UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark one)

 

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

 

For the quarterly period ended March 31, 2011

 

 or

 

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

 

For the transition period from _______________to ________________

 

Commission File Number: 333-148928

 

CHINA ENVIRONMENTAL PROTECTION, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

NEVADA		75-3255056
(State or Other jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

 

C/O Jiangsu Zhenyu Environmental Protection Technology Co. Ltd.
West Garden, Gaocheng Town, Yixing City, Jiangsu Province, P.R. China		214214
(Address of Principal Executive Offices)		(Zip Code)

 

86-510-87838598

(Registrant’s Telephone Number, Including Area Code)

N/A

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes 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 (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)

 

Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer ¨	Smaller reporting company x

 

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

 

Indicated the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date

 

17,170,015 shares of common stock are issued and outstanding as of May 15, 2011.

 

 

TABLE OF CONTENTS

 

		Page
	PART I
Item 1.	Financial Statements.	F-1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operation.	3
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	9
Item 4.	Controls and Procedures.	9
	PART II
Item 1.	Legal Proceedings.	10
Item 1A.	Risk Factors.	10
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	10
Item 3.	Defaults Upon Senior Securities.	10
Item 4.	Mine Safety Disclosures.	10
Item 5.	Other Information.	10
Item 6.	Exhibits.	10
SIGNATURES		12

 

 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D TASTE ON DEMAND INC)

 

FINANCIAL REPORT

 

AT MARCH 31, 2011 AND SEPTEMBER 30, 2010 , AND

FOR THE THREE AND SIX MONTHS ENDED MARCH 31, 2011 AND 2010

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D TASTE ON DEMAND INC)

 

INDEX

 

		PAGE
CONSOLIDATED BALANCE SHEETS		3
CONSOLIDATED STATEMENTS OF OPERATIONS		4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME		5
CONSOLIDATED STATEMENTS OF CASH FLOWS		5
NOTES TO CONSOLICATED FINANCIAL STATEMENTS		7-31

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D TASTE ON DEMAND INC)

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		March 31,				September 30,
		2011				2010
		(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents		$	2,345,963			$	1,268,674
Restricted cash			-				5,844,020
Accounts receivable, net (Note 4)			4,734,036				815,566
Others receivables			33,658				93,310
Inventory (Note 5)			1,725,967				9,045,390
Advance to suppliers			10,035				1,606,018
Prepaid expenses			-				15,424
Deferred tax assets			-				98,514
Total current assets			8,849,659				18,786,916
Property, Plant and Equipment, net (Note 6)			1,503,429				1,536,358
Other Assets
Intangible assets, net (Note 7)			1,119,366				1,109,867
Refundable security deposit			3,142,366				2,501,031
Total other assets			4,261,732				3,610,898
Total Assets		$	14,614,820			$	23,934,172
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Bank loans (Note 8)		$	761,023			$	746,480
Accounts payable			6,316,368				4,223,235
Salary and welfare payables			281,647				671,797
Others payable			961				83,056
Taxes payable (Note 9)			1,992,375				1,768,495
Advance from customers			645,634				7,449,518
Due to the CEO			1,797,104				894,714
Total Current Liabilities			11,795,112				15,837,295
COMMITMENTS AND CONTINGENCIES (Note 14)			-				-
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value. 10,000,000 shares authorized; Authorized 10,000,000 shares; none issued as of March 31, 2011 and September 30, 2010, respectively			-				-
Common stock, $0.01 par value; authorized 34,639,823 shares; Issued and outstanding- 17,170,015 shares as of March 31, 2011 and September 30, 2010, respectively			171,700				171,700
Additional paid-in capital			2,960,904				2,960,904
Retained earnings			(496,937	)			4,889,989
Accumulated other comprehensive income (loss)			184,041				74,284
Total Shareholders' Equity			2,819,708				8,096,877
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY		$	14,614,820			$	23,934,172

 

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

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D TASTE ON DEMAND INC)

