average profit were to equal three years of energy-saved we estimate, the value of the energy-saving market for steam system in China would be approximately 360 billion RMB.

 

4.Biomass Utilization Projects

 

A new business for the Company is biomass power generation projects. The Company cooperates actively with different levels of municipal governments, corporations and strategic partners, to jointly develop potential projects in this area. At present, the Company is discussing with a municipality a biomass central gas supply project to a county. This project will use the slurry from local chicken farms and straw to generate gas and establish a city gas pipeline supply system.

 

Biomass is the only renewable resource which can directly produce gases, liquids, solid and other clean energies in large-scale. The development and utilization of biomass energy will help diversify the energy structure and achieve the objective of low-carbon development in China. It is also important for adjusting the industrial structure, promoting the mode of economic growth, and promoting a sustainable economic and social development. Currently, the potential energy converted from organic waste in China is equivalent to approximately 500 million tons of standard coal. The estimated future potential of such conversion can reach to 700 million to 1 billion tons of standard coal, which approximately 15%- 20% of total energy consumption in future. We believe the development of biomass energy has significant business potential.

 

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In 2010,the Company has worked on biomass utilization projects to reduce the consumption of coal. These projects bring, not only economic benefits, but also environmental benefits as well.

 

5.Comprehensive Energy Conservation And Emission Reduction Services For Municipalities

 

A 2012 government report from the office of the Chinese Premier, Wen Jiabao stated that: “We made progress in conserving energy,reducing emissions,and protecting the ecological environment. We adopted and implemented the Comprehensive Work Plan for Conserving Energy and Reducing Emissions and the Work Plan for Controlling Greenhouse Gas Emissions for the Twelfth Five-Year Plan period, and the Guidelines on Strengthening Key Environmental Protection Tasks. The installed power capacity using clean energy reached 290 million KW,and increase of 33.56 million KW over the previous year. We strengthened the development of major energy conservation and environmental protection projects. We increased daily sewage treatment capacity by 11 million tons in urban areas, and installed desulphurization systems on all new coal-fired power-generating units with a total capacity of over 50 million KW. We tightened controls over industries that are energy intensive, have high emissions or possess excess production capacity, and closed down outdated production facilities whose production capacity amounted to 150 million tons of cement, 31.22 million tons of iron, and 19.25 million tons of coke.”This indicates that in 2012 and thereafter low carbon initiatives”…will become a new impetus and engine for economic developments,and it will become a new weathervane for construction of leading industrial systems and consumption patterns. ”

 

On April 6, 2010, the State Council of China approved the “Opinion on Accelerating the Implementation of Energy Management Contract to Promote the Development of Energy Service Industry,” (“the Opinion”) which was proposed by the National Development and Reform Commission, the Ministry of Finance, People’s Bank of China and the State Taxation Administration. A series of new tax benefits will stimulate China’s domestic energy conservation projects and services development. NF Energy will further develop its energy conservation projects by using “Energy Management Contract” (“EMC”) and “Energy Performance Certificate” models.

 

The stimulation plan of expanding environmental infrastructure that the Chinese government implements, should provide the Company with a significant opportunity to provide energy saving services to the government supported infrastructure and industrial companies’ energy saving infrastructure. In October 2010, the Company was recommended as one of the first batch of “Energy Saving Service Companies” by Chinese National Development and Reform Commission, and consequently, we believe that we will benefit from the government’s new tax deduction policy to energy saving service companies.

 

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In 2011, the Twelfth Five Year Plan was launched with seven strategic emerging industries’ being promoted, including new energy and renewable energy. The production of electric power development continues to increase in major river valleys, and it is anticipated that the total installed capacity will reach 1.4 billion kilowatts by 2015. Hydropower to be installed will reach between 280 and 290 million KW; nuclear power to be installed will reach between 40 and 50 million KW; wind power installed will reach between 90 and 100 million KW; it is anticipated that the total output will reach between 1.6 and 1.8 billion KW, hydropower and nuclear power to be installed will reach 70 – 80 million KW and 100 -150 million KW respectively. Conventional thermal power will be maintained at current levels, which can also generate new opportunities for us.

 

Looking forward 10 years, the fixed asset investment in hydro development is expected to be 4 trillion RMB, which is a 400 billion RMB annual investment on average. The investment in such field was 180 billion RMB in 2009. The annual growth is estimated to 122%. Investment in hydro power is expected to be between 800 and 900 billion RMB for the next 5 years; the investment on re-installed incremental capacity in the Twelfth Five Year Plan is estimated to triple the actual investment achieved in the eleventh five year plan.

 

As a result of the Twelfth Five-Year Plan, we believe ecological environmental protection will bring about high demand and supply in the market. Many aspects will be developed continuously ,such as desulfurization, denitration, industrial sewage and water supply and sewerage works of the city

 

Therefore, the Company believes that it has strong market opportunities not only in terms of intelligent flow control equipment and energy efficient flow control equipment it supplies to power plants, hydropower plants and water transportation projects, but also in terms of energy conservation services and energy saving projects by using the EPC model. The Company already has experience in energy project management in China. Going forward, the Company plans to further develop its business model and regularly seek projects to develop comprehensive energy conservation and emission reduction solutions for energy saving reconstruction of steam heat energy system projects, industrial waste heat utilization,industrial boiler and furnace retrofitting and reconstruction, biomass utilization and other energy conservation fields.

 

Patents and Technology

 

Nengfa Energy currently has been issued four invention patents and has applied for twelve utility model patents in the PRC. We will maintain the innovation of the new product in order to maintain our leading position in the market.

 

The invention patents include the following:

 

1.Processing technology of butterfly valve seal (ZL2006 1 0152644.8), which expires on September 26, 2026;

 

2.Butterfly valve body dynamic seal ring pointing device (ZL2007 1 0159250.X), which expires on December 28, 2027;

 

3.The closing and locking equipment for valves (ZL2009 1 0011939.7), which expires on June 11, 2029; and

 

4.Valve body active seal circle position monitor equipment (ZL2009 2 0014504.3), which expires on July 21, 2030.

 

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The utility model patents that we have applied for include the following:

 

5.An energy-saving heat-sink used in heating (ZL2008 2 0218146.3), with an application date of September 23, 2008

 

6.A device used in energy-saving boiler combustion ( ZL2008 2 0218145.9), with an application date of September 23, 2008;

 

7.Butterfly valve sealing ring instruction device (ZL2007 2 0185293.0), with an application date of December 12, 2007;

 

8.Butterfly valve with block for opening butterfly plate (ZL2007 2 0185289.4), with an application date of December 12, 2007;

 

9.Piston flow-adjusting valve with removable piston sealing ring (ZL2007 2 0185288.X), with an application date of December 12, 2007;

 

10.J-shapes large dimension butterfly valve hard sealing ring (ZL2007 2 0185292.6), with an application date of December 12, 2007;

 

11.Composite valve sealing ring (ZL2007 2 0185290.7), with an application date of December 12, 2007;

 

12.Multi-level buffering full oriented valve fuel tank (ZL2007 2 0185287.5), with an application date of December 12, 2007;

 

13.Fluid control valve on-off speed control device (ZL2007 2 0185286.0), with an application date of December 12, 2007;

 

14.T-shaped large dimension butterfly valve rubber sealing ring (ZL2007 2 0185291.1), with an application date of December 12, 2007;

 

15.Butterfly valve with butterfly plate adjusting device (ZL2008 2 0231340.5), with an application date of, September 23, 2008; and

 

16.Two-way sealed butterfly valve (ZL 2009 2 0014504.3), with an application date of June 11, 2009.

 

In addition to the patent protection that we seek, we also rely on the confidentiality of our operations, proprietary know-how and business secrets. Although we do not have formal agreements with our employees, we do consider our employees work to be proprietary and owned by the Company. Where necessary, we will take steps to protect our intellectual property interests under the laws of the PRC. There can be no assurance that we will be able to enforce our rights if they are improperly taken by our employees or adopted by our competitors outside of sanctioned use and royalty agreements with the Company.

 

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Certain of our service offerings will not be patentable or otherwise registrable as intellectual property. Therefore, the Company will rely solely on such services being proprietary. As such the Company will have to rely on the services being more advanced or better than its competitors’ offerings or rely on trade secret laws and protections. Such protections in the PRC are considered rather weak and are difficult if not impossible to enforce. Consequently, it may be possible for our competitors to obtain our information and to copy, adopt or adapt our methods, services and technical aspects to their own business with no assurance that we will be able to prevent them from using the intellectual property in competition with us.

 

The Company does not have any significant trademarks in use at this time. As our business develops, we will consider the advantage of developing specific trademarks for our products and services and seeking registration of those marks with the PRC government authorities for their protection.

 

Markets and Customers

 

The South-North Water Diversion Project is a multi-decade project undertaken by the Chinese government to better utilize water resources available to China. Part of this massive project was brought forward to provide additional water supply for the 2008 Olympics in Beijing. While the main task is to divert water from the Yangtze River to the Yellow River and Hai River, other spin-off plans are also included. Among these, a plan calling for the capture and diversion of water from Brahmaputra River, located in Yarlung Zangbo Grand Canyon north of India, has been under study for years. This is because the heavily industrialized Northern China has a much lower rainfall and its rivers are running at reduced rates as demand increases for industrial water and general population usage. For example, the Yellow River and Hai River have experienced significant flow reduction and at times during certain years have been dry.

 

Currently, the Grand Canal is being upgraded, as the Eastern route for diverting water to the North. Water from the Yangtze River will be drawn into the canal in Jiangdu City, where a giant 400 m³/s. pumping station was built in the 1980s, and will then be fed uphill by pumping stations along the Grand Canal and through a tunnel under the Yellow River, from where it can flow downhill to reservoirs near Tianjin. Construction on the eastern route officially began in December 2002, and water is supposed to reach Tianjin by 2012.

 

The central route for the water diversion project is from Danjiangkou Reservoir on the Han River, a tributary of the Yangtze River, to Beijing. This route is built on the North China Plain and, once the Yellow River has been crossed, water can flow all the way to Beijing by gravity. The main engineering challenge is to build a tunnel under the Yellow River. Construction on the central route began in 2004. In 2008 the 307 km-long northern stretch of the central route was completed at a cost of $2 billion. Water in that stretch of the canal does not yet come from the Han River, but from various reservoirs in Hebei Province south of Beijing. Farmers and industries in Hebei have had to cut back their water consumption to allow for water to be transferred to Beijing. The whole project was initially expected to be completed around 2010, however, this has recently been set back to 2014 to allow for more environmental protection elements to be built into the system. A major difficulty in completion of the central route has been the resettlement of approximately 250,000 persons around Danjiangkou Reservoir and along the route. Another consideration that has to be accommodated in the implementation of the central route is the effect of removing approximately one third of the water from Han River and the effect of that reduction on the environment and other users that currently depend on the Han River. One long-term plan to reduce the effect on the Han River basin is to build another canal to divert water from the Three Gorges Dam to Danjiangkou Reservoir.

 

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The western route for the water diversion project is to divert water from the headwaters of the Yangtze River into the headwaters of the Yellow River. In order to move the water through the drainage divide between these rivers, huge dams and long tunnels are needed to be built to cross the Tibetan-Qinghai and Western Yunnan Plateaus. The feasibility of this route is still under study and this part of the project will not start anytime soon.

 

To date, the Company has participated in the water diversion project by being a supplier of flow control equipment for various parts of the water flow infrastructure, with contract value over $3 million for the first four phases of the project. And as part of providing that equipment, the Company has also provided design and related services. The contracts related to this project accounted for 10% of total revenues in 2011. We anticipate that revenues related to this project will continue to represent a significant portion of the Company revenues for 2012. In the newly released Twelfth Five Year Plan announced by Chinese government, the fixed asset investment in hydro and water diversion projects will be increased dramatically in the next 5 to 10 years. The expected investment is 4 trillion RMB in 10 years, with annual average investment of 400 billion RMB. This is 122% higher than the investment in 2009.

 

In addition to the water diversion project, the Company also supplies flow control equipment and related equipment to the power generation industry (thermal power plants, hydroelectric, wind and nuclear power plants). Customers in these market segments are well-established, larger state and private corporations. Combined, these markets represent approximately 90 % of the revenues of the Company for 2011.

 

In connection with its work on the water diversion project and some of the power plan projects, the Company has a preferred provider agreement with Nengfa Weiye Tieling Valve Joint Stock Co., Ltd. (“Tieling Valve”) under which Nengfa Energy is the preferred provider of the valves and other related flow control equipment that Tieling Valve requires in its own work on the water diversion project. The agreement is in the manner of a right of first refusal whereby Tieling Valve is obliged to offer supply opportunities to Nengfa Energy within its scope of product offerings and expertise, but Tieling Valve is not prohibited from developing other supply arrangements. Tieling Valve and Nengfa Energy have agreed to cooperate to develop and market their respective technologies, equipment, products and services for their respective and mutual benefit, and will work together to examine and expand their respective businesses. Under the agreement, each party retains full right to their respective intellectual property. The agreement terminates in 2013, but by its terms will automatically extend for additional one year terms unless notice of termination is given by one party to the other at least six months prior to the then termination date.

 

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The Company will focus its marketing to the wind power generation and the boiler/furnace industry through participation in and addressing government organizations and industry associations related to energy conservation and emission reduction. Marketing will also focus on equipment suppliers and end-users such as the larger and medium sized high energy consumption enterprises that provide or use the kinds of products and services that the Company currently offers or plans to offer. The focus will not only be to sell the products and services, but also to learn of the customers needs so that the Company can develop and adapt its products and services to the needs of its customer base. Another important aspect of the marketing strategy will be to participate directly in the consulting and reconstruction services of energy conservation projects organized by government agencies. Nevertheless, the Company plans to continue to participate in the bidding process for government projects, in an effort to enhance its market position.

 

The Company’s marketing and sales strategy also relies on the use of exclusive agents throughout China who act as marketing agents and after sale service providers. The Company currently has 23 exclusive agents national wide. At certain times each year, the Company provides and organizes training sessions for these agents and their personnel. These sessions provide the Company with a valuable opportunity to gather feedback and to foster an exchange of technical ideas. These agents have agreements with the Company to sell NF flow control equipment and systems, and they are managed by the Sales Company. The Company evaluates the productivity of these exclusive agents annually, based on how well they achieve the annual sales target established by the Company. The Company typically will terminate its agreement with those agents that miss the sales targets.

 

Raw Materials

 

The major raw materials for our production are pig iron, steel, copper, and plastic. We source our materials locally in China. Nengfa Energy is located in Liaoning Province which is China’s largest production base for iron and steel. We have stable long term supply arrangements for our principal raw material suppliers based on long standing business relationships. Since we are located close to the supplies of many of our essential raw materials, we enjoy price and transportation cost advantages over our competitors and competing users. Through our advanced technology and our management of raw materials, we are able to manage and improve our consumption rates of the raw materials we use in production, which results in lower operating expense and extension of our inventories.

 

Regulatory Compliance

 

The products that represent a majority of our sales are subject to regulatory standards and enforcement codes which typically require that these products meet stringent performance criteria. Standards are established by industry testing and certification organizations such as the Ministry of Mechanical and Electronic Engineering of China, the American Society of Mechanical Engineers (A.S.M.E.), the Canadian Standards Association (C.S.A.), the Japanese Standards Association (J.S.A.), the International Association of Plumbing and Mechanical Officials (I.A.P.M.O.), Factory Mutual (F.M.), and Underwriters Laboratory (U.L.). These standards are incorporated into state and municipal plumbing and heating, building and fire protection codes in China.

 

We maintain stringent quality control and testing procedures at each of our manufacturing facilities in order to manufacture products in compliance with code requirements. Our products are certified to conform to the ISO 9001 standards by the Det Norske Veritas Management System.

 

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Competition

 

We think that the valve products of the Company place it in a leading position in the super-saving flow control in China. The Company has an extensive competitive advantage compared to Chinese domestic manufactures in this field. Other manufactures that are focusing on the development of different products may finally enter into this field. Our potential competitor is China Valve Technology in this this field.

 

In the other areas of the Company’s business, there are many different competitors with differing focuses and strengths. To some extent, boilers and furnaces are specialized to particular industries and output requirements. This specialization engenders specialization in the design, manufacture and installation of new equipment and retrofit solutions. Therefore, there are many engineering and manufacturing companies that focus on certain types of boilers and furnaces resulting in a relatively fragmented market for these services. The same is true for the retrofit and reconstruction of other industrial systems for improved energy efficiency, as well as for the localized projects for energy conservation and biomass utililization, and similar projects. Therefore, the competition that the Company faces tends to be localized companies with no dominant players at this time.

 

The utilization of Biomass energy is matured in China. Although the technology is widely used in China, it is still at a stage of individual household build gas digesters, rather with a large scale piped gas supply system. The county-city level gas supply project the Company concentrates on will generate a local area monopoly business operation. There is no direct competition in short term.

 

We plan to compete based on our ability to address a wide spectrum of solutions in our various market areas. We believe our competitive advantages result from our patented technologies, our strategic relationships with engineering companies, our marketing and our business relationships. We plan to continue to expand these aspects of our business to further grow our core businesses and provide solutions for the energy savings and green energy projects. We intend to participate actively in the government sponsored projects and government contracting.

 

Research and Development

 

The research and development expenses are to develop new products or new production technologies.The research and development expenses include the materials and labor costs, application fees for patents and significant improvements to existing products. During the year of 2010 and 2011, we completed two patents and applied for one additional utilization model patent as well as a series of improvements to existing products , the accumulated increase R&D cost of $120,451 for two years.

 

Employees

 

As of December 31, 2011, there were 225 employees including 32 technical staff working in our subsidiaries located in China. We believe we have a good relationship with our employees.

 

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Others

 

Our internet website address is http://www.nfenergy.com . Through our website, we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports, proxy statement and registration statements, and all of our insider Section 16 reports, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission, or SEC. These SEC reports can be accessed through the “Investors” section of our website.

 

ITEM 1A. RISK FACTORS

 

Investors should carefully consider the following risk factors, in addition to other information included in this annual report, in evaluating NF Energy Saving Corporation and our business. If any of the following risks occur, our business, financial condition and operating results could be materially adversely affected.

 

Risks Related to Our Business

 

We have a relatively short operating history and are subject to the risks of any growing enterprise, any one of which could limit our growth and our product and market development.

 

Our operating history makes it difficult to predict how our businesses will develop and where the Company will find success. This is especially true in respect of our expansion into areas other than flow valve technology and their design, sales and installation. Accordingly, we face all of the risks and uncertainties encountered by companies in earlier stages of development and initial expansion, such as: (i) uncertain and continued market acceptance for our product extensions and our services; (ii) the evolving nature of the wind energy equipment industry in the PRC, where significant consolidation may occur, leading to the formation of companies which may be better able to compete with us than is currently the case; (iii) the fragmented nature of the boiler and furnace business which may limit our ability to penetrate the market and provide comprehensive solutions on a sufficiently wide basis to make the business profitable; (iv) changing competitive conditions, technological advances or customer preferences could adversely effect the sales of our products or services; (v) maintaining our competitive position in the PRC and competing with Chinese and international companies, many of which have longer operating histories and greater financial resources than us; (vi) continuing to offer commercially successful products to attract and retain a larger base of direct customers and ultimate users; (vii) maintaining effective control of our costs and expenses; and (viii) retaining our management and skilled technical staff and recruiting additional key employees.

 

If we are not able to meet the challenges of building our businesses and managing our growth, the likely result will be slowed growth, lower margins, additional operational costs and lower income.

 

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We may be unable to generate sufficient cash flow from operations or obtain financing in the future to support our operations and expansion.

 

Having access to sufficient operating funds and capital funds for expansion will affect our ability to execute our business plan. We finance our business mainly through internally generated funds and, from time to time, selling equity securities to raise additional capital. There is no guarantee that we will always have internal funds available for our future development or that we will be able to raise capital from investor financing and loans granted by investors and financial institutions in the future. In addition, there may be delays in the process of selling our securities, which may require us to cut back on our operations or expansion activities. Our access to debt or equity financing depends on the investors’ and banks’ willingness to lend to and invest in us, our financial condition and on general conditions in the capital markets. We may not be able to secure additional sources of financing on commercially acceptable terms, if at all. Any shortfall in our cash flow and capital needs may result in our having to curtail our business plans or have an adverse effect on our financial condition.

 

We believe that we need to raise additional capital for the expansionary elements of our business plan, which financing may not be available or available on terms favorable to us.

 

During the next phase of our business development, as we continue our planned expansion into the wind energy equipment segment and other aspects of the energy savings industry, including steam energy, we believe that we will need to raise additional capital from outside sources during the next year or two. We cannot be certain that we will be able to obtain additional financing on favorable terms, if at all. One possible impediment to raising capital is the tightening credit policies of the Chinese banks and the continued effects of tightening in the global credit markets as a result of the recent economic financial crisis. If we cannot raise additional capital on acceptable terms, we may not be able to develop or enhance our products or services, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements. We cannot be sure that we will be able to secure all the financing we will require, or that it will be available on favorable terms. If we are unable to obtain any necessary additional financing, we will be required to substantially curtail our approach to implementing our business objectives. Additional financing may be debt, equity or a combination of debt and equity. If equity is used, it could result in significant dilution to our shareholders.

 

Efforts to protect our intellectual property rights and to defend against claims against us can increase our costs and will not always succeed. Any failures could adversely affect our sales and results of operations or restrict our ability to conduct our business.

 

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Intellectual property rights are important to many aspects of our business. We actively pursue patent protection in our flow valve business, and we expect to pursue intellectual property rights in our other business endeavors as we develop unique solutions to business demands. We, however, may be unable to obtain protection for our intellectual property. Even if protection is obtained, competitors may raise legal challenges to our rights or illegally infringe on our rights, including through means that may be difficult to prevent, detect or defend. In addition, because of the rapid pace of technological change and the confidentiality of patent applications in some jurisdictions, competitors may be issued patents from applications that were unknown to us prior to issuance. The patents of others could reduce the value of our commercial or pipeline of products or, to the extent they cover key technologies on which we have unknowingly relied, require that we seek to obtain licenses at a financial cost to us or cease using the technology, no matter how valuable the patents may be to our business. We cannot assure you we would be able to obtain such licenses on acceptable terms. Also, litigation may be necessary to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of our and the proprietary rights of others. There is a risk that the outcome of such litigation will not be in our favor. Such litigation may be costly and may divert management attention as well as expend other resources which could otherwise have been devoted to our business. An adverse determination in any such litigation will impair our intellectual property rights and may harm our business, prospects and reputation. In addition, we have no insurance coverage against litigation costs and would have to bear all costs arising from such litigation to the extent we are unable to recover such costs from other parties. The occurrence of any of the foregoing may harm our business, results of operations and financial condition.

 

Finally, implementation of PRC intellectual property-related laws has historically been limited, primarily because of ambiguities in the PRC laws and difficulties in enforcement. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries, which increases the risk that we may not be able to adequately protect our intellectual property.

 

For aspects of our business we rely on strategic relationships, and there is no assurance that we will be able to renew these arrangements.

 

We have several strategic relationships which provide us with access to technology and provide us with a competitive advantage. These include the relationships with Shanghai Electric Co., LTD., Sichuan Eastern Electric Co., LTD,Harbin Electric Co., LTD, China Datang Corporation, China Huadian Group, China Huaneng Group and China Guodian Group. There is no guarantee that any of these agreements and arrangements will provide the benefits that we hope will result or that the relationships will be renewed on substantially similar terms or at all. Moreover, there is no assurance that any steps we have already taken or might take in the future will ensure the successful renewal of any or all our rights or the granting of further new rights or that the terms of any renewals would not be significantly less favorable to us than the terms of our current agreements. The loss of such arrangements or diminution of the rights may have an adverse impact on our business development, including product offerings, research and development and competitive position.

 

We derive a substantial part of our revenues from several major customers, therefore if we lose any of these customers or they reduce the amount of business they do with us in the future, our revenues may be affected

 

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Our first largest customer, Nengfa Weiye Tieling Valve Joint Stock Co. Ltd, accounted for 39% of our revenues for the years ended December 31, 2011 Our second largest customer, Zhongye Valve Group Co. Ltd accounted for 21% of our revenue in the year ended December 31, 2011.As of December 31,2011, these two customers accounted for 60% in our total revenue and will continue to be the largest customers in 2012. These customers may not maintain the same volume of business with us in the future. If we lose any of these customers or they reduce the amount of business they do with us, our revenues may be materially and adversely affected. Although we have a strategic partnership with our current largest customer and a preferred provider agreement with our current second largest customer till until up to 2013 and the agreement can be automatically extended . there can be no assurance that these customers will continue to provide the current level of demand or will not seek to modify or terminate their respective agreements.

 

Our technology may not satisfy the changing needs of our customers.

 

With any technology, including the technology of our current and proposed products, there are risks that the technology may not successfully address our customers' needs. Certain of our product offerings in relation to the wind energy equipment will be new for the Company. While we have already established successful relationships with our customers, their needs may change or vary. This may affect the ability of our present or proposed products to address all of our customers' ultimate technology needs in an economically feasible manner.

 

We may not be able to keep pace with rapid technological changes and competition in our industry.

 

While we believe that we have hired or engaged personnel and outside consultants who have the experience and ability necessary to keep pace with advances in technology, and while we continue to seek out and develop "next generation" technology through our research and development efforts, there is no guarantee that we will be able to keep pace with technological developments and market demands in this evolving industry and market. In addition, our industry is competitive in various aspects. Although we believe that we have developed strategic relationships to best penetrate the China market, we face competition from other manufacturers of product similar to our products and services. Some of these companies have significant advantages over us with respect to their products, marketing and services, and their financial resources and customer relationships.

 

If we are not as successful as our competitors in our target markets, our sales could decline, our margins could be negatively impacted and we could lose market share, any of which could materially harm our business.

 

We depend on our productivity capacity to complete existing orders and provide delivery on time. If we are unable to finish the production when needed we would experience delays in realizing our sales objectives and our financial results could be adversely affected. The first phase of our new production facility, which will include expansion for a number of our business lines, including our wind energy equipment business, was completed in the end of 2011 and the second phase of it is under construction and expected to be fully completed by the end of second quarter of 2012. If there is a delay completing the new facility, or ramping up the new facility for production, it will negatively impact our production capability, which in turn would negatively affect our financial results.

 

We may experience high accounts receivable balances from time to time, which may have an adverse effect on our operating profitability and cash flow and financing needs.

 

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Although we generally have a 30 to 90 day accounts receivable period, if our customers extend the period in which they pay, we will experience a reduced cash flow, which could have an adverse effect on our ability to fund our operations and growth. One result may be that we will have to obtain outside financing and our operating expense will increase. Extension of the accounts receivable period may also result in reduced collections, which will adversely affect our operations and profitability.

 

In 2011, we have two new large customers, and we offered them a better accounts receivable collection policy than our other customers. Although these customers are large entities with good creditability, the return payments may delay, and result in reduced collections, which will adversely affect our operations and profitability.

 

To the extent that we depend on government projects, our business is dependent on government policy and, to some extent, government funding and government contracts.

 

Although we do not characterize our business as a government contractor, some aspects of our business are indirectly dependent on government policy, government funding, and government contracts. For example, the water diversion project is largely a government funded project, and our customers are contractors with the government. On the other hand, our saving-energy project and adjustment of our product and service which are depended on the policies issued by the government . As a consequence, it is possible that our requirements based on the product and service to be provided will be diminished resulting in a decrease in our revenue. It is possible that our wind energy equipment business will also be highly dependent on government funding, if not government contracts. Much of the pollution control and green industries are dependent on government policy to implement societal improvements. Our business has a number of aspects that are dependent on the government and our products, services and revenues are dependent on policies that can change if the government officials determine to redirect attention and investment to other aspects of society and industrial development.

Additionally, as a number of our customers are dependent on the government for their revenues through the provision of products and services on government contracts or government funded projects, there may be delays in our receiving payment for our products and services.

 

Fluctuation in the availability and cost of our raw materials may have an adverse effect on our operations and results of operations.

 

A portion of the inventory of raw materials and parts may be affected by fluctuations in the availability of the items and the price. Such things may include steel, electronic components, power systems, paints and welding rods. We do not generally have long term supply contracts with our suppliers, but rely on long standing relationships. To the extent that we are not able to obtain the required materials and parts necessary to enable us to fabricate our products, or we are required to pay more for such items, then there could be an adverse effect on our operations and our results of operations.

 

We may be unable to effectively manage our growth.

 

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As we expand our business into several different areas of energy savings and green industry, we will need to manage our growth effectively, which may entail devising and effectively implementing business plans, training and managing our growing workforce, managing our costs, and implementing adequate control in our reporting systems in a timely manner. We may not be able to successfully manage our growth. Our failure to do so could affect our success in executing our business plan and adversely affect our revenues, profitability and results of operations.

 

If we fail to successfully manage our planned expansion of operations, our growth prospects will be diminished and our operating expenses could exceed budgeted amounts.

 

Our ability to offer our products and services in an evolving market and in different markets requires effective planning and management process. Since inception, and we intend to continue to expand them in the foreseeable future. This rapid growth places significant demand on our managerial and operational resources and our internal training capabilities. In addition, we plan to increase our total work force. This growth will place a substantial burden on our management team. To manage growth effectively, we must implement and improve our operational, financial and other systems, procedures and controls on a timely basis and expand, train and manage our workforce, particularly our sales and marketing and support organizations. We cannot be certain that our systems, procedures and controls will be adequate to support our current or future operations or that our management will be able to handle such expansion and still achieve the execution necessary to meet our growth expectations. Failure to manage our growth effectively could diminish our growth prospects and could result in lost opportunities as well as operating expenses exceeding the amount budgeted.

 

If we fail to establish and maintain an effective system of internal control, we may not be able to report our financial results accurately or to prevent fraud. Any inability to report and file our financial results accurately and timely could harm our business and adversely impact the trading price of our common stock.

 

We are required to establish and maintain internal controls over financial reporting, disclosure controls, and to comply with other requirements of the Sarbanes-Oxley Act and the rules promulgated by the SEC thereunder. Our management, including our Chief Executive Officer and Chief Financial Officer, cannot guarantee that our internal controls and disclosure controls will prevent all possible errors or all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. In addition, the design of a control system must reflect the fact that there are resource constraints and the benefit of controls must be relative to their costs. Because of the inherent limitations in all control systems, no system of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Further, controls can be circumvented by individual acts of some persons, by collusion of two or more persons, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may become inadequate because of changes in conditions or the degree of compliance with policies or procedures may deteriorate. Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.

 

26
 

 

Our operations are vulnerable to natural disasters or other events.

 

Our operating income may be reduced by natural disasters, in locations where we own and/or operate significant manufacturing facilities or are working on significant projects. Some types of losses, such as from earthquake, severe winter storms and environmental hazards, may be either uninsurable or too expensive to justify insuring against. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in any particular property, as well as any anticipated future revenue from such property.

 

Our products may contain defects, which could adversely affect our reputation and cause us to incur significant costs.

 

Despite numerous testing and quality controls, defects may be found in existing or new products. Any such defects could cause us to incur significant return and exchange costs, re-engineering costs, divert the attention of our engineering personnel from product development efforts, and cause significant customer relations and business reputation problems. Any such defects could force us to undertake a product recall program, which could cause us to incur significant expenses and could harm our reputation and that of our products. If we deliver products with defects, our credibility and the market acceptance and sales of our products could be harmed.

 

Our business could be subject to environmental liabilities.

 

We use certain hazardous substances in our operations. Currently we do not anticipate any material adverse effect on our business, revenues or results of operations, as a result of compliance with Chinese environmental laws and regulations. However, the risk of environmental liability and charges associated with maintaining compliance with environmental laws is inherent in the nature of our business, and there is no assurance that material environmental liabilities and compliance charges will not arise in the future.

 

In addition, we have entered into a supplement to our Lease Agreement with Tieling Valve, the landlord for our current production facilities, pursuant to which Tieling Valve is responsible for disposing and discharging of the pollutants generated from our activities at our production facility and paying the discharge fee to the relevant authorities. There can be no assurance that Tieling Valve will continue to fulfill its responsibilities with respect to compliance with environmental protection regulations, or that we will not be exposed to liabilities as a result of such non-compliance, which liabilities could result in a material adverse effect on our business.

 

We have limited business insurance coverage in China

 

27
 

 

 

The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited business insurance products. As a result, we do not have any business liability or disruption insurance coverage for our operations in China. Any business disruption, litigation or natural disaster might result in substantial costs and diversion of resources.

 

Because our funds are held in banks in the PRC that do not provide insurance, the failure of any bank in which we deposit our funds could affect our ability to continue in business.

 

Banks and other financial institutions in the PRC do not provide insurance for funds held on deposit. A portion of our assets are in the form of cash deposited with banks in the PRC, and in the event of a bank failure, we may not have access to our funds on deposit. Depending upon the amount of money we maintain in a bank that fails, our inability to have access to our cash could impair our operations, and, if we are not able to access funds to pay our suppliers, employees and other creditors, we may be unable to continue in business.

 

We substantially depend on a few key personnel who, if not retained, could cause declines in productivity and operational results and loss of our strategic guidance, all of which would diminish our business prospects and value to investors.

 

Our success depends to a large extent upon the continued service of a few executive officers and key employees, including, Mr. Gang Li, our Chairman, Chief Executive Officer and President. The loss of the services of one or more of our key employees would have an adverse effect on us and our PRC operating subsidiaries, as these individuals play a significant role in developing and executing our overall business plan and maintaining customer relationships and proprietary technology systems. While none of our key personnel is irreplaceable, the loss of the services of any of these individuals would be disruptive to our business. We believe that our overall future success depends in large part upon our ability to attract and retain highly skilled managerial and marketing personnel. There is no assurance that we will be successful in attracting and retaining such personnel on terms acceptable to the Company or the employee. Inadequate personnel will limit our growth, and will be seen as a detriment to our prospects, leading potentially to a loss in value for investors.

 

We are controlled by a small group of our existing stockholders, whose interests may differ from other stockholders.

 

Our Chairman, Chief Executive Officer and President, Mr. Gang Li, beneficially owns approximately 38.15% of the outstanding shares of our common stock and is our largest single stockholder. Together with, Ms Lihua Wang, who is our Chief Financial Officer, they own 47. 69% of the outstanding shares of our common stock. Accordingly these stockholders acting together will have significant influence in determining the outcome of any corporate transaction or other matter submitted to the stockholders for approval, including mergers, consolidations, the sale of all or substantially all of our assets, election of directors and other significant corporate actions. They will also have significant influence in preventing or causing a change in control. In addition, without the consent of these stockholders, we may be prevented from entering into transactions. The interests of these stockholders may differ from the interests of the other stockholders.

 

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We are responsible for the indemnification of our officers and directors.

 

Delaware law and our Bylaws provide for the indemnification of our directors, officers, employees, and agents, under certain circumstances, against costs and expenses incurred by them in any litigation to which they become a party arising from their association with or activities on our behalf. Consequently, we may be required to expend substantial funds to satisfy these indemnity obligations. Any payment in respect of these indemnification rights could have an adverse effect on our cash flow and our results of operations.

 

Risks Related to Our Company’s Common Stock

 

Future sales of our common stock could adversely affect our stock price.

 

We have a substantial amount of outstanding shares held by persons that are able to sell or will be able to sell in the near future under Rule 144. The holders of these shares subject to Rule 144 include our significant shareholders and a number of investors. If our shareholders sell substantial amounts of our common stock in the public market, the market price of our common stock could be adversely affected. In addition, the sale of these shares could impair our ability to raise capital through the sale of additional equity or equity based securities.

 

Trading volume of our common stock has fluctuated from time to time, which may make it difficult for investors to sell their shares at times and prices that investors feel are appropriate.

 

To date, the trading volume of our common stock has fluctuated. Generally, lower trading volumes adversely effects the liquidity of our common stock, not only in terms of the number of shares that can be bought and sold at a given price, but also through delays in the timing of transactions and reduction in security analysts’ and the media’s coverage of us. This may result in lower prices for our common stock than might otherwise be obtained and could also result in a larger spread between the bid and asked prices for our common stock.

 

The Nasdaq Capital Market imposes listing standards on our common stock that we may not be able to fulfill, thereby leading to a possible delisting of our common stock.

 

As a listed Nasdaq Capital Market company, we are subject to rules covering, among other things, certain major corporate transactions, the composition of our Board of Directors and committees thereof, minimum bid price of our common stock and minimum stockholders equity. We currently are not in compliance with Nasdaq’s minimum bid price requirement. The failure regain compliance with Nasdaq’s minimum bid price requirement or meet the other Nasdaq Capital Market requirements may result in the de-listing of our common stock from the Nasdaq Capital Market, which could adversely affect the liquidity and market price thereof.

 

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We believe that period-to-period comparisons of our financial results will not necessarily be indicative of our future performance.

 

The price for our common stock may fluctuate in response to a number of events and factors, such as quarterly variations in operating results, announcements of technological innovations or new products and media reports by us or our competitors, changes in financial estimates and recommendations by securities analysts, the operating and stock price performance of other companies that investors may deem comparable to us, and news reports relating to trends in our markets or general economic conditions. The volatile price of our stock makes it difficult for investors to predict the value of our investment, to sell shares at a profit at any given time, or to plan purchases and sales in advance.

 

In addition, the stock market in general has experienced extreme price and volume fluctuations that may have been unrelated and disproportionate to the operating performance of individual companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance.

 

Because we have not paid dividends, investors will not realize any income from an investment in our common stock unless and until investors sell their shares at profit.

 

We have not paid dividends on our common stock, and we do not anticipate paying any dividends in the near future. Investors will only realize income on an investment in our stock in the event they sell or otherwise dispose of their shares at a price higher than the price they paid for their shares. Such a gain would result only from an increase in the market price of our common stock, which is uncertain and unpredictable.

 

The payment of any future dividends will be at the discretion of the Board of Directors and will depend upon a number of factors, including future earnings, the success of our business activities, general financial condition, future prospects, general business conditions and such other factors as our Board of Directors may deem relevant.

 

Risk Related to Doing Business in China

 

Adverse changes in economic and political policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.

 

All of our business operations are currently conducted in the PRC, under the jurisdiction of the PRC government. Accordingly, our results of operations, financial condition and prospects are subject to a significant degree to economic, political and legal developments in China. China’s economy differs from the economies of most developed countries in many respects, including with respect to the amount of government involvement, level of development, growth rate, and control of foreign exchange and allocation of resources. While the PRC economy has experienced significant growth in the past 20 years, growth has been uneven across different regions and among various economic sectors of China. The PRC government has implemented various measures to encourage economic development and guide the allocation of resources. Some of these measures benefit the overall PRC economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.

 

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Unprecedented rapid economic growth in China may increase our costs of doing business, and may negatively impact our profit margins and/or profitability.

 

Our business depends in part upon the availability of relatively low-cost labor and materials. Rising wages in China may increase our overall costs of production. In addition, rising raw material costs, due to strong demand and greater scarcity, may increase our overall costs of production. If we are not able to pass these costs on to our customers in the form of higher prices, our profit margins and/or profitability could decline

 

We may suffer currency exchange losses if the RMB depreciates relative to the US Dollar.

 

Our reporting currency is the US Dollar. However, substantially all of our revenues are denominated in RMB. In July 2005, China changed its exchange rate regime by establishing a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. The RMB is no longer officially pegged to the US dollar, and the exchange rate will have some flexibility, although recently it has been fairly stable. Despite the stability, there is increasing pressure to dissociate the RMB from the US Dollar and let it float more in line with the state of the Chinese economy and other important trading currencies. Hence, considering the floating exchange rate regime, if the RMB depreciates relative to the US Dollar, our revenues as expressed in our US Dollar financial statements will decline in value and if the RMB appreciates relative to the US Dollar, our revenues as expressed in our US Dollar financial statements will increase in value. There are very limited hedging transactions available in China to reduce our exposure to exchange rate fluctuations. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we may not be able to successfully hedge our exposure, if at all. In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into US Dollars.

 

Labor laws in the PRC may adversely affect our results of operations.

 

On January 1, 2008, the PRC government promulgated the Labor Contract Law of the PRC, or the New Labor Contract Law. The New Labor Contract Law imposes greater liabilities on employers and significantly impacts the cost of an employer’s decision to reduce its workforce. Further, it requires certain terminations to be based upon seniority and not merit. In the event we decide to significantly change or decrease our workforce, the New Labor Contract Law could adversely affect our ability to enact such changes in a manner that is most advantageous to our business or in a timely and cost effective manner, thus materially and adversely affecting our financial condition and results of operations.

 

Changes in PRC Corporate Income Tax Law may affect our effective tax.

 

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In March 2007, the Chinese government enacted the Corporate Income Tax Law, and promulgated related regulations, which were effective January 1, 2008. The Corporate Income Tax Law, among other things, imposes a unified income tax rate of 25% for both domestic and foreign invested enterprises. The previous income tax laws and rules, which stipulated income tax rates for domestic and foreign invested enterprises at different rates, expired upon the effectiveness of the Corporate Income Tax Law.

 

The Corporate Income Tax Law provides a five-year transitional period for those entities established before March 16, 2007, which enjoyed a favorable income tax rate of less than 25% under the previous income tax laws and rules, to gradually change their rates to 25%. In addition, the Corporate Income Tax Law provides grandfather treatment to allow foreign invested enterprises to continue to enjoy their unexpired tax holiday under the previous income tax laws and rules.

 

The Corporate Income Tax Law also imposes a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding company outside China, which were exempted under the previous income tax laws and rules. A lower withholding tax rate will be applied if there is a tax treaty arrangement between mainland China and the jurisdiction of the foreign holding company. Holding companies in Hong Kong, for example, will be subject to a 5% rate. All of these foreign invested enterprises will be subject to the withholding tax on January 1, 2008. Since we intend to reinvest our earnings to further expand our businesses in mainland China, we do not intend to declare dividends in the foreseeable future. Accordingly, as of December 31, 2011, we have not recorded any withholding tax on the retained earnings of our foreign invested subsidiary in China.

 

The Corporate Income Tax Law emphasizes the requirement of an arm’s length basis for transfer pricing arrangements between related parties. Also, it requires enterprises with related party transactions to prepare transfer pricing documentation which includes the basis for determining pricing, the computation methodology and detailed explanations. Under a tax inspection by tax authorities, if our transfer pricing arrangements between the China-based subsidiaries are judged as tax avoidance, or related documentation does not meet the requirements of the Corporate Income Tax Law, our China-based subsidiaries may be subject to tax adjustments and late payment interest.

 

Our China subsidiary Nengfa Energy, being a foreign invested enterprise, enjoyed a two year exemption from corporate income tax for 2007-2008 and a reduced corporate income rate of 15% for the three years from 2009-2011. If we cannot continue to obtain the unexpired tax holidays and reduced corporate tax rate or if the withholding tax on dividends is applied to our business, our effective tax rate will be increased significantly.

 

Governmental control of currency conversion may affect the value of your investment

 

The PRC government imposes controls on the convertibility of the RMB into foreign currencies and, in certain cases, the remittance of currency out of China. We receive all our revenues in RMB. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade related transactions, can be made in foreign currencies without prior approval from the SAFE by complying with certain procedural requirements. However, approval from the SAFE or its local branch is required where RMB is to be converted into foreign currency and can be remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions.

   

The PRC legal system embodies uncertainties which could limit the legal protections available to us and you, or could lead to penalties on us.

 

The PRC legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little precedential value. In 1979, the PRC Government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. The overall effect of legislation over the past 25 years has significantly enhanced the protections afforded to various forms of foreign investment in mainland China. Our PRC operating subsidiary, Nengfa Energy, a wholly foreign-owned enterprises (“WFOEs”), is subject to laws and regulations applicable to foreign investment in the PRC in general and laws and regulations applicable to WFOEs in particular.

 

It may be difficult to enforce any civil judgments against us or our board of directors or officers, because most of our operating and/or fixed assets are located outside of the United States.

 

Although we are incorporated in the State of Delaware, most of our operating and fixed assets are located in the PRC. As a result, it may be difficult for investors to enforce judgments outside the United States obtained in actions brought against us in the United States, including actions predicated upon the civil liability provisions of the federal securities laws of the United States or of the securities laws of any state of the United States. In addition, certain of our directors and officers (principally based in the PRC) and all or a substantial portion of their assets are located outside the United States. As a result, it may not be possible for investors to effect service of process within the United States upon those directors and officers, or to enforce against them or us judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the federal securities laws of the United States or of the securities laws of any state of the United States. We have been advised by our PRC counsel that, in their opinion, there is doubt as to the enforceability in the PRC, in original actions or in actions for enforcement of judgments of United States courts, of civil liabilities predicated solely upon the federal securities laws of the United States or the securities laws of any state of the United States.

 

Because our assets are located overseas, shareholders may not receive distributions that they would otherwise be entitled to if we were declared bankrupt or insolvent.

 

Because all of our assets are located in the PRC, they may be outside of the jurisdiction of U.S. courts to administer if we are the subject of an insolvency or bankruptcy proceeding. As a result, if we declared bankruptcy or insolvency, our shareholders may not receive the distributions on liquidation that they would otherwise be entitled to if our assets were to be located within the U.S., under U.S. Bankruptcy law.

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES

 

Our main manufacturing operations during 2011 were located at 118 Guang Yu St., Yinzhou District, Tieling City, Liaoning Province, People’s Republic of China, which was leased from a third party for a payment of approximately $47,240 per year. The lease expired in February 2012, and the Company has moved to the industrial park , in Tieling City,Liaoning Province.

 

Nengfa Energy established a manufacturing facility for its energy-saving products in Yingzhou District Industrial Park, Tieling City, Liaoning Province. We built a new equipment manufacturing facility that we believe will meet international and domestic standards for a high technology facility. This facility will cover an area of 81,561 sq.m acres. The construction of Phase I covers an area of 23,514 sq.m. The construction I has been basically completed by the end of 2011 and accounted for 67% of total investment budget. The construction of Phase II will be completed during 2012. Total estimated construction cost of a new manufacturing facility will be approximately $24 million. After completion, we anticipate that this facility will significantly increase Nengfa’s total manufacturing capacity to 20,000 tons of flow control equipment and new energy equipment, which is approximately triple the current capacity.

 

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ITEM 3. LEGAL PROCEEDINGS

 

Robert E. Dawley v. NF Energy Corp. of America, M.D. Fla. Case no. 6:10-cv-0115-Orl-22DAB. Robert Dawley (“Dawley”) commenced this action in the United States District Court for the Middle District of Florida against the Company, Mr. Gang Li and the Company’s litigation counsel on October 1, 2011. The allegations in this action are identical to those that Dawley raised in a prior proceeding in which the United States Court of Appeals for the Eleventh Circuit entered judgment against him and in favor of the Company.

 

Upon motion by the defendants, in an order dated December 29,2010, the District Court dismissed six of Dawley’s ten claims on the ground that they were precluded by the Eleventh Circuit’s prior judgment. Dawley attempted to appeal the District Court’s order to the Eleventh Circuit. (Dawley v NF Energy Saving Corp. of America, U.S.C.A. 11th Cir. Appeal no. 11-10201-F.) However, the Eleventh Circuit dismissed Dawley’s appeal as premature. Dawley asked the Eleventh Circuit to reconsider, but it declined.

 

This District Court, in an order dated July 19,2011, dismissed Dawley’s remaining four claims with prejudice on the grounds that he had failed to plead them with the specificity required by law. The District Court then entered Judgment against him on July 20,2011. Dawley filed a Notice of Appeal of the District Court’s Judgment on July 25,2011. There has been no further action in the case on appeal.

 

As of December 31, 2011, the Company accrued $200,000 for this contingent liability and the Company’s directors, Mr. Gang Li and Ms. Lihua Wang have personally agreed to guarantee all contingent liabilities and costs to be incurred in connection with this litigation claim. At this point, the Company does not believe that the judgment would have a material impact on, or result in significant contingencies to, the Company.

 

ITEM 4. MINE SAFTEY DISCLOSURE

 

Not applicable.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information

 

Our common stock, $.001 par value, began trading on the OTC Bulletin Board (“OTCBB”) on December 4, 2004 under the symbol “DGNA.OB”. The symbol after the Company’s name change to NF Energy Saving Corporation of America was “NFES.OB”. On August 26, 2009, the Company further changed its name to NF Energy Saving Corporation, and the symbol was changed to “NFEC.OB”. On October 4, 2010, the Company commenced trading on the Nasdaq Global Market, under the symbol “NFEC”. On March 7, 2012, the trading for the common stock was changed to the Nasdaq Capital Market. The following table sets forth the high and low bid prices for our common stock for the years ended December 31, 2011 and 2010 and for the periods indicated. The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions. On March 23, 2012, the closing price was $1.08 per share.

 

   Common Stock (Adjusted
Stock Price)
 
   High   Low 
Fiscal year ends at December 31, 2011          
First quarter  $5.05   $3.07 
Second quarter  $3.38   $1.66 
Third quarter  $2.38   $0.76 
Forth quarter  $0.92   $0.46 
           
Fiscal year ends at December 31, 2010          
First quarter  $11.93    8.00 
Second quarter  $10.00   $6.25 
Third quarter  $8.99   $5.63 
Forth quarter  $6.25   $4.01 

 

Record Holders

 

As of March 12, 2012, we had 1,346 common shareholders of record.

 

Dividends

 

Since inception of NFEC, has not paid cash dividends on its common stock. It is our present policy not to pay cash dividends and to retain future earnings to support our growth. Any payments of cash dividends in the future will be dependent upon, among other things, the amount of funds available therefore, our earnings, financial condition, capital requirements, and other factors which the Board of Directors deems relevant.

 

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Securities Authorized for Issuance Under Equity Compensation Plans

 

As of the date of this Form 10-K, we have not authorized any equity compensation plan, nor has our Board of Directors authorized the reservation or issuance of any securities under any equity compensation plan.

 

Transfer Agent

 

On September 5, 2009, we changed our transfer agent to Corporate Stock Transfer, Inc, located at 3200 Cherry Creek Drive South, Suite 430, Denver, Colorado, 80209.

 

ITEM 6. SELECTED FINANCIAL DATA

 

Not Applicable.

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Report on Form 10-K. The discussion in this section of this Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section, those discussed in “Risk Factors” and those discussed elsewhere in this Report on Form 10-K.

 

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FORWARD LOOKING STATEMENTS

 

Certain statements in this report, including statements of our expectations, intentions, plans and beliefs, including those contained in or implied by "Management's Discussion and Analysis" and the Notes to Consolidated Financial Statements, are "forward-looking statements", within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that are subject to certain events, risks and uncertainties that may be outside our control. The words “believe”, “expect”, “anticipate”, “optimistic”, “intend”, “will”, and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. The Company undertakes no obligation to update or revise any forward-looking statements. These forward-looking statements include statements of management's plans and objectives for our future operations and statements of future economic performance, information regarding our expansion and possible results from expansion, our expected growth, our capital budget and future capital requirements, the availability of funds and our ability to meet future capital needs, the realization of our deferred tax assets, and the assumptions described in this report underlying such forward-looking statements. Actual results and developments could differ materially from those expressed in or implied by such statements due to a number of factors, including, without limitation, those described in the context of such forward-looking statements, our expansion and acquisition strategy, our ability to achieve operating efficiencies, industry pricing and technology trends, evolving industry standards, regulatory matters, general economic and business conditions, the strength and financial resources of our competitors, our ability to find and retain skilled personnel, the political and economic climate in which we conduct operations and the risk factors described from time to time in our other documents and reports filed with the Securities and Exchange Commission (the "Commission"). Additional factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to: 1) our ability to successfully develop, manufacture and deliver our products on a timely basis and in the prescribed condition; 2) our ability to compete effectively with other companies in the same industry; 3) our ability to raise sufficient capital in order to effectuate our business plan; and 4) our ability to retain our key executives.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments 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 the reported amounts of revenues and expenses during the reporting periods. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue, receivable, inventory, and accrued expenses. We base our estimates on historical experience, known trends and events and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Changes in estimates are recorded in the period in which they become known.

 

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

 

Revenue recognition

 

In accordance with the ASC Topic 605, “Revenue Recognition”, the Company recognizes revenue when persuasive evidence of an arrangement exists, transfer of title has occurred or services have been rendered, the selling price is fixed or determinable and collectability is reasonably assured.

 

The Company’s revenue is principally derived from three primary sources: sales of energy saving flow control equipment, provision of energy project management and sub-contracting services, and provision of energy-saving reconstruction projects.

 

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(a)   Sale of products

 

The Company derives a majority of its revenues from the sale of energy saving flow control equipment. Generally, the energy saving flow control equipment is manufactured and configured to customer requirements. The Company typically produces the energy saving flow control equipment for customers during a period from one to six months. When the Company completes the production in accordance with the customer’s specification, the customer is required to inspect the finished products for quality and suitability, to its full satisfaction, then the company makes delivery to the customer

 

The Company recognizes revenue from the sale of such finished products upon delivery to the customers, when the title and risk of loss are fully transferred to the customers. The Company records its revenues, net of value added taxes (“VAT”). The Company is subject to VAT which is levied on the majority of the products at the rate of 17% on the invoiced value of sales.

 

(b)   Service revenue

 

Service revenue is derived from energy-saving technical services, project management or sub-contracting services that are not an element of the arrangement for the sale of products. These services are generally billed on a time-cost plus basis, for the period of service which is generally from two to three months.

 

Revenue is recognized, net of business taxes when the service is rendered and accepted by the customers.

 

(c) Interest income

 

Interest income is recognized on a time apportionment basis, taking into account the principal amounts outstanding and the interest rates applicable.

 

Accounts receivable and allowance for doubtful accounts

 

Accounts receivable are recorded at the invoiced amount, do not bear interest and are due within the contractual payment terms, generally 30 to 90 days from shipment. Credit is extended based on evaluation of a customer's financial condition, the customer’s credit-worthiness and their payment history. Accounts receivable outstanding longer than the contractual payment terms are considered past due. Past due balances over 90 days and those over a specified amount are reviewed individually for collectability. At the end of each period, the Company specifically evaluates each individual customer’s financial condition, credit history, and the current economic conditions to monitor the progress of the collection of accounts receivable. The Company will consider an allowance for doubtful accounts for any estimated losses resulting from the inability of its customers to make required payments. For the receivables that are past due or not being paid according to payment terms, the appropriate actions are taken to exhaust all means of collection, including seeking legal resolution in a court of law.

 

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The payment terms for our accounts receivable from each source of revenue is set forth below:

 

  Revenue items   General payment terms:
       
1. Sales of products   (a)      10% of the contract value will be paid by the customer upon signing the contract.
      (b)      50% of the contract value will be paid by the customer after the physical inspection (with a credit term from 30 to 90 days).
      (c)       30% to 35% of the contract value will be paid upon the delivery to the customer (with a credit term from 30 to 90 days).
      (d)      5% to 10% of the contract value will be paid within 12 to 24 months (from the delivery date) as warranty retention for the product.
       
2. Services  

(a)      10% to 15 % of the contract value will be paid by the customer upon signing the contract. 

       (b)     The remaining contract value will be paid by the customer upon the completion of the service (with a credit term from 30 to 90 days).
       
3. Projects   Payments based on the achievement of certain milestones to be made over the term of the project.

 

In general, accounts receivable with aging within 90 days, between 91 and 180 days, and between 181 and 360 days represent approximately 30-40%, 50-60%, and 5%-15%, respectively, of the total accounts receivable. The Company is highly aware of the risk of default, and as a result, we actively monitor accounts receivable with aging above 1 year and those accounting for at least 1% of the total accounts receivable.

 

For most of our contracts, our customers are generally large or state-owned construction contractors or developers mainly engaged in government-sponsored infrastructure projects such as large hydraulic/aqua-engineering projects, power plants and urban sewage network projects in the PRC. Usually, these infrastructure projects are undertaken in a number of phrases over a certain period of time. Our flow control equipment components are generally considered as major or significant components in the development phase of these infrastructure projects. In our industry practice, we are paid by these construction contractors and/or developers when they have been paid by the local government or state-owned enterprises after the full inspection of each milestone during the construction phrase. Given that the construction of these infrastructure projects are very large in sizes and complex and require a high quality level in completion, the inspection process may take a considerable amount of time. Therefore, we may not collect the accounts receivable on a timely manner or only after a period longer than our agreed payment terms.

 

We have a high level of assurance on the recoverability of these accounts receivable, based on our ongoing assessment of the customer’s credit-worthiness and their payment history. These customers are usually large state-owned corporations with good credit ratings. At the end of each period, we specifically evaluate the structure and collectability of accounts receivable and for receivables that are past due or not being paid according to the payment terms, and we take appropriate actions to exhaust all means of collection, including seeking legal resolution in a court of law. For customers with a large accounts receivable balance, we may take other steps, such as limiting sales and changing payment terms and requesting forms of security. We will consider an adjustment to the allowance for doubtful accounts for any estimated losses resulting from the inability of our customers to make required payments.

 

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Account balances are charged off against the allowance for doubtful accounts after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance sheet credit exposure related to its customers.

 

Inventories

 

Inventories are stated at the lower of cost or market value (net realizable value), cost being determined on a weighted average method. Costs include material, labor and manufacturing overhead costs. The Company reviews historical sales activity quarterly to determine excess, slow moving items and potentially obsolete items and also evaluates the impact of any anticipated changes in future demand. The Company provides inventory allowances based on excess and obsolete inventories determined principally by customer demand.

 

Plant and Equipment

 

Plant and equipment are stated at cost less accumulated depreciation and accumulated impairment losses, if any. Depreciation is calculated on the straight-line basis over the following expected useful lives from the date on which the asset becomes fully operational and after taking into account its estimated residual values:

 

   Expected useful  life   Residual value 
Building  30 years    5%
          
Plant and machinery  10 – 20 years    5%
          
Furniture, fixture and equipment  5 - 8 years    5%
           

Expenditure for repairs and maintenance is expensed as incurred. When assets have been retired or sold, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in the results of operations.

 

Land use right

 

All land in the PRC is owned by the PRC government. The government in the PRC, according to the relevant PRC law, may sell the right to use the land for a specified period of time. Thus, the Company’s land purchase in the PRC is considered to be leasehold land and is stated at cost less accumulated amortization and any recognized impairment loss. Amortization is provided over the term of the land use right agreement on a straight-line basis, which is 50 years and will expire in 2059.

 

40
 

 

Finance leases

 

Leases that transfer substantially all the rewards and risks of ownership to the lessee, other than legal title, are accounted for as finance leases. Substantially all of the risks or benefits of ownership are deemed to have been transferred if any one of the four criteria is met: (i) transfer of ownership to the lessee at the end of the lease term, (ii) a lease containing a bargain purchase option, (iii) a lease term exceeding 75% of the estimated economic life of the leased asset, (iv) the present value of the minimum lease payments exceeding 90% of the fair value. At the inception of a finance lease, the Company as the lessee records an asset and an obligation at an amount equal to the present value of the minimum lease payments. The leased asset is amortized over the shorter of the lease term or its estimated useful life if title does not transfer to the Company, while the leased asset is depreciated in accordance with the Company’s normal depreciation policy if the title is to eventually transfer to the Company. The periodic rent payments made during the lease term are allocated between a reduction in the obligation and interest element using the effective interest method in accordance with the provisions of Accounting Standards Codification ("ASC") Topic 835-30, “Imputation of Interest”.

 

Stock based compensation

 

The Company adopts ASC Topic 718, "Stock Compensation", ("ASC 718") using the fair value method. Under ASC 718, stock-based compensation is measured using the Black-Scholes Option-Pricing model on the date of grant. For non-employee stock based compensation, the Company adopts ASC Topic 505-50, “Equity-Based Payments to Non-Employees”, stock based compensation related to non-employees is accounted for based on the fair value of the related stock or options or the fair value of the services on the grant date, whichever is more readily determinable in accordance with ASC 718.

 

Income taxes

 

Income taxes are determined in accordance with the provisions of ASC Topic 740, “Income Taxes”(“ASC 740”). Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Any effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

ASC 740 prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. Under ASC 740, tax positions must initially be recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions must initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts.

 

Foreign currencies translation

 

Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency using the applicable exchange rates at the balance sheet dates. The resulting exchange differences are recorded in the statement of operations. The reporting currency of the Company is the United States Dollar ("US$"). The Company's subsidiaries in the PRC maintain their books and records in their local currency, the Renminbi Yuan ("RMB"), which is the functional currency as being the primary currency of the economic environment in which these entities operate.

 

41
 

 

 

In general, for consolidation purposes, assets and liabilities of its subsidiaries whose functional currency is not the US$ are translated into US$, in accordance with ASC Topic 830-30, “Translation of Financial Statement”, using the exchange rate on the balance sheet date. Revenues and expenses are translated at average rates prevailing during the period. The gains and losses resulting from translation of financial statements of foreign subsidiaries are recorded as a separate component of accumulated other comprehensive income within the statement of stockholders’ equity.

 

Translation of amounts from RMB into US$1 have been made at the following exchange rates for the respective year:

 

   2011   2010 
Year-end RMB:US$1 exchange rate   6.3523    6.6118 
Annual average RMB:US$1 exchange rate   6.4544    6.7788 

 

RESULTS OF OPERATIONS

 

Year Ended December 31, 2011 compared to Year Ended December 31, 2010

 

The following discussion should be read in conjunction with the financial statements included in this report and is qualified in its entirety by the foregoing.

 

REVENUES

 

Total revenues were $14,929,430 and $25,372,206 for the years ended December 31, 2011 and 2010, respectively. Total revenues decreased $10,442,776, a 41% decrease, for the year ended December 31, 2011 compared to total revenues for the year ended December 31, 2010. Decrease in total revenue was due to the decrease in product revenue, service revenue and project revenue as explained below..

 

Product Revenues

 

Product revenues are derived principally from the sale of self-manufactured products and energy saving flow control equipment. Product revenues were $10,897,946 and $16,786,854, or 73% and 66.16% of total revenues for the years ended December 31, 2011 and 2010, respectively. Product revenues for the year ended December 31, 2011 decreased $5,888,908or 35.08% decrease, compared to the product revenue for the year ended December 31, 2010. The decrease in product revenue was primarily due to the delay in the completion of the Company’s new production facility which resulted in the Company having to take a portion of its manufacturing capabilities off-line while moving production equipment from the old facility to the new facility.

 

Service Revenues

 

Service revenues are derived principally from energy-saving technical services and product collaboration processing services. The energy-saving technical services include providing energy saving auditing, conservation plans, and/or related service reports. The product re-processing services are generally billed on a time-cost plus basis. Service revenues were $4,031,484 and $7,828,840 for the years ended December 31, 2011 and 2010 respectively, a decrease of $3,797,356 or 48.5%. The decrease in service revenue was primarily due to the delay in the completion of the Company’s new production facility which resulted in a disruption of the Company’s operations..

 

42
 

 

Project Revenues

 

Project revenues are derived principally from energy-saving re-engineering projects and new energy projects that require significant modifications, customizations or installations, and are subject to the customer’s final approval. The Company applies the installment-method for short term projects and percentage-of-completion method for projects over one year to recognize project revenues. There was no project revenue for the year ended December 31, 2011, as compared to $756,512 for the same year ended in 2010. Given the economic uncertainty, projects originally planned for the year were postponed, which prevented the Company from realizing any project revenue in the year ended December 31, 2011.

 

COSTS AND EXPENSES

 

Cost of Revenues

 

Cost of revenues consists primarily of material costs, direct labor, depreciation and manufacturing overhead, which are directly attributable to the manufacture of products and the rendering of services. Total cost of revenues was $10,757,351and $18,534,434, or 72.05% and 73.05% of total revenues, for the years ended December 31, 2011 and 2010, respectively. The total cost of revenues decreased by $7,777,083 or 41.96% for the year ended December 31, 2011 compared to the total cost of revenues for the year ended December 31, 2010. The decrease in total cost of revenues was primarily due to the decrease in product revenue and service revenue during the year.

 

The overall gross profit for the Company was $4,172,079 and $6,837,772, or 27.94% and 26.95% of total revenues, for the years ended December 31, 2011 and 2010, respectively. There is no significant fluction on the gross margin when compared with 2010.

 

Cost of Products

 

Total cost of product revenues was $8,151,829 and $12,629,265 for the years ended December 31, 2011 and 2010, respectively. The cost of product revenues decreased by $4,477,436 or 35.45% for the year ended December 31, 2011 compared to the cost of revenues for the year ended December 31, 2010. The decrease in product costs was due to the transfer of our production machines from our leased facility to our new manufacturing facility during the last two quarters, which affected our production capacity when compared to last year,

 

The gross profit for products was $2,746,117 and $4,157,589, the gross profit margin was 25.20% and 24.77% for the years ended December 31, 2011 and 2010, respectively. There was no significant fluction on the gross margin when compared with 2010.

 

43
 

 

Cost of Service

 

Total cost of service revenues was $2,605,522 and $5,287,351 for the years ended December 31, 2011 and 2010, respectively. The cost of service revenues decreased by $2,681,829 or 50.72% for the year ended December 31, 2011 compared to the cost of revenues for the year ended December 31, 2010. The gross margin for services was $1,425,962 and $2,541,489, or 35.37% and 32.46%, for the years ended December 31, 2011 and 2010, respectively. The increase in gross margin is due to the significant increase in gross margin of energy conservation technology services.

 

Cost of Projects

 

There was no project revenue for the year ended December 31, 2011, therefore there was no cost of projects recognized during the year.

 

Operating Expenses

 

The total operating expenses were $1,454,151 and $1,234,597 , or 9.74% and 4.87% of total revenues, for the year ended December 31, 2011 and 2010, respectively. The total operating expenses increased by $219,554 or 17.78% for the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase of operating expenses is primarily due to the Company receiving its land use rights for the new facility located in Yinzhou District Industrial Park and starting to pay the land use rights tax. The Company also starts to pay the NASDAQ listing fees. There was also an increase in legal and professional fees, and IR fees during the year..

 

Sales and marketing expenses

 

The total sales and marketing expenses were $101,586 and $81,885, or 0.68% and 0.32% of total revenues, for the years ended December 31, 2011 and 2010, respectively. The sales and marketing expenses increased by $19,701 or 24.06%. The increase in sales and marketing is due to the increase in traveling expenses incurred by the sales staff in order to explore more business opportunities for the company.

 

General and administrative expenses

 

General and administrative expenses were $1,352,565 and $1,152,712, or 9.05% and 4.54% of total revenue, for the year ended December 31, 2011 and 2010, respectively. The general and administrative expenses increased by $199,853 or 17.34%. The increase in general and administrative expenses was caused by the increase in bank loan guarantee fee, legal and professional fees and investor relations fees.

 

Income from Operations

 

As a result of the foregoing, our income from operations was $2,717,928 or 18.21% of total revenues, for the year ended December 31, 2011, as compared to $5,603,175 or 22.08% of total revenues, for the year ended December 31, 2010, a decrease of $2,885,247 or 51.49%.

 

Other income (expenses)

 

For the year ended December 31, 2011, interest income was $5,838 as compared to $1,007 for the year ended December 31, 2010. In 2011, interest expense was $375,773, a decrease of $146,880 as compared to $522,653 for the year ended December 31, 2010. The Company issued $960,000 of convertible notes at beginning of 2010, which incurred a non-cash interest expenses of $396,072 for the year ended December 31, 2010. The debt discount on convertible notes was fully discount in February 2011 and there was only $70,271 non-cash interest expenses for the year 2011.

  

44
 

 

Income Tax Expenses

 

For the years ended December 31, 2011 and 2010, income tax expenses were $301,533 and $778,765 respectively. The decrease of income tax expenses of $477,232 or 61.28% is due to the decrease in Income Before Tax . Nengfa Energy is entitled to a two-year exemption from corporate income tax till the year ended December 31, 2011. The new income tax rate will be 25% from 2012 onwards.

 

As of December 31, 2011, the Company’s operations in the United States of America incurred $2,660,710 of cumulative net operating losses, which can be carried forward to offset future taxable income. The net operating loss carried forwards begin to expire in 2031, if unutilized. The Company has provided for a full valuation allowance against the deferred tax assets of $904,641 on the expected future tax benefits from the net operating loss carried forwards as the management believes it is more likely than not that these assets will not be realized in the future.

 

Net Income

 

As a result of the foregoing, we recorded net income of $2,046,460, a 13.70% profit margin on revenue for the year ended December 31, 2011, as compared to net income of $4,302,764, a16.96% profit margin on revenues, for the year ended December 31, 2010. The net income for the year ended December 31, 2011 decreased by $2,256,304, a decrease of 52.44%, compared to the year ended December 31, 2010. The decrease in net income was mainly due to the increase in operating expenses and the decrease in revenues.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Operating activities

 

For the year ended December 31, 2011, net cash provided by operating activities was $2,488,573. This was primarily attributable to our net income of $2,046,460, adjusted by non-cash items of depreciation and amortization of $588,278, reversal of allowance for doubtful account of $930, and non-cash interest expenses of $ 70,271. The increase in cash flow in 2011 were due primarily the decrease in inventories by $271,495, decrease in prepayments and other receivables by $393,503, increase in accounts payable by $1,466,017, and increase in other payables and accrued liabilities by $357,650.These were partially off-set by the increase in accounts and retention receivable by $2,673,870 (excluding the non-cash transaction of $7,830,649 which represented the prepayment for construction in progress in lieu of accounts receivable) and $32,161 decrease in income tax payable in this year.

 

The decrease in accounts and retention receivable of $4,589,393, a decrease of 28.79% over the accounts and retention receivables balance at December 31, 2010 are mainly due to the transfer of accounts receivable due from two customers amounting to $7.8 million on a non-recourse basis to an independent project management company in the PRC as the prepayment for construction cost.

 

45
 

The Company is highly aware of the risk of default, and as a result, we actively monitor accounts receivable with aging above 1 year and those accounting for about 15% of the total accounts receivable, thus there is no significant credit risk. The Company will consider an allowance for doubtful accounts for any estimated losses resulting from the inability of its customers to make required payments. The Company’s accounts receivable aging was as follows:

 

Items  Total   1-90 days   91-180 days   181-365 days   over 365 days 
                     
Product   9,778,015    3,386,389    4,035,706    808,152    1,547,768 
Service   847,158    839,504    -    7,654    - 
Total   10,625,173    4,225,893    4,035,706    815,806    1,547,768 
                          
Less: allowance for doubtful accounts   7,757    -    -    6,713    1,044 
Accounts receivable, net   10,617,416    4,225,893    4.035,706    809,093    1,546,724 

 

Most of our customers make payments in accordance with the agreed payment terms in a timely manner. In rare cases, we may offer extended payment terms to certain customers for equipment sales. These customers are usually large state-owned corporations with good credit ratings. At the end of each period, we evaluate the structure and collectability of accounts receivable and for those receivables that are past due or not being paid according to the payment terms. We take appropriate actions to exhaust all means of collection, including seeking legal resolution in a court of law, for our collection efforts.

 

We offer a free 12 to 24 months of product warranty on a case-by-case basis, depending upon the type of customers, nature and size of the infrastructure projects. Under such arrangements, a portion of the project contract balance (usually 5-10% of contract value) is withheld by a customer from 12 to 24 months, until the product warranty has expired.

 

The reason for the decrease in inventories of $242,222 is mainly due to the decreasing inventory volume in light of change in orders. The reason for the increase in the prepayments and other receivables of $338,886,or 28.39% are mainly due to the guarantee deposit of $314,847 paid to an independent guarantor for the guarantee of bank loan. The $824,430 decrease in accounts payable of from 31 December 2010 to $2,679,267 was mainly due to the decrease in purchase of raw materials due to the decrease in revenue. The $494,804 decrease in financing lease payable was due to a payment for equipment leasing purchase. The decrease of $27,729 from income tax payable is due to the Company’s annual taxable income in 2011 being less than the taxable income for year ended December 31, 2010.

 

Investing activities

 

For the year ended December 31, 2011,net cash used in investing activities was $3,161,644. The $3,122,962 cash used in 2011 is primarily used in construction, and $38,682 which was used for purchasing plant and equipment.

 

In 2008, the Company was approved by the local government to construct a new manufacturing facility for energy-saving products and equipment in Yingzhou District Industrial Park, Tieling City, Liaoning Province, the PRC which cover an area of 33 acres. Total estimated construction cost of the new manufacturing facility is approximately $24 million. Phase I of the project is complete and began its operations in December 2011. Phase II of the project is expected to be completed during 2012.

 

46
 

 

Financing activities

 

For the year ended December 31, 2011, the net financing cash inflow was $2,087,582 which was due to the proceeds from short-term bank loans and issuance of note of $2,533,156 and $1,500,000 respectively and advance from a related party of $112,005. These were partially off-set by the increase in restricted cash of $1,549,331 and payment on finance lease of $508,248.

  

In February,2011, the Company obtained a short-term bank borrowing of $1,574,233 (Equivalent to RMB10,000,000) with interest rate at 1.3 times of the Bank of China Benchmark Lending Rate, monthly payable, which is guaranteed by a guarantee company in Shenyang City, the PRC, this bank borrowing was repaid in February 16 ,2012.

 

In November ,2011, the Company obtained another short-term bank borrowing of $2,573,871 (Equivalent to RMB 16,350,000), from a commercial bank in China, Bank of Jilin, due 15 December 2012, with interest rate at 1.4 times of the Bank of China Benchmark Lending Rate, monthly payable, which is guaranteed by Mr. Gang Li (the Company’s CEO) and a guarantee company in Shenyang City, the PRC.

 

In November ,2011, the Company obtained a bank note of $3,148,466 (Equivalent to RMB 20,000,000) from a commercial bank in China, Bank of Liaoyang, due May 2012,which is collateralized by restricted cash of $1,574,233 (Equivalent to RMB 10,000,000) and guaranteed by a third party. The bank note was issued to settle the accounts payable and there was no cash proceeds for the bank note.

 

As of December 31, 2011, the amount due to a related party of $431,682 represented a temporary advance made by Cloverbay International Ltd., the Company’s major stockholder, which is controlled by Ms. Lihua Wang (the Company’s CFO) and Mr. Gang Li (the Company’s CEO), which is unsecured, interest-free and bears no fixed repayment term. Imputed interest on this amount is considered insignificant.

 

In June 2011, the Company obtained a new short-term loan of $1,500,000 from Cloverbay International Ltd. which is controlled by Ms. Lihua Wang (the Company’s CFO) and Mr. Gang Li (the Company’s CEO), to repay a short-term loan due June 10, 2011. This note is unsecured, carries interest at 2.5% per annum, payable at maturity and repayable on May 31, 2012.

 

Inflation

 

We believe that the relatively moderate rate of inflation over the past few years has not had a significant impact on our results of operations . At present we are able to increase our prices due to the rising prices of raw materials.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

We do not have any material off-balance sheet arrangements.

 

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IMPACT OF RECENTLY ISSUED NEW ACCOUNTING STANDARDS

 

We do not expect adoption of recently issued accounting pronouncements to have a significant impact on our results of operations, financial position or cash flow.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

  Page
   
Report of Independent Registered Public Accounting Firm F-2
   
Consolidated Balance Sheets F-3
   
Consolidated Statements of Operations And Comprehensive Income F-4
   
Consolidated Statements of Cash Flows F-5
   
Consolidated Statements of Stockholders’ Equity F-6
   
Notes to Consolidated Financial Statements F-7 to F-26

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Stockholders

NF Energy Saving Corporation

 

We have audited the accompanying consolidated balance sheets of NF Energy Saving Corporation and its subsidiaries (“the Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations and comprehensive income, cash flows and changes in stockholders’ equity for the years ended December 31, 2011 and 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits include consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2011 and 2010, and the results of its operations and cash flows for the years ended December 31, 2011 and 2010 in conformity with accounting principles generally accepted in the United States of America.

   

HKCMCPA Company Limited

Certified Public Accountants

 

Hong Kong, China

March 28, 2012

  

 

F-2
 

 

NF ENERGY SAVING CORPORATION

CONSOLIDATED BALANCE SHEETS

AS OF DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

   As of December 31, 
   2011   2010 
ASSETS          
Current assets:          
Cash and cash equivalents  $2,317,456   $823,717 
Restricted cash   1,574,233    - 
Accounts receivable, net   10,617,416    14,658,067 
Retention receivable, current   734,214    813,579 
Inventories   581,176    823,398 
Prepayments and other receivables   1,532,283    1,193,397 
           
Total current assets   17,356,778    18,312,158 
           
Retention receivable, non-current   -    469,377 
Plant and equipment, net   11,236,347    4,166,584 
Land use right, net   3,118,482    3,058,507 
Construction in progress   12,106,316    8,027,219 
           
TOTAL ASSETS  $43,817,923   $34,033,845 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current liabilities:          
Accounts payable, trade  $2,679,267   $3,503,697 
Short-term bank borrowings   7,296,570    1,512,447 
Note payable, related party   1,500,000    - 
Current portion of obligation under finance lease   34,287    492,264 
Income tax payable   93,407    121,136 
Amount due to a related party   431,682    318,946 
Other payables and accrued liabilities   1,304,887    902,889 
           
Total current liabilities   13,340,100    6,851,379 
           
Long-term liabilities:          
Convertible promissory notes, net   960,000    889,730 
Obligation under finance lease   -    36,827 
           
TOTAL LIABILITIES   14,300,100    7,777,936 
           
Commitments and contingencies          
           
Stockholders’ equity:          
Common stock, $0.001 par value; 50,000,000 shares authorized; 5,326,501 and 5,326,501 shares issued and outstanding, respectively   5,326    5,326 
Additional paid-in capital   8,443,563    8,443,563 
Statutory reserve   2,203,798    1,965,556 
Accumulated other comprehensive income   3,431,354    2,215,900 
Retained earnings   15,433,782    13,625,564 
           
Total stockholders’ equity   29,517,823    26,255,909 
           
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $43,817,923   $34,033,845 

 

See accompanying notes to consolidated financial statements.

 

F-3
 

 

NF ENERGY SAVING CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

   Years ended December 31, 
   2011   2010 
REVENUES, NET          
Products  $10,897,946   $16,786,854 
Services   4,031,484    7,828,840 
Project   -    756,512 
Total revenues, net   14,929,430    25,372,206 
           
COST OF REVENUES:          
Cost of products   8,151,829    12,629,265 
Cost of services   2,605,522    5,287,351 
Cost of project   -    617,818 
Total cost of revenues   10,757,351    18,534,434 
           
GROSS PROFIT   4,172,079    6,837,772 
           
OPERATING EXPENSES:          
Sales and marketing   101,586    81,885 
General and administrative   1,352,565    1,152,712 
Total operating expenses   1,454,151    1,234,597 
           
INCOME FROM OPERATIONS   2,717,928    5,603,175 
           
Other (expense) income:          
Interest income   5,838    1,007 
Interest expense   (375,773)   (522,653)
           
INCOME BEFORE INCOME TAXES   2,347,993    5,081,529 
           
Income tax expense   (301,533)   (778,765)
           
NET INCOME  $2,046,460   $4,302,764 
           
Other comprehensive income:          
– Foreign currency translation gain   1,215,454    867,518 
           
COMPREHENSIVE INCOME  $3,261,914   $5,170,282 
           
Net income per share:          
– Basic  $0.38   $0.81 
– Diluted  $0.38   $0.79 
           
Weighted average common shares outstanding:          
– Basic   5,326,501    5,326,501 
– Diluted   5,454,501    5,458,109 

 

See accompanying notes to consolidated financial statements.

 

F-4
 

 

NF ENERGY SAVING CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

   Years ended December 31, 
   2011   2010 
Cash flows from operating activities:          
Net income  $2,046,460   $4,302,764 
Adjustments to reconcile net income to net cash provided by operating activities          
Depreciation and amortization   588,278    394,033 
Allowance for (reversal of allowance for) doubtful accounts   930    (6,389)
Gain on disposal of plant and equipment   -    (225)
Deferred tax expense   -    1,420 
Interest expenses, non-cash   70,271    396,072 
Change in operating assets and liabilities:          
Accounts and retention receivable   (2,673,870)   (2,040,981)
Inventories   271,495    (158,836)
Prepayments and other receivables   393,503    (495,757)
Accounts payable, trade   1,466,017    1,343,841 
Income tax payable   (32,161)   (85,065)
Other payables and accrued liabilities   357,650    (290,879)
Net cash provided by operating activities   2,488,573    3,359,998 
           
Cash flows from investing activities:          
Purchase of plant and equipment   (38,682)   (42,221)
Payments on construction in progress   (3,122,962)   (4,836,398)
Proceeds from disposal of plant and equipment   -    1,261 
Net cash used in investing activities   (3,161,644)   (4,877,358)
           
Cash flows from financing activities:          
Change in restricted cash   (1,549,331)   - 
Advance from a related party   112,005    318,209 
Net proceeds from short-term bank borrowing   2,533,156    1,475,198 
Payments on finance lease   (508,248)   (607,269)
Proceeds from issuance of notes   1,500,000    - 
Proceeds from private placement   -    900,000 
Net cash provided by financing activities   2,087,582    2,086,138 
           
Effect on exchange rate change on cash and cash equivalents   79,228    27,610 
           
NET CHANGE IN CASH AND CASH EQUIVALENTS   1,493,739    596,388 
           
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR   823,717    227,329 
           
CASH AND CASH EQUIVALENTS, END OF YEAR  $2,317,456   $823,717 
           
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:             
Cash paid for income taxes  $333,615   $862,254 
Cash paid for interest  $275,502   $91,745 
           
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:          
Settlement of note payable to offset with accounts receivable  $-   $544,481 
Settlement of prepayment and accounts payable in lieu of bank demand notes  $3,098,661   $- 
Prepayment for construction in progress in lieu of accounts receivable  $7,830,649   $- 
Transfer from construction in progress to plant and equipment  $7,276,065   $2,167,487 
Transfer from construction in progress to land use right  $-   $3,044,062 

  

See accompanying notes to consolidated financial statements.

 

F-5
 

 

NF ENERGY SAVING CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

   Common stock   Additional   Statutory   Accumulated
other
comprehensive
   Retained   Total
stockholders’
 
   No. of shares   Amount   paid-in capital   reserve   income   earnings   equity 
                             
Balance as of January 1, 2010   5,326,501   $5,326   $7,977,221   $1,449,345   $1,348,382   $9,839,011   $20,619,285 
                                    
Foreign currency translation adjustment   -    -    -    -    867,518    -    867,518 
Beneficial conversion feature and warrants granted in connection with convertible promissory notes   -    -    466,342    -    -    -    466,342 
Net income for the year   -    -    -    -    -    4,302,764    4,302,764 
Appropriation to statutory reserve   -    -    -    516,211    -    (516,211)   - 
                                    
Balance as of December 31, 2010   5,326,501   $5,326   $8,443,563   $1,965,556   $2,215,900   $13,625,564   $26,255,909 
                                    
Foreign currency translation adjustment   -    -    -    -    1,215,454    -    1,215,454 
Net income for the year   -    -    -    -    -    2,046,460    2,046,460 
Appropriation to statutory reserve   -    -    -    238,242    -    (238,242)   - 
                                    
Balance as of December 31, 2011   5,326,501   $5,326   $8,443,563   $2,203,798   $3,431,354   $15,433,782   $29,517,823 

  

See accompanying notes to consolidated financial statements.

 

F-6
 

  

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

  

1.ORGANIZATION AND BUSINESS BACKGROUND

 

NF Energy Saving Corporation (the “Company” or “NFEC”) was incorporated in the State of Delaware in the name of Galli Process, Inc. on October 31, 2000. On February 7, 2002, the Company changed its name to “Global Broadcast Group, Inc.” On November 12, 2004, the Company changed its name to “Diagnostic Corporation of America.” On March 15, 2007, the Company changed its name to “NF Energy Saving Corporation of America.” On August 24, 2009, the Company further changed its current name to “NF Energy Saving Corporation.” On October 1, 2010, the Company’s common stock was traded on Nasdaq Stock Market.

 

The Company, through its subsidiaries, mainly operates in the energy technology business in the People’s of Republic of China (the “PRC”). The Company specializes in the provision of energy saving technology consulting, optimization design services, energy saving reconstruction of pipeline networks and contractual energy management services to China’s electric power, petrochemical, coal, metallurgy, construction, and municipal infrastructure development industries. The Company also engages in the manufacturing and sales of the energy-saving flow control equipment. All the customers are located in PRC.

 

On September 16, 2010, the Company effected a 1 for 2.5 reverse stock split of its common stock. As a result of the reverse stock split, the number of issued and outstanding shares of the Company's common stock was decreased from 13,315,486 pre-split shares to 5,326,501 post-split shares.

 

Description of subsidiaries

 

Name  Place of incorporation
and kind of 
legal entity
  Principal activities
and place of operation
  Particulars of
issued/
registered share
capital
   Effective
interest
held
 
               
Liaoning Nengfa Weiye Energy Technology Co. Ltd (“Nengfa Energy”)  The PRC, a limited liability company  Production of a variety of industrial valve components which are widely used in water supply and sewage system, coal and gas fields, power generation stations, petroleum and chemical industries in the PRC  US$3,580,880    100%
                 
Liaoning Nengfa Weiye Tei Fa Sales Co., Ltd. (“Sales Company”)  The PRC, a limited liability company  Sales and marketing of valves components and products in the PRC  RMB5,000,000    99%

  

NFEC and its subsidiaries are hereinafter referred to as (the “Company”).

 

2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

  

·Basis of presentation

 

These accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”).

 

F-7
 

  

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

  

·Use of estimates

 

In preparing these consolidated financial statements, management makes estimates and assumptions that affect the reported amounts of assets and liabilities in the balance sheet and revenues and expenses during the years reported. Actual results may differ from these estimates.

 

·Basis of consolidation

 

The consolidated financial statements include the financial statements of NFEC and its subsidiaries. All significant inter-company balances and transactions within the Company have been eliminated upon consolidation.

 

The accounts of Sales Company are consolidated as a wholly-owned subsidiary from its inception to December 31, 2011, in which the Company holds 99%-majority interest and has the ability to exercise significant influence over Sales Company. The consolidation of 1% equity interest of Sales Company is not material to the financial position and results of operations for the years presented.

 

·Cash and cash equivalents

 

Cash and cash equivalents are carried at cost and represent cash on hand, demand deposits placed with banks or other financial institutions and all highly liquid investments with an original maturity of three months or less as of the purchase date of such investments.

 

·Restricted cash

 

The Company maintains restricted cash accounts held with financial institutions in the PRC, which are pledged as collateral for short-term bank demand notes payable that will be expired or matured in the next twelve months.

 

·Accounts receivable and allowance for doubtful accounts

 

Accounts receivable are recorded at the invoiced amount and do not bear interest, which are due within contractual payment terms, generally 30 to 90 days from shipment. Credit is extended based on evaluation of a customer's financial condition, the customer credit-worthiness and their payment history. Accounts receivable outstanding longer than the contractual payment terms are considered past due. Past due balances over 90 days and over a specified amount are reviewed individually for collectability. At the end of each period, the Company specifically evaluates individual customer’s financial condition, credit history, and the current economic conditions to monitor the progress of the collection of accounts receivables. The Company will consider the allowance for doubtful accounts for any estimated losses resulting from the inability of its customers to make required payments. For the receivables that are past due or not being paid according to payment terms, the appropriate actions are taken to exhaust all means of collection, including seeking legal resolution in a court of law. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance-sheet credit exposure related to its customers.

 

·Retention receivable

 

Retention receivable is the amount withheld by a customer based upon 5-10% of the contract value, until a product warranty is expired.

 

·Inventories

 

Inventories are stated at the lower of cost or market value (net realizable value), cost being determined on a weighted average method. Costs include material, labor and manufacturing overhead costs. The Company reviews historical sales activity quarterly to determine excess, slow moving items and potentially obsolete items and also evaluates the impact of any anticipated changes in future demand. The Company provides inventory allowances based on excess and obsolete inventories determined principally by customer demand. As of December 31, 2011 and 2010, the Company did not record an allowance for obsolete inventories, nor have there been any write-offs.

 

F-8
 

  

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

  

·Plant and equipment

 

Plant and equipment are stated at cost less accumulated depreciation and accumulated impairment losses, if any. Depreciation is calculated on the straight-line basis over the following expected useful lives from the date on which they become fully operational and after taking into account their estimated residual values:

 

  Expected useful lives  Residual value 
Building  30 years   5%
Plant and machinery  10 – 20 years   5%
Furniture, fixture and equipment  5 – 8 years   5%

 

Expenditures for repairs and maintenance are expensed as incurred. When assets have been retired or sold, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in the results of operations.

 

·Land use right

 

All lands in the PRC are owned by the PRC government. The government in the PRC, according to the relevant PRC law, may sell the right to use the land for a specified period of time. Thus, the Company’s land purchases in the PRC is considered to be leasehold land and is stated at cost less accumulated amortization and any recognized impairment loss. Amortization is provided over the term of the land use right agreement on a straight-line basis, which is 50 years and will expire in 2059.

 

·Construction in progress

 

Construction in progress is stated at cost, which includes acquisition of land use rights, cost of construction, purchases of plant and equipment and other direct costs attributable to the construction of a new manufacturing facility in Yinzhou District Industrial Park, Tieling City, Liaoning Province, the PRC. Construction in progress is not depreciated until such time as the assets are completed and put into operational use. No capitalized interest is incurred during the period of construction.

 

·Finance leases

 

Leases that transfer substantially all the rewards and risks of ownership to the lessee, other than legal title, are accounted for as finance leases. Substantially all of the risks or benefits of ownership are deemed to have been transferred if any one of the four criteria is met: (i) transfer of ownership to the lessee at the end of the lease term, (ii) a lease containing a bargain purchase option, (iii) a lease term exceeding 75% of the estimated economic life of the leased asset, (iv) the present value of the minimum lease payments exceeding 90% of the fair value. At the inception of a finance lease, the Company as the lessee records an asset and an obligation at an amount equal to the present value of the minimum lease payments. The leased asset is amortized over the shorter of the lease term or its estimated useful life if title does not transfer to the Company, while the leased asset is depreciated in accordance with the Company’s normal depreciation policy if the title is to eventually transfer to the Company. The periodic rent payments made during the lease term are allocated between a reduction in the obligation and interest element using the effective interest method in accordance with the provisions of Accounting Standards Codification ("ASC") Topic 835-30, “Imputation of Interest”.

 

·Impairment of long-lived assets

 

In accordance with the provisions of ASC Topic 360-10-5, “Impairment or Disposal of Long-Lived Assets”, all long-lived assets such as plant and equipment held and used by the Company and construction in progress are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is evaluated by a comparison of the carrying amount of assets to estimated discounted net cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amounts of the assets exceed the fair value of the assets. There has been no impairment charges for the years presented.

 

F-9
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

  

·Revenue recognition

 

The Company offers the following products and service to its customers:

 

(a)Energy saving flow control equipment;
(b)Energy project management and sub-contracting service, and
(c)Energy-saving construction projects

 

In accordance with the ASC Topic 605, “Revenue Recognition”, the Company recognizes revenue when persuasive evidence of an arrangement exists, transfer of title has occurred or services have been rendered, the selling price is fixed or determinable and collectability is reasonably assured.

 

(a)Sale of products

 

The Company derives a majority of its revenues from the sale of energy saving flow control equipment. Generally, these products are manufactured and configured to customer requirements. The Company typically produces and builds the energy saving flow control equipment for customers in a period from 1 to 6 months. When the Company completes the production in accordance with the customer’s specification, the customer is required to inspect the finished products for quality and product conditions, to its full satisfaction, then the Company makes delivery to the customer.

 

The Company recognizes revenue from the sale of such finished products upon delivery to the customer, whereas the title and risk of loss are fully transferred to the customers. The Company records its revenues, net of value added taxes (“VAT”). The Company is subject to VAT which is levied on the majority of the products at the rate of 17% on the invoiced value of sales. The Company experienced no product returns and recorded no reserve for sales returns for the years ended December 31, 2011 and 2010.

 

(b)Service revenue

 

Service revenue is primarily derived from energy-saving technical services or project management or sub-contracting services that are not an element of an arrangement for the sale of products. These services are generally billed on a time-cost plus basis, for a period of service time from 2 to 3 months. Revenue is recognized, net of business taxes when the service is rendered and accepted by the customer.

 

(c)Project revenue

 

In February 2010, NFEC, through its subsidiary Nengfa Energy, entered into a cooperative arrangement with a biomass energy technology company in the PRC (the “customer”) for the development of energy-related systems and facilities and the provision of an economic energy saving solutions to the farmers in Laoning Province, the PRC for a term of 1 year. Under this project arrangement, Nengfa Energy agreed to design, build and provide the energy-related equipment and components, as well as provide training to the customer to operate these energy-related facilities. The customer agreed to operate the administration of this arrangement and provide on-site training to the farmers to operate these facilities. In consideration for this cooperative arrangement, both parties agreed to equally share in the sales of energy-related systems during the term of the project, in accordance with the agreed energy-saving milestone requirement. At the end of the project term, Nengfa agreed to transfer its ownership and proprietary rights to the energy-related system and facility to the customer.

 

Under this cooperative arrangement, its project revenue is recognized when the Company makes the billings upon the satisfaction of the agreed milestone requirement during the year ended December 31, 2010.

 

F-10
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

  

No such revenue was incurred during the year ended December 31, 2011.

 

(d)Interest income

 

Interest income is recognized on a time apportionment basis, taking into account the principal amounts outstanding and the interest rates applicable.

 

·Cost of revenue

 

Cost of revenue consists primarily of material costs, direct labor, depreciation and manufacturing overhead, which are directly attributable to the manufacture of products and the rendering of services or projects. Shipping and handling costs, associated with the distribution of finished products to customers, are borne by the customers.

 

·Advertising expense

  

Advertising costs are expensed as incurred under ASC Topic 720-35, “Advertising Costs”. No advertising expense was incurred for the years ended December 31, 2011 and 2010.

 

·Research and development

 

Research and development costs are expensed when incurred in the development of new products or processes including significant improvements and refinements of existing products. Such costs mainly relate to labor and material cost. The Company incurred $51,781 and $68,670 of such costs for the years ended December 31, 2011 and 2010.

 

·Comprehensive income

 

ASC Topic 220, “Comprehensive Income”, establishes standards for reporting and display of comprehensive income, its components and accumulated balances. Comprehensive income as defined includes all changes in equity during a period from non-owner sources. Accumulated other comprehensive income, as presented in the accompanying condensed consolidated statement of stockholders’ equity, consists of changes in unrealized gains and losses on foreign currency translation. This comprehensive income is not included in the computation of income tax expense or benefit.

 

·Income taxes

 

Income taxes are determined in accordance with the provisions of ASC Topic 740, “Income Taxes” (“ASC 740”). Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Any effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

ASC 740 prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. Under ASC 740, tax positions must initially be recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions must initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts.

 

For the years ended December 31, 2011 and 2010, the Company did not have any interest and penalties associated with tax positions. As of December 31, 2011, the Company did not have any significant unrecognized uncertain tax positions.

 

F-11
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

  

The Company conducts the majority of its businesses in the PRC and is subject to tax in this jurisdiction. As a result of its business activities, the Company files tax returns that are subject to examination by a foreign tax authority. For the year ended December 31, 2011, the Company filed and cleared 2010 tax return with its local tax authority.

 

·Product warranty

 

Under the terms of the contracts, the Company offers its customers with a free product warranty on a case-by-case basis, depending upon the type of customers, nature and size of the infrastructure projects. Under such arrangements, a portion of the project contract balance (usually 5-10% of contract value) is withheld by a customer from 12 to 24 months, until the product warranty has expired. The Company has not experienced any material returns or claims where it was under obligation to honor this standard warranty provision. As such, no reserve for product warranty has been provided in the result of operations for the years ended December 31, 2011 and 2010.

 

·Stock based compensation

 

The Company adopts ASC Topic 718, "Stock Compensation", ("ASC 718") using the fair value method. Under ASC 718, stock based compensation is measured using the Black-Scholes Option-Pricing model on the date of grant.

 

For non-employee stock based compensation, the Company adopts ASC Topic 505-50, “Equity-Based Payments to Non-Employees”, stock based compensation related to non-employees is accounted for based on the fair value of the related stock or options or the fair value of the services on the grant date, whichever is more readily determinable in accordance with ASC 718.

 

·Net income per share

 

The Company calculates net income per share in accordance with ASC Topic 260, “Earnings per Share.” Basic income per share is computed by dividing the net income by the weighted-average number of common shares outstanding during the period. Diluted income per share is computed similar to basic income per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common stock equivalents had been issued and if the additional common shares were dilutive.

 

·Foreign currencies translation

 

Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency using the applicable exchange rates at the balance sheet dates. The resulting exchange differences are recorded in the statement of operations.

 

The reporting currency of the Company is the United States Dollar ("US$"). The Company's subsidiaries in the PRC maintain their books and records in their local currency, the Renminbi Yuan ("RMB"), which is the functional currency as being the primary currency of the economic environment in which these entities operate.

 

In general, for consolidation purposes, assets and liabilities of its subsidiaries whose functional currency is not the US$ are translated into US$, in accordance with ASC Topic 830-30, “Translation of Financial Statement”, using the exchange rate on the balance sheet date. Revenues and expenses are translated at average rates prevailing during the period. The gains and losses resulting from translation of financial statements of foreign subsidiaries are recorded as a separate component of accumulated other comprehensive income within the statement of stockholders’ equity.

 

Translation of amounts from RMB into US$1 has been made at the following exchange rates for the respective year:

 

   2011   2010 
Year-end RMB:US$1 exchange rate   6.3523    6.6118 
Annual average RMB:US$1 exchange rate   6.4544    6.7788 

 

F-12
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

  

·Retirement plan costs

 

Contributions to retirement plans (which are defined contribution plans) are charged to general and administrative expenses in the accompanying consolidated statements of operation as the related employee service is provided.

 

·Related parties

 

Parties, which can be a corporation or individual, are considered to be related if the Company has the ability, directly or indirectly, to control the other party or exercise significant influence over the other party in making financial and operational decisions. Companies are also considered to be related if they are subject to common control or common significant influence.

 

·Segment reporting

 

ASC Topic 280, “Segment Reporting” establishes standards for reporting information about operating segments on a basis consistent with the Company’s internal organization structure as well as information about geographical areas, business segments and major customers in financial statements. For the years ended December 31, 2011 and 2010, the Company operates in two reportable operating segments in the PRC.

 

·Fair value of financial instruments

 

The carrying value of the Company’s financial instruments (excluding obligation under finance lease, short-term bank borrowing and convertible promissory notes): cash and cash equivalents, restricted cash, accounts and retention receivable, prepayments and other receivables, accounts payable, income tax payable, amount due to a related party, other payables and accrued liabilities approximate at their fair values because of the short-term nature of these financial instruments.

 

Management believes, based on the current market prices or interest rates for similar debt instruments, the fair value of its obligation under finance lease and short-term bank borrowing approximate the carrying amount. The fair value of convertible promissory notes is disclosed in Note 10.

 

The Company also follows the guidance of the ASC Topic 820-10, “Fair Value Measurements and Disclosures” ("ASC 820-10"), with respect to financial assets and liabilities that are measured at fair value. ASC 820-10 establishes a three-tier fair value hierarchy that prioritizes the inputs used in measuring fair value as follows:

 

·Level 1 : Inputs are based upon unadjusted quoted prices for identical instruments traded in active markets;

 

·Level 2 : Inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. Black-Scholes Option-Pricing model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs; and

 

·Level 3 : Inputs are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models.

 

Fair value estimates are made at a specific point in time based on relevant market information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

F-13
 

  

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

  

·Recent accounting pronouncements

 

The Company has reviewed all recently issued, but not yet effective, accounting pronouncements and does not believe the future adoption of any such pronouncements may be expected to cause a material impact on its financial condition or the results of its operations, as follows:

 

In December 2010, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2010-28 regarding the goodwill impairment test for reporting units with zero or negative carrying amounts. The guidance clarifies the steps to be performed to determine whether goodwill has been impaired and addresses the steps for reporting units with zero or negative carrying amounts. This guidance is effective for fiscal years (and interim periods within such years) beginning after December 15, 2010. The adoption of this guidance had no impact on the Company’s consolidated financial statements.

 

In May 2011, the FASB issued ASU No. 2011-04 regarding fair value measurements and disclosures. This new guidance clarifies the application of existing fair value measurement guidance and revises certain measurement and disclosure requirements to achieve convergence with International Financial Reporting Standards. This guidance is effective for the first interim or annual period beginning after December 15, 2011. In the period of adoption, the Company will include the required disclosures in its filings and believes the adoption will have no impact on its consolidated financial statements.

 

In June 2011, the FASB issued ASU No. 2011-05 regarding the presentation of comprehensive income. This new guidance amends the previous application of comprehensive income and the requirements regarding presentation in the financial statements. It requires the disclosure of the components of comprehensive income, which the Company currently discloses in other sections of its filings, to be presented as part of one statement of comprehensive income, or as a separate statement of comprehensive income following the statement of earnings. In December 2011, the FASB issued ASU No. 2011-12 which temporarily defers those changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. This guidance is effective for fiscal years (and interim periods within such years) beginning after December 15, 2011. The Company is currently evaluating the impact the adoption will have on its consolidated financial statements.

 

In December 2011, the FASB issued ASU No. 2011-11 regarding disclosures about offsetting assets and liabilities. This new guidance requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. This guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The Company is currently evaluating the impact the adoption will have on its consolidated financial statements.

 

3.ACCOUNTS RECEIVABLE

 

The majority of the Company’s sales are on open credit terms and in accordance with terms specified in the contracts governing the relevant transactions. The Company evaluates the need of an allowance for doubtful accounts based on specifically identified amounts that management believes to be uncollectible. If actual collections experience changes, revisions to the allowance may be required. Based upon the aforementioned criteria, the Company recognized $930 allowance for the year ended December 31, 2011 and recovered $6,389 from the allowance for the year ended December 31, 2010.

 

   As of December 31, 
   2011   2010 
         
Accounts receivable, cost  $10,625,173   $14,664,612 
Less: allowance for doubtful accounts   (7,757)   (6,545)
           
Accounts receivable, net  $10,617,416   $14,658,067 

 

F-14
 

  

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

  

Up to February 29, 2012, the Company has subsequently recovered from approximately 17% of the accounts receivable as of December 31, 2011.

 

4.INVENTORIES

 

Inventories consisted of the following:

 

   As of December 31, 
   2011   2010 
         
Raw materials  $328,293   $373,847 
Work-in-process   185,492    359,832 
Finished goods   67,391    89,719 
           
   $581,176   $823,398 

 

For the years ended December 31, 2011 and 2010, no allowance for obsolete inventories was recorded by the Company.

 

5.PREPAYMENTS AND OTHER RECEIVABLES

 

Prepayments and other receivables consisted of the following:

 

   As of December 31, 
   2011   2010 
         
Prepayment to vendors for raw materials  $1,071,177   $1,080,227 
Guarantee deposit   314,847    - 
Prepaid operating expenses   142,445    107,543 
Other receivables   3,814    5,627 
           
   $1,532,283   $1,193,397 

 

The Company generally makes prepayments to vendors for raw materials in the normal course of business. Prepayments to vendors are recorded when payment is made by the Company and relieved against inventory when goods are received, which include provisions that set the purchase price and delivery date of raw materials.

 

F-15
 

  

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

  

6.PLANT AND EQUIPMENT

 

Plant and equipment consisted of the following:

 

   As of December 31, 
   2011   2010 
         
Building  $7,191,316   $- 
Plant and machinery   5,404,559    5,289,265 
Furniture, fixture and equipment   67,731    61,361 
Foreign translation difference   696,762    344,762 
    13,360,368    5,695,388 
Less: accumulated depreciation   (1,968,247)   (1,443,910)
Less: foreign translation difference   (155,774)   (84,894)
           
Plant and equipment, net  $11,236,347   $4,166,584 

 

Depreciation expense for the years ended December 31, 2011 and 2010 were $524,337 and $333,152, of which $483,039 and $293,156 were included in cost of revenue, respectively.

 

As of December 31, 2011, the Company’s carrying value of plant and equipment held under finance leases amounting to $1,840,858.

 

7.LAND USE RIGHT

 

Land use right consisted of the following:

 

   As of December 31, 
   2011   2010 
         
Land use right, at cost  $3,044,062   $3,044,062 
Less: accumulated amortization   (124,822)   (60,881)
    2,919,240    2,983,181 
Add: foreign translation difference   199,242    75,326 
           
Land use right, net  $3,118,482   $3,058,507 

 

Amortization expense for the years ended December 31, 2011 and 2010 were $63,941 and $60,881, respectively.

 

The estimated amortization expense on the land use right in the next five years and thereafter is as follows:

 

Year ending December 31:    
2012  $64,968 
2013   64,968 
2014   64,968 
2015   64,968 
2016   64,968 
Thereafter   2,793,642 
      
Total:  $3,118,482 

 

8.CONSTRUCTION IN PROGRESS

 

In 2008, the Company received approval from the local government to construct a new manufacturing facility for energy-saving products and equipment in Yingzhou District Industrial Park, Tieling City, Liaoning Province, the PRC. Total estimated construction cost of a new manufacturing facility is approximately $24 million.

 

F-16
 

 

 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

The construction project is partially completed and began its operations in December 2011.

 

For the year ended December 31, 2011, the Company transferred its accounts receivable due from two customers amounting to $7.8 million on a non-recourse basis to an independent project management company in the PRC as the prepayment for construction cost to complete the remaining construction of new manufacturing facility. The remainder of the construction project is expected to be fully completed during 2012.

 

9.SHORT-TERM BANK BORROWINGS

 

Short-term bank borrowings consist of the following:

 

   As of December 31, 
   2011   2010 
         
Payable to financial institutions in the PRC:          
           
Demand bank notes:          
Equivalent to RMB20,000,000, due May 2012, which is collateralized by its restricted cash and guaranteed by a third party. The notes bear the handling fee equal to 0.05% of its face value  $3,148,466   $- 
           
Short-term borrowings:          
Equivalent to RMB10,000,000 with interest rate at 1.3 times of the Bank of China Benchmark Lending Rate, monthly payable, due December 21, 2011, which is secured by properties owned by its vendor and guaranteed by Mr. Gang Li (the Company’s CEO) and a related party to him   -    1,512,447 
           
Equivalent to RMB10,000,000 with interest rate at 1.3 times of the Bank of China Benchmark Lending Rate, monthly payable, due February 16, 2012, which is guaranteed by a guarantee company in Shenyang City, the PRC   1,574,233    - 
           
Equivalent to RMB16,350,000 with interest rate at 1.4 times of the Bank of China Benchmark Lending Rate, monthly payable, due December 15, 2012, which is guaranteed by Mr. Gang Li (the Company’s CEO) and a guarantee company in Shenyang City, the PRC   2,573,871    - 
Total short-term bank borrowings  $7,296,570   $1,512,447 

 

(a)The bank loan was repaid in full upon maturity, subsequent to December 31, 2011.

 

The average effective interest rate is 8.24% and 7.553% per annum for the years ended December 31, 2011 and 2010.

 

10.NOTE PAYABLE, RELATED PARTY

 

In June 2011, the Company obtained a new short-term loan of $1,500,000 from a related company which is controlled by Ms. Lihua Wang (the Company’s CFO) and Mr. Gang Li (the Company’s CEO), to repay a short-term loan due June 10, 2011. This note is unsecured, carries interest at 2.5% per annum, payable at maturity and due on May 31, 2012.

 

F-17
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

11.    CONVERTIBLE PROMISSORY NOTES

 

On February 24, 2010 and March 4, 2010, the Company sold, through a private placement to two accredited investors, convertible promissory notes (the “Notes”) in the aggregate principal amount of $960,000 and warrants (the "Warrants") to purchase 64,000 shares of its common stock, par value $0.001 per share ("Common Stock"). The Company used the net proceeds of approximately $900,000 from the private placement for working capital and general corporate purposes.

 

The Notes while outstanding had an effective interest at the rate of 6% per annum and, absent an “event of default,” are payable in shares of the Company’s Common Stock. Provided no "event of default" has occurred and is not then continuing, the Notes initially were to convert upon the earlier to occur of (i) the commencement of trading of the Company's Common Stock on a major US stock exchange, or (ii) one year after issuance. Upon conversion, the holders of the Notes shall receive such number of shares of Common Stock equal to the quotient obtained by dividing (a) the then-outstanding principal amount and accrued but unpaid interest on the Notes by (b) the then-current conversion price, which currently is $7.50 per share. The conversion price is subject to adjustment for stock dividends, splits, combinations and similar events. The Notes while outstanding were secured by a security interest in and lien upon all of the Company’s assets.

 

On October 4, 2010, the Company entered into a Note Modification Agreement and agreed to amend the terms of the Notes, as follows:

 

(1)The Notes shall be automatically convert, through no action on the part of the holders of the Notes, into that number of shares of Common Stock equal to the quotient obtained by dividing (a) the then outstanding obligations by (b) the conversion price then in effect;

 

(2)Interest due under the Notes shall not accrue past October 4, 2010;

 

(3)The security interest in and lien upon all of the Company’s assets is terminated and shall be of no further force or effect.

 

The Warrants, which were exercisable for shares of Common Stock at an exercise price of $10 per share and were to terminate five years thereafter. The exercise price is subject to adjustment for stock dividends, splits, combinations and similar events. The warrants also contained an exercise price ratchet adjustment in the event the Company issues warrants having an exercise price at less than the exercise price then in effect for the Warrants. The Company had agreed to provide the investors with “piggy-back” registration rights with respect to the shares of Common Stock issuable upon exercise of the Warrants.

 

The Company engaged an independent appraiser to perform a valuation of the Notes and the Company determined that the Notes should be recorded in accordance with ASC Topic 470-20, “Debt with conversion and other options ”. The Company allocated the proceeds received between the Notes and the Warrants on a relative fair value basis. The relative fair values of the Notes and the Warrants determine the debt discount attributable to the Warrants and are recorded as additional paid-in capital. The resulting discount on the Notes is being amortized over the life of the Notes using the effective interest method.

 

For the year ended December 31, 2011, the Company recognized $70,271 as amortization of debt discount and recorded as interest expense in the consolidated statement of operations. As of December 31, 2011, the carrying value of the convertible promissory notes is amounted to $960,000.

 

On February 24, 2011, the Company and the holders of the Notes mutually agreed to extend the maturity date to February 24, 2012 and the Warrants were fully cancelled.

 

 

F-18
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

Subsequently, the Notes were agreed to further extend the maturity term to February 24, 2013. 

 

12.    OBLIGATION UNDER FINANCE LEASE

 

The Company purchased certain equipment under finance lease agreements with an effective interest rate of 8.6% per annum, due through May 25, 2012, with principal and interest payable monthly.

 

The obligation under the finance lease is as follows:

 

   As of December 31, 
   2011   2010 
         
Finance lease  $34,287   $529,091 
Less: current portion   (34,287)   (492,264)
           
Non-current portion  $-   $36,827 

 

The maturities of the finance lease obligation for the next year are as follows:

 

Years ending December 31:      
2011   $44,874 
Less: interest    (10,587)
       
Present value of minimum obligation   $34,287 

 

The obligation under the finance lease was guaranteed by the Company’s executive officers and directors, Mr. Gang Li and Ms. Li Hua Wang.

 

13.    AMOUNT DUE TO A RELATED PARTY

 

As of December 31, 2011, the amount due to a related party represented temporary advances made by the Company’s major stockholder, Pelaris International Ltd, which is controlled by Ms. Li Hua Wang (the Company’s CFO) and Mr. Gang Li (the Company’s CEO), which was unsecured, interest-free with no fixed repayment term. Imputed interest on this amount is considered insignificant.

 

14.    OTHER PAYABLES AND ACCRUED LIABILITIES

 

Other payables and accrued liabilities consisted of the following:

 

   As of December 31, 
   2011   2010 
         
Rent payable  $43,291   $41,592 
Payable to equipment vendors   130,636    111,558 
Customer deposits   381,055    18,916 
Value-added tax payable   170,055    248,385 
Provision for contingent liability   200,000    200,000 
Accrued operating expenses   371,979    256,706 
Other payable   7,871    25,732 
           
   $1,304,887   $902,889 

 

F-19
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

15. STOCKHOLDERS’ EQUITY

 

(a)    Common stock

 

As of December 31, 2011, the Company had a total of 5,326,501 shares of its common stock issued and outstanding.

 

(b)    Warrants

 

Transactions involving warrants during the year ended December 31, 2011 are summarized as follows (warrants were not issued to employees):

 

   Warrants outstanding 
   Number of
warrants
   Exercise price
range per
share
   Weighted
average
exercise price
per share
   Weighted
average
grant-date fair
value per share
 
                 
Balance as of January 1, 2011   87,334    $ 4.50-10.00   $8.50   $5.39 
                     
Warrants granted   -    -    -    - 
Warrants cancelled   (64,000)   (10.00)   (10.00)   (4.46)
Warrants exercised   -    -    -    - 
                     
Balance as of December 31, 2011   23,334    4.50    4.50    7.93 

 

The warrants were cancelled in relation to the extension of convertible promissory notes. The Company adopted ASC 718 using the Black-Scholes Option-Pricing model to measure the fair value of warrants on the grant date, with the following assumptions:

 

Expected life (in years)   5 
Volatility   340.61%- 456.53
Risk free interest rate   2.28% - 2.89
Dividend yield   0%

 

16.    INCOME TAXES

 

For the years ended December 31, 2011 and 2010, the local (“United States of America”) and foreign components of income (loss) before income taxes were comprised of the following:

 

   Years ended December 31, 
   2011   2010 
Tax jurisdiction from:          
- Local  $(493,206)  $(865,081)
- Foreign   2,841,199    5,946,610 
           
Income before income taxes  $2,347,993   $5,081,529 

 

F-20
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

The provision for income taxes consisted of the following:

 

   Years ended December 31, 
   2011   2010 
Current:          
- Local  $-   $- 
- Foreign   301,533    777,357 
           
Deferred:          
- Local   -    - 
- Foreign   -    1,408 
           
Income tax expense  $301,533   $778,765 

 

The effective tax rate in the years presented is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rate. The Company operates in various countries: United States of America and the PRC that are subject to taxes in the jurisdictions in which they operate, as follows:

 

United States of America

 

NFEC is registered in the State of Delaware and is subject to the tax laws of United States of America.

 

As of December 31, 2011, the operations in the United States of America incurred $2,660,710 of cumulative net operating losses which can be carried forward to offset future taxable income. The net operating loss carryforwards begin to expire in 2031, if unutilized. The Company has provided for a full valuation allowance against the deferred tax assets of $904,641 on the expected future tax benefits from the net operating loss carryforwards as the management believes it is more likely than not that these assets will not be realized in the future.

 

The PRC

 

The Company’s subsidiaries operating in the PRC are subject to the Corporate Income Tax Law of the People’s Republic of China at a unified income tax rate of 25%. Nengfa Energy is considered as a foreign investment enterprise and entitled to enjoy the unexpired tax holiday of 50%-reduction on the unified income tax through 2011 under a transitional policy. Sales Company is a domestic company with a unified income tax rate of 25%.

 

The reconciliation of income tax rate to the effective income tax rate for the years ended December 31, 2011 and 2010 is as follows:

 

   Years ended December 31, 
   2011   2010 
         
Income before income taxes from PRC operation  $2,841,199   $5,946,610 
Statutory income tax rate   25%   25%
Income tax expense at statutory rate   710,300    1,486,652 
Tax effect of non-taxable items   (4,825)   (6,340)
Tax effect from tax holiday   (355,012)   (742,036)
Tax adjustments   (48,930)   40,489 
           
Income tax expense  $301,533   $778,765 

 

F-21
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

The following table sets forth the significant components of the aggregate deferred tax assets of the Company as of December 31, 2011 and 2010:

 

   As of December 31, 
   2011   2010 
Deferred tax assets:          
Net operating loss carryforwards  $904,641   $736,951 
Less: valuation allowance   (904,641)   (736,951)
           
Deferred tax assets  $-   $- 

 

Management believes that it is more likely than not that the deferred tax assets will not be fully realizable in the future. Accordingly, the Company provided for a full valuation allowance against its deferred tax assets of $904,641 as of December 31, 2011. During 2011, the valuation allowance increased by $167,690, primarily relating to net operating loss carryforwards from the local tax regime.

 

17.    NET INCOME PER SHARE

 

Basic net income per share is computed using the weighted average number of common shares outstanding during the year. The dilutive effect of potential common shares outstanding is included in diluted net income per share. On September 16, 2011, the Company effected a 1 for 2.5 reverse split of its common stock. All common stock and per share data for all periods presented in these financial statements have been restated to give effect to the reverse stock split.

 

The following table sets forth the computation of basic and diluted net income per share for the years ended December 31, 2011 and 2010:

 

   Years ended December 31, 
   2011   2010 
         
Net income attributable to common shareholders  $2,046,460   $4,302,764 
           
Weighted average common shares outstanding – Basic   5,326,501    5,326,501 
Plus: incremental shares from assumed conversions          
- Convertible shares from convertible promissory notes   128,000    108,274 
- Warrants to purchase common stock   -    23,334 
           
Weighted average common shares outstanding – Diluted   5,454,501    5,458,109 
           
Net income per share – Basic  $0.38   $0.81 
Net income per share – Diluted  $0.38   $0.79 

 

For the year ended December 31, 2011, warrants exercisable to 23,334 shares of common stock were excluded from the diluted income per share as the exercise price of the warrants was higher than the average market price of the common stock during the year, thereby making the warrants anti-dilutive under the treasury method.

 

F-22
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

18.    CHINA CONTRIBUTION PLAN

 

Under the PRC Law, full-time employees of the Company’s subsidiaries in the PRC, Nengfa Energy and Sales Company are entitled to staff welfare benefits including medical care, welfare subsidies, unemployment insurance and pension benefits through a China government-mandated multi-employer defined contribution plan. Nengfa Energy and Sales Company are required to accrue for these benefits based on certain percentages of the employees’ salaries. The total contributions made for such employee benefits were $190,925 and $180,904 for the years ended December 31, 2011 and 2010, respectively.

 

19.    STATUTORY RESERVES

 

Under the PRC Law the Company’s subsidiaries, Nengfa Energy and Sales Company are required to make appropriations to the statutory reserve based on after-tax net earnings and determined in accordance with generally accepted accounting principles of the People’s Republic of China (the “PRC GAAP”). Appropriation to the statutory reserve should be at least 10% of the after-tax net income until the reserve is equal to 50% of the registered capital. The statutory reserve is established for the purpose of providing employee facilities and other collective benefits to the employees and is non-distributable other than in liquidation.

 

For the years ended December 31, 2011 and 2010, the Company’s subsidiaries made appropriation of $238,242 and $516,211 to statutory reserve, respectively.

 

20.    SEGMENT INFORMATION

 

The Company’s business units have been aggregated into two reportable segments, as defined by ASC Topic 280:

 

·Heavy manufacturing business – production of valves components and the provision of valve improvement and engineering services;

 

·Energy-saving related business – provision of energy-saving related re-engineering and technical services and long-term construction project.

 

The Company operates these business segments in the PRC and all of the identifiable assets of the Company are located in the PRC during the years presented.

 

The accounting policies of the segments are the same as those described in the summary of significant accounting policies (see Note 2). The Company had no inter-segment sales for the years ended December 31, 2011 and 2010. The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. Summarized financial information concerning the Company’s reportable segments is shown in the following table for the years ended December 31, 2011 and 2010:

 

   Year ended December 31, 2011 
   Heavy         
   manufacturing   Energy-saving     
   business   related business   Total 
Operating revenues, net:               
- Products  $10,896,009   $1,937   $10,897,946 
- Services   3,228,931    802,553    4,031,484 
- Project   -    -    - 
Total operating revenues   14,124,940    804,490    14,929,430 
Cost of revenues   (10,511,112)   (246,239)   (10,757,351)
                
Gross profit   3,613,828   $558,251   $4,172,079 
Depreciation and amortization   556,654    31,624    588,278 
Total assets   41,510,530    2,307,393    43,817,923 
Expenditure for long-lived assets  $10,992,293   $-   $10,992,293 

 

F-23
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

   Year ended December 31, 2010 
   Heavy         
   manufacturing   Energy-saving     
   business   related business   Total 
Operating revenues, net:               
- Products  $16,380,801   $406,053   $16,786,854 
- Services   6,569,301    1,259,539    7,828,840 
- Project   -    756,512    756,512 
Total operating revenues   22,950,102    2,422,104    25,372,206 
Cost of revenues   (17,457,925)   (1,076,509)   (18,534,434)
                
Gross profit   5,492,177    1,345,595    6,837,772 
Depreciation and amortization   299,802    33,350    333,152 
Total assets   30,634,405    3,399,440    34,033,845 
Expenditure for long-lived assets  $3,959,966   $-   $3,959,966 

 

21.    CONCENTRATIONS OF RISK

 

The Company is exposed to the following concentrations of risk:

 

(a) Major customers

 

For the years ended December 31, 2011 and 2010, customers who accounted for 10% or more of the Company’s revenues and its outstanding balance as at year-end dates, are presented as follows:

 

   Year ended December 31, 2011      December 31, 2011 
Customer  Revenues   Percentage
of revenues
      Accounts and
retention
receivable
 
                
Customer A  $5,753,720    39%     $7,578,206 
Customer B   3,186,753    21%      - 
                   
Total:  $8,940,473    60%  Total:  $7,578,206 

 

   Year ended December 31, 2010      December 31, 2010 
Customer  Revenues   Percentage
of revenues
      Accounts and
retention
receivable
 
                
Customer B  $6,432,959    25%     $5,599,183 
Customer A   5,193,377    20%      4,451,847 
Customer C   4,794,836    19%      2,716,303 
                   
Total:  $16,421,172    64%  Total:  $12,767,333 

 

F-24
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

(b)    Major vendors

 

For the year ended December 31, 2011, one vendor represented more than 10% of the Company’s purchases. This vendor accounted for 46% of the Company’s purchase amounting to $4,535,267, with $0 of accounts payable.

 

For the year ended December 31, 2010, one vendor represented more than 10% of the Company’s purchases. This vendor accounted for 49% of the Company’s purchase amounting to $8,749,485, with $180,247 of accounts payable.

 

(c)    Credit risk

 

Financial instruments that are potentially subject to credit risk consist principally of trade receivables. The Company believes the concentration of credit risk in its trade receivables is substantially mitigated by its ongoing credit evaluation process and relatively short collection terms. The Company does not generally require collateral from customers. The Company evaluates the need for an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information.

 

(d)    Interest rate risk

 

As the Company has no significant interest-bearing assets, the Company’s income and operating cash flows are substantially independent of changes in market interest rates.

 

The Company’s interest-rate risk arises from borrowings under promissory notes, finance lease and short-term bank borrowing. The Company manages interest rate risk by varying the issuance and maturity dates variable rate debt, limiting the amount of variable rate debt, and continually monitoring the effects of market changes in interest rates. As of December 31, 2011, borrowings under promissory notes and finance lease were at fixed rates and short-term bank borrowing was at variable rates.

 

(e)    Exchange rate risk

 

The reporting currency of the Company is US$, to date the majority of the revenues and costs are denominated in RMB and a significant portion of the assets and liabilities are denominated in RMB. As a result, the Company is exposed to foreign exchange risk as its revenues and results of operations may be affected by fluctuations in the exchange rate between US$ and RMB. If RMB depreciates against US$, the value of RMB revenues and assets as expressed in US$ financial statements will decline. The Company does not hold any derivative or other financial instruments that expose to substantial market risk.

 

(f)    Economic and political risks

 

The Company's operations are conducted in the PRC. Accordingly, the Company's business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy.

 

The Company's operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company's results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation.

 

F-25
 

 

NF ENERGY SAVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

22.    COMMITMENTS AND CONTINGENCIES

 

(a)Operating lease commitments

 

The Company is committed under a non-cancelable operating lease with fixed monthly rentals, due through February 9, 2012. Costs incurred under the operating lease, which are considered to equivalent to the market rate, are recorded as rental expense and totaled approximately $54,227 and $46,099 for the years ended December 31, 2011 and 2010.

 

As of December 31, 2011, the Company has future minimum rental payments of $3,936 due under this non-cancelable operating lease in the next twelve months.

 

(b)Capital commitments

 

As of December 31, 2011, the Company is committed to the future contingent payments of approximately $0.7 million on the purchase of new plant and equipment and third party contractors relating to its construction project in the next twelve months.

 

(c)Unused credit facility

 

For the year ended December 31, 2011, the Company obtained a credit facility with the maximum limit of $5.88 million (equivalent to RMB40 million), in a term of 2 years, expiry on June 28, 2012. Advances under this credit facility are unsecured and bear interest at an annual rate of 1.3 times the Bank of China Benchmark Lending Rate, payable monthly. There were no borrowings under this credit facility as of December 31, 2011.

 

(d)Legal proceedings

 

Robert E. Dawley v. NF Energy Corp. of America, M.D. Fla. Case no. 6:10-cv-0115-Orl-22DAB. Robert Dawley (“Dawley”) commenced this action in the United States District Court for the Middle District of Florida against the Company, Mr. Gang Li and the Company’s litigation counsel on October 1, 2011. The allegations in this action are identical to those that Dawley raised in a prior proceeding in which the United States Court of Appeals for the Eleventh Circuit entered judgment against him and in favor of the Company.

 

Upon motion by the defendants, in an order dated December 29,2010, the District Court dismissed six of Dawley’s ten claims on the ground that they were precluded by the Eleventh Circuit’s prior judgment. Dawley attempted to appeal the District Court’s order to the Eleventh Circuit. (Dawley v NF Energy Saving Corp. of America, U.S.C.A. 11th Cir. Appeal no. 11-10201-F.) However, the Eleventh Circuit dismissed Dawley’s appeal as premature. Dawley asked the Eleventh Circuit to reconsider, but it declined.

 

This District Court, in an order dated July 19,2011, dismissed Dawley’s remaining four claims with prejudice on the grounds that he had failed to plead them with the specificity required by law. The District Court then entered Judgment against him on July 20,2011. Dawley filed a Notice of Appeal of the District Court’s Judgment on July 25,2011. There has been no further action in the case on appeal.

 

As of December 31, 2011, the Company accrued $200,000 for this contingent liability and the Company’s directors, Mr. Gang Li and Ms. Lihua Wang have personally agreed to guarantee all contingent liabilities and costs to be incurred in connection with this litigation claim. At this point, the Company does not believe that the judgment would have a material impact on, or result in significant contingencies to, the Company.

 

23.    SUBSEQUENT EVENTS

 

In accordance with ASC Topic 855, “Subsequent Events”, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued, the Company has evaluated all events or transactions that occurred after December 31, 2011 up through the date was the Company issued the audited consolidated financial statements. During the period, the Company did not have any material recognizable subsequent events.

 

 

F-26
 

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

 

(a)     Evaluation of Disclosure Controls and Procedures .

 

Our chief executive officer and chief financial officer evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2011. The term “disclosure controls and procedures,” as defined in Rule 13a-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, to allow timely decisions regarding required disclosure. Based on the evaluation of our disclosure controls and procedures as of December 31, 2011, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective.

 

(b)Management’s Annual Report on Internal Control Over Financial Reporting .

 

Management’s Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) under the Exchange Act as a process designed by, or under the supervision of, the company’s principal executive officer and principal financial officer and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

 

·Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

 

·Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with management authorization; and

 

·Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2011. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.

 

Based on this assessment, our management concluded that, as of December 31, 2011, our internal control over financial reporting is effective.

 

50
 

 

c)    Changes in Internal Controls

 

No change in our internal control over financial reporting occurred during the fiscal quarter ended December 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

 

None.

 

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

Directors and Executive Officers

 

The persons listed below are the current officers and directors of the Company as of the filing date of this report. Our directors are elected at the annual meeting of shareholders, or may be appointed by the Board to fill an existing vacancy, and hold office for one year and until their successors are elected and qualified. Our officers are appointed by the Board of Directors and serve at the pleasure of the Board. We have not entered into any employment agreements with our executive officers.

  

Name Age Position
Gang, Li 59 Chairman and Chief Executive Officer and President
Lihua, Wang 52 Director, CFO
Mia Kuang, Ching 46 Independent Director, Chair of Audit Committee
Jason, Wang 59 Independent Director, Chair of Nomination Committee
Jiuding, Yan 46 Independent Director, Chair of Compensation Committee

 

Gang LiPresident and Chief Executive Officer

 

Mr. Gang Li became the Chairman and Chief Executive Officer and President of the Company in November 2006. Mr. Li was born in 1953. He graduated from Tianjin University with a bachelor degree in science and a master degree in law.

 

Mr. Li was the director of Technology Innovation Department under the Liaoning Province Planning and Economy Commission as well as the Director of the Economic Operation Department under Liaoning Province Economic and Trade Commission. From April 1984 to July 1998, he participated in and helped to prepare the Eighth and the Ninth Five-Year Plan regarding the technological improvement in eight industries including energy, transportation, and other various metallurgical industries. Mr. Li has also helped to organize and implement several projects in connection with technological improvements spanning across over 500 key products, 100 major projects, 100 enterprises and 8 industries, including the famous “115 engineering project”. Due to Mr. Li’s leadership on the “115 engineering project” and as a result of the above-mentioned technological improvements, he was awarded the Enterprise Technology Advancement Award by China’s National Technology Improvement Commission.

 

Mr. Li is also an accomplished author and with several published papers and books discussing various industry topics. His book “An Introduction to Technological Improvement” was published by the prestigious Xinhua Publishing House. In addition, the Liaoning Provincial Government awarded his paper titled “Macro-indicator Review Systems in Enterprise Technology Improvement” with the National Major Outcome prize and a second-place award in the category of Technological Advancement.

 

51
 

 

Between 1998 and 2006, Mr. Li was the General Manager of Liaoning project company, one of the three pilot and demonstration companies of the GEF/WB/NDRC China Energy Conservation Promotion Project. Mr. Li led the team working on “Energy Management Contract” model of energy saving projects, completed 256 energy saving projects for 216 customers. The accumulated total investment for the projects was 0.452 billion RMB, with an accumulated savings of 1.67 million tons of standard coal, which resulted in a reduction of CO2 emissions by 1.52 million tons. These achievements have been highly awarded by the World Bank and National Development and Reform Commission (NDRC). In 2006, after the promotion projects were completed, Mr. Li established Liaoning Nengfa Weiye Energy Technology Corporation Ltd. Mr. Li also serves as the Deputy Director of the Liaoning Provincial Resource Saving and Comprehensive Application Association. He also holds the offices of Deputy Director for the China Energy Conservation Association and Deputy Director for the Energy Conservation Committee under the China Energy Research Association. We believe Mr. Li’s qualifications to serve on our Board of Directors include his relationships with various government officials at local and provincial levels, and his experience in consolidating resources and ability to obtaining capital financing.

 

Lihua Wang —Chief Financial Officer

 

Ms. Lihua Wang was born in 1960. Ms. Wang has been a Director and the Chief Financial Officer of the Company since November 2006. She is also the general manager of the 100% owned subsidiary Liaoning Nengfa Weiye Energy Technology Company Ltd. in China. She graduated with a master degree in accounting from the Graduate School of the Ministry of Finance in the Peoples Republic of China.

 

Since May 1996, Ms. Wang has been involved in the building of Liaoning Energy Management Contract (EMC) Project company , which is one of the three pilot and demonstration companies of the GEF/WB/NDRC China Energy Conservation Promotion Project.. Ms. Wang is the chief financial officer of Liaoning EMC. In August 2003, the World Bank recommended her as the premier expert to the Chinese EMC Association. We believe Ms. Wang’s qualifications to serve on our Board of Directors include her knowledge of PRC tax policies, her ability to manage corporate risk, and her experience in project assessments.

 

Mia Kuang Ching — Independent Director, Chairman of Audit Committee

 

Mr. Mia Kuang Ching is currently a private consultant on merger and acquisition projects. Up until 2 December 2011 he was the managing partner of SBA Stone Forest Corporate Advisory (Shanghai) Co., Ltd. From 1992 to 1994 he was Regional Accountant (South Europe) of Singapore Airlines. From 1994 to 1997, he was the Group Financial Controller of Fullmark Pte. Ltd., and responsible for operations in China, Hong Kong, Malaysia and Vietnam. He was in-charge of strategic investment, group financing and mergers and acquisitions. From 1997 to 2000, he was the Chief Accountant of Dalian Container Terminal, a joint venture formed by PSA Corporation of Singapore and the Port of Dalian Authority.

 

Mr. Ching became an Independent Director of the Company in August 2009 and is Chairman of the Audit Committee. We believe Mr. Ching’s qualifications to serve on our Board of Directors include his years of business experience and his familiarity with financial accounting matters.

 

Jianxin (Jason) Wang — Independent Director, Chairman of Nomination Committee

 

Mr. Jianxin Wang, Independent Director of NFEC, is a senior corporate executive with over 15 years of experience in promoting industrial energy efficiency, and strong leadership skills in corporate strategy development, business management and equity investment, as well as in depth knowledge on Chinese government policies and regulations on clean technology, renewable energy and energy efficiency. Mr. Wang has been the General Manager of Gaoping Ronggao PV Solar Development Co. ltd. a privately owned Chinese wafer and PV cell company, since September 2011. From January 2008 until December 2010, Mr. Wang was the Managing Director of China Carbon Corporation (CCC), an international company engaged in carbon trading, and the Managing Director of Cosmos International Corp. a Canadian investment consulting firm in Beijing. Previously, Mr. Wang served as the President of Sparkles International Development Corp. a Virginia based energy efficiency consulting and trading firm from 1993 to December 2007, and a senior consultant for Chicago Climate Exchange in 2006 and a research assistant at the World Bank in 1991. Mr. Wang is the Deputy Director of the Enterprise Energy Saving Committee and the Deputy Secretary General of the Energy Efficiency Investment and Assessment Committee of China Energy Research Society and he is an energy expert for the State Development Bank of China

 

Mr. Wang became an Independent Director of the Company in August 2009 and is Chairman of the Nominating Committee. We believe Mr. Wang’s qualifications to serve on our Board of Directors include his experience in the areas of climate change and carbon trade and energy efficiency.

 

52
 

 

Jiuding Yan- Independent Director-Chairman of Compensation Committee

 

Mr. Yan has degrees from Shenyang Agricultural University and the California State University, Hayward. Mr. Jiuding Yan has been the Vice President of Zhong Tian Securities Corporation Limited since July 2004.

From 1996 to July 2004, Mr. Yan was the Deputy General Manager of Liaoning Orient Securities Company.

 

Mr. Yan became an Independent Director of the Company in September 2009 and is Chairman of the Compensation Committee. We believe Mr. Yan’s qualifications to serve on our Board of Directors include his experience as a financial consultant to public and non-public companies operating in the People’s Republic of China and in other countries.

 

Family Relationships

 

None.

 

Audit Committee

 

The current members of our audit committee are Mia Kuang Ching (Chairman), Jason Wang and Jiuding Yan, each of whom we believe satisfies the independence requirements of the Securities and Exchange Commission. We believe Mr. Ching is qualified as an audit committee financial expert under the regulations of the SEC by reason of his work experience. Our audit committee assists our Board of Directors in its oversight of:

 

• the integrity of our financial statements;

 

• our independent registered public accounting firm’s qualifications and independence; and

 

• the performance of our independent auditors.

 

Code of Ethics

 

The Company has adopted a code of ethics (the "Code of Ethics") that applies to the Company’s principal chief executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. A copy of the Code of Ethics is attached as Exhibit 14.1 hereto. The Code of Ethics is designed with the intent to deter wrongdoing, and to promote the following:

 

·Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;

 

·Full, fair, accurate, timely and understandable disclosure in reports and documents that the Company files with, or submits to, the SEC and in other public communication made by the Company;

 

53
 

 

·Compliance with applicable governmental laws, rules and regulations;

 

·The prompt internal reporting of violations of the code to an appropriate person or persons identified in the code; and

 

Accountability for adherence to the Code.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Under Section 16(a) of the Exchange Act, all executive officers, directors, and each person who is the beneficial owner of more than 10% of the common stock of a company that files reports pursuant to Section 12 of the Exchange Act, are required to report the ownership of such common stock, options, and stock appreciation rights (other than certain cash-only rights) and any changes in that ownership with the SEC. Specific due dates for these reports have been established, and the Company is required to report, in this Form 10-K, any failure to comply therewith during the fiscal year ended December 31, 2011. The Company believes that all of these filing requirements were satisfied by its executive officers, directors and by the beneficial owners of more than 10% of the Company’s common stock. In making this statement, the Company has relied solely on copies of any reporting forms received by it, and upon any written representations received from reporting persons that no Form 5 (Annual Statement of Changes in Beneficial Ownership) was required to be filed under applicable rules of the SEC.

 

ITEM 11. EXECUTIVE COMPENSATION

 

Compensation of Executive Officers

 

We did not provide any compensation to our executive officers for the years ended December 31, 2011 or 2010.

 

Compensation of Directors

 

As at December 31, 2011, we had five non-employee directors, to whom we provided a total amount of $100,000 in compensation, as set forth in the table below. As employees of the Company and/or its subsidiaries, Gang Li, Lihua Wang and Hong Li (who resigned from the Board of Directors effective December 31, 2011) received no additional compensation for their services as directors.

 

NON-EMPLOYEE DIRECTOR COMPENSATION TABLE FOR YEAR ENDED DECEMBER 31, 2011

 

Name  Fees Earned or
Paid in Cash
($)
   All Other
Compensation
($)
  Total
($)
 
Mia Kuang Ching   24,000   N/A   24,000 
Jianxin (Jason) Wang   24,000   N/A   24,000 
Jiuding Yan   24,000   N/A   24,000 
John MacLean(1)   14,000   N/A   14,000 
Joshua Kurtzig(2)   14,000   N/A   14,000 

 

(1) Resigned effective July 30, 2011

(2) Resigned effective December 31, 2011

 

54
 

 

Outstanding equity awards at fiscal year-end

 

We have not implemented a stock option plan at this time and since inception, have issued no stock options, SARs or other equity awards. We may decide, at a later date, and reserve the right to, initiate such a plan as deemed necessary by the Board.

 

Pension benefits

 

We have not entered into any pension benefit agreements with our executive officers or directors. We contribute to the social insurance for our employees each month, which includes pension, medical insurance, unemployment insurance, occupational injuries insurance and housing provision funds in accordance with PRC regulations.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The following table sets forth certain information concerning the ownership of NF Energy Saving Corporation’s Common Stock as of March 11, 2012, with respect to: (i) each person known to us to be the beneficial owner of more than five percent of NF Energy Saving Corporation’s Common Stock, (ii) each director and executive officer; and (iii) all directors and named executive officer of the Company as a group. The notes accompanying the information in the table below are necessary for a complete understanding of the figures provided below. As of March 11, 2011, there were 5,326,501 shares of common stock outstanding. As of March 25, 2012, there were no preferred shares outstanding.

 

Name and Address of Beneficial Owner(s)  Amount and Nature of
Beneficial Owner(s)
 (1) (2)
   Percentage of Beneficial
Ownership
 
         
Pelaria(3)
P.O. Box 957
Offshore Incorporations Centre
Road Town, Tortola
   2,540,118    47.69%
           
Gang, Li(4)
Chairman, CEO and President
   2,032,095    38.15%
           
Lihua Wang(5)
Director and CFO
   508,023    9.54%
           
Mia Kuang Ching   0    0%
Independent Director
Chair of Audit Committee
          
           
Jianxin (Jason) Wang   0    0%
Independent Director
Chair of Nomination Committee
          
           
Jiuding Yan   0    0%
Independent Director
Chair of Compensation Committee
          
           
All officers and directors as a group (five persons)   2,540,118    47.69%

 

55
 

 

(1) Pursuant to Rule 13-d-3 under the Securities Exchange Act of 1934, as amended, beneficial ownership of a security consists of sole or shared voting power (including the power to vote or direct the voting) and/or sole or shared investment power (including the power to dispose or direct the disposition) with respect to a security whether through a contract, arrangement, understanding, relationship or otherwise. Unless otherwise indicated, each person indicated above has sole power to vote, or dispose or direct the disposition of all shares beneficially owned. We are unaware of any shareholders whose voting rights would be affected by community property laws. Unless as otherwise set forth in the table, the address of each beneficial owner is 3106, Tower C, 390 Qingnian Avenue, Heping District, Shenyang City, Liaoning Province, P. R. China 110015.

 

(2) This table is based upon information obtained from our stock records. Unless otherwise indicated in the footnotes to the above tables and subject to community property laws where applicable, we believe that each shareholder named in the above table has sole or shared voting and investment power with respect to the shares indicated as beneficially owned.

 

(3) Pelaria International Ltd. (“Pelaria”) is the record owner of the stated number of shares. Pelaria is a wholly-owned subsidiary of Liaoning Nengfa Weiye New Energy Application Co., Ltd. (“Weiye Energy”). Weiye Energy is 80% owned by Gang Li and 20% owned by Lihua Wang. Mr. Li and Ms. Wang are two of the three directors of Weiye Energy, and therefore, effectively share the voting and dispositive authority over the shares.

 

(4) Represents the 80% beneficial ownership of the shares of Weiye Energy, described in footnote 3 above.

 

(5) Represents the 20% beneficial ownership of the shares of Weiye Energy, described in footnote 3 above.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

Transactions with related persons, promoters and certain control persons

 

In June 2011, the Company obtained a new short-term loan of $1,500,000 from Pelaria, its major stockholder which is controlled by Ms. Lihua Wang (the Company’s CFO) and Mr. Gang Li (the Company’s CEO), to repay a short-term loan due June 10, 2011. This note is unsecured, carries interest at 2.5% per annum, payable at maturity, and is due on May 31, 2012. As of December 31, 2011, the total amount outstanding under the loan was $1,500,000 .

 

  Director Independence

 

We undertook a review of the independence of our directors and, using the definitions and independence standards for directors provided in the rules of The NASDAQ Stock Market, considered whether any director has a material relationship with us that could interfere with his or her ability to exercise independent judgment in carrying out their responsibilities. As a result of this review, we determined that Mia Kuang Ching, Jianxin (Jason) Wang and Jiuding Yan were "independent directors" as defined under the rules of The NASDAQ Stock Market.

 

56
 

 

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

 

Fees Billed For Audit and Non-Audit Services

 

The following table represents the aggregate fees billed for professional audit services rendered by our independent auditor, HKCMCPA Company Limited (“HKCMCPA”) for their audit of our annual financial statements during the years ended December 31, 2011 and 2010. Audit fees and other fees of auditors are listed as follows:

 

Year Ended December 31  2011   2010 
         
Audit Fees  $74,500   $79,500 
Audit-Related Fees        
Tax Fees        
All Other Fees        
Total Accounting Fees and Services  $74,500   $79,500 

 

Audit Fees. These are fees for professional services for the audit of the Company’s annual financial statements, and for the review of the financial statements included in the Company’s filings on Form 10-Q, and for services that are normally provided in connection with statutory and regulatory filings or engagements, The amounts $74,500 shown for HKCMCPA in 2011 related to (i) the audit of the Company’s annual financial statements for the fiscal year ended December 31, 2011, and (ii) the review of the financial statements included in the Company’s filings on Form 10-Q for the first, second and third quarters of 2011. The amounts $79,500 shown for HKCMCPA in 2010 related to (i) the audit of the Company’s annual financial statements for the fiscal year ended December 31, 2010, and (ii) the review of the financial statements included in the Company’s filings on Form 10-Q for the first, second and third quarters of 2010.

 

Audit-Related Fees. These are fees for the assurance and related services reasonably related to the performance of the audit or the review of the Company’s financial statements. There were no audit-related fees billed during the years ended December 31, 2011or 2010.

Tax Fees. These are fees for professional services with respect to tax compliance, tax advice, and tax planning. There were no tax fees billed during the years ended December 31, 2011or 2010.

 

All Other Fees. These are fees for permissible work that does not fall within any of the other fee categories, i.e. Audit Fees, Audit-Related Fees, Tax Fees and allowable working costs. There were no other fees billed during the years ended December 31, 2011 or 2010

 

Pre-Approval Policy and Procedures for Audit and Non-Audit Services

 

The audit committee has the sole and direct responsibility for appointing, evaluating and retaining our independent registered public accounting firm and overseeing their work. All audit services to be provided to us and all non-audit services, other than de minims non-audit services, to be provided to us by our independent auditors must be approved in advance by our audit committee.

 

57
 

 

PART IV

 

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

 

(a)(1)      Financial Statements.

For a list of the financial information included herein, see “Index to Financial Statements” on page 49.

 

(a)(2)      Financial Statement Schedules.

All schedules are omitted because they are not applicable or the required information is shown in the Financial Statements or Notes thereto.

 

(a)(3)    Exhibits. The list of Exhibits filed as a part of this Form 10-K are set forth on the Exhibit Index immediately preceding such Exhibits and is incorporated herein by this reference.

 

58
 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned.

 

  NF ENERGY SAVING CORPORATION
  (Registrant)
   
Date: March  25, 2012 By: /s/ Gang Li
    Gang Li
    President and Chief Executive Officer

 

Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.

 

Signature   Title   Date
         
    President, Chief Executive Officer and   March 25, 2012
/s/ Gang Li   Chairman (principal executive officer)    
Gang Li        
         
/s/ Lihua Wang  

Chief Financial Officer and Director

(principal financial officer and principal

accounting officer)

  March 25, 2012
Lihua Wang        
         
/s/ Mia Kuang Ching   Independent Director, Chair of Audit Committee   March 25, 2012
Mia Kuang Ching        
         
/s/ Jason Wang   Independent Director, Chair of Nomination Committee   March 25, 2012
Jason Wang        
         
/s/ Jiuding Yan  

Independent Director

Chair of Compensation Committee

  March 25, 2012
Jiuding Yan        

 

59
 

 

INDEX TO EXHIBITS

 

Exhibit 

Number

 

 

Description

 

Incorporated by

Reference to

3.1   Certificate of Incorporation  

Exhibits with the corresponding numbers filed with our registration statement on Form 10-SB filed January 17, 2003.

(File No. 000-50155).

3.2   Certificate of Amendment  

Exhibits submitted with our registration statement on Form 10-SB filed January 17, 2003.

(File No. 000-50155)

3.3

 

  Certificate of Amendment to Certificate of Incorporation  

Exhibits submitted with our registration statement on Form 10-SB filed January 17, 2003. (File No. 000-50155)

Incorporated by reference from the Company’s Definitive Information Statement on Schedule 14C, filed July 23, 2009

3.4  

Certificate of Amendment to Certificate of Incorporation

 

  Incorporated by reference from the Company’s Current Report on Form 8-K, filed on September 16, 2010

3.5

 

 

Bylaws

 

  Exhibits submitted with our registration statement on Form 10-SB filed January 17, 2003. (File No. 000-50155)
10.1   Form of Securities Purchase Agreement among NF Energy Saving Corporation of America, South World Ltd. (investor), Oriental United Resources Ltd. (investor), Mr. Gang Li (guarantor), Ms. Lihua Wang (guarantor), Pelaria International Ltd. (guarantor), and Cloverbay International Ltd. (guarantor)   Exhibits submitted with our Current Report on Form 8-K/A filed April 30, 2008. (File No. 000-50155)
10.2   Form of Director Retainer Agreement with Mr. Mia Kuang Ching, including Proprietary Information and Inventions Agreement and Indemnity Agreement   Incorporated by reference from the Company’s Current Report on Form 8-K, filed August 12, 2009
10.3   Form of Director Retainer Agreement with Mr. Jianxin Wang, including Proprietary Information and Inventions Agreement and Indemnity Agreement   Incorporated by reference from the Company’s Current Report on Form 8-K, filed August 12, 2009
10.4   Form of Director Retainer Agreement with Mr. Zhongmin Wang, including Proprietary Information and Inventions Agreement and Indemnity Agreement 4   Incorporated by reference from the Company’s Current Report on Form 8-K, filed September 14, 2009
10.5   Form of Director Retainer Agreement with Mr. Jiuding Yan, including Proprietary Information and Inventions Agreement and Indemnity Agreement   Incorporated by reference from the Company’s Current Report on Form 8-K, filed September 14, 2009
10.6   Form of Director Retainer Agreement with Mr. John C. MacLean, including Proprietary Information and Inventions Agreement and Indemnity Agreement   Incorporated by reference from the Company’s Current Report on Form 8-K, filed September 14, 2009

 

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10.7   Form of Securities Purchase Agreement (including form of Convertible Promissory Note and Form of Warrant   Incorporated by reference from the Company’s Current Report on Form 8-K, filed on March 3, 2010
14.1   Code of ethics of NF Energy Saving Corporation    
21.1   Subsidiaries of Registrant    
23.1   Consent of Independent Registered Public Accounting Firm    
31.1  

Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14 of the

Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

   
31.2   Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002    
32.1   Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002    
32.2   Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002    

  

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