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

		For the Three Months Ended								For the Six Months Ended
		March 31,								March 31,
		2011				2010				2011				2010
		(unaudited)				(unaudited)				(unaudited)				(unaudited)
Revenues
Sales of Installation projects		$	24,850,263			$	10,837,672			$	24,850,263			$	17,145,371
Sales of equipment			256,422				733				714,492				1,049,179
Total revenues			25,106,685				10,838,405				25,564,755				18,194,550
Costs of Revenues
Cost of installation projects			17,229,686				7,461,235				17,229,686				11,743,602
Cost of equipment			238,671				506				523,035				718,994
Total costs of revenues			17,468,357				7,461,741				17,752,721				12,462,596
Gross profit			7,638,328				3,376,664				7,812,034				5,731,954
Operating Expense
Selling Expenses
Payroll and Commission			-				922,180				-				1,122,330
Fright out			54				3,578				1,946				3,705
Office expenses			-				187				-				73,588
Total selling expenses			54				925,945				1,946				1,199,623
General and administrative expenses
Payroll			65,336				43,830				113,296				125,626
Employee benefit and pension			5,465				4,750				9,644				7,903
Depreciation and amortization expenses			21,304				22,784				42,589				42,707
Professional fees and consultancy fees			25,297				13,362				25,297				13,362
Taxes			11,542				10,772				17,682				17,812
Office expenses			34,839				19,965				46,308				84,032
Bad debt expenses			7,699,122				-				8,028,106				68,163
Travel and entertainment			21,884				22,140				36,833				40,826
Total General and Administrative Expenses			7,884,789				137,603				8,319,755				400,431
Total operating expenses			7,884,843				1,063,548				8,321,701				1,600,054
Income from operations			(246,515	)			2,313,116				(509,667	)			4,131,900
Non-operating income (expenses):
Interest income			104				93				216				100
Interest expenses			(11,750	)			(10,694	)			(20,160	)			(16,208	)
Gain on bargain purchase			-				52,016				-				52,016
Governmental subsidy			0				-				4,526				-
Other income (expenses)			33				-				1,117				-
Total non-operating income (expenses)			(11,613	)			41,415				(14,301	)			35,908
Income before income taxes			(258,128	)			2,354,531				(523,968	)			4,167,808
Provision for income taxes
Current income tax expense			237,589				587,790				237,589				1,040,814
Deferred income tax expense			95,729				(12,038	)			99,547				(11,742	)
Total provision for income taxes			333,318				575,752				337,136				1,029,072
Net income before extraordinary item			(591,446	)			1,778,779				(861,104	)			3,138,736
Extraordinary item  (Note 12)			(4,525,822	)			-				(4,525,822	)			-
Net income (loss)			(5,117,268	)			1,778,779				(5,386,926	)			3,138,736
Less: Net income attributable to noncontrolling interest			-				-				-				(222	)
Net Loss attributable to China Environmental Protection, Inc.		$	(5,117,268	)		$	1,778,779			$	(5,386,926	)		$	3,138,514
Basic and diluted earnings per share		$	(0.03	)		$	0.11			$	(0.05	)		$	0.19
Weighted average number of shares			17,170,015				16,374,180				17,170,015				16,374,180

 

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

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D TASTE ON DEMAND INC)

 

CONSOLIDATED STATEMENT OF COMPRESENTATIVE INCOME

 

		For the Three Months Ended								For the Six Months Ended
		March 31,								March 31,
		2011				2010				2011				2010
		(unaudited)				(unaudited)				(unaudited)				(unaudited)
Net income		$	(5,117,268	)		$	1,778,779			$	(5,386,926	)		$	3,138,736
Other comprehensive income, net of tax:
Effects of foreign currency conversion			6,326				(23,757	)			109,757				(20,388	)
Total other comprehensive, not of tax			6,326				(23,757	)			109,757				(20,388	)
Comprehensive income			(5,110,942	)			1,755,022				(5,277,169	)			3,118,348
Comprehensive income attributable to the noncontrolling interest			-				(174	)			-				222
Comprehensive income attributable to the Company		$	(5,110,942	)		$	1,755,196			$	(5,277,169	)		$	3,118,126

 

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

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D TASTE ON DEMAND INC)

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		For the Six Months Ended
		March 31,
		2011				2010
		(unaudited)				(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income including noncontrolling interest		$	(5,386,926	)		$	3,138,736
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			78,605				77,403
Bad debt expense			8,028,106				68,163
Impairment of fixed assets			15,818				6,581
Gain on bargain purchase			-				(52,016	)
Deferred tax expense			99,547				(11,742	)
Decrease (increase) in assets:
Restricted cash			5,905,267				77,042
Accounts receivable			(11,896,228	)			(233,871	)
Other receivable			60,927				(22,972	)
Advances to suppliers			1,612,903				18,798
Inventory			7,429,461				(3,219,427	)
Prepaid expenses			15,586				28,841
Refundable security deposit			(587,377	)			(801,529	)
Increase (decrease) in liabilities:
Accounts payables			1,993,099				1,611,424
Salaries and welfare payable			(399,678	)			(135,216	)
Other payables			(82,974	)			-
Taxes payable			187,753				1,054,059
Advance from customers			(6,887,658	)			1,641,246
Net cash provided by operating activities			186,231				3,245,520
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of  property and equipment			(4,280	)			(95,366	)
Purcahse of minority shares by Dragon Path			-				(280,000	)
Net cash used in investing activities			(4,280	)			(375,366	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Shareholder capital contribution			-				295,000
Proceeds from bank loans			754,304				732,340
Repayments of bank loans			(754,304	)			(292,936	)
Proceeds from the CEO			877,145				1,387,931
Repayments to the CEO			-				(10,253	)
Net cash provided by financing activities			877,145				2,112,082
EFFECT OF EXCHANGE RATE CHANGE ON CASH AND CASH EQUIVALENTS			18,193				(5,425	)
NET INCREASE IN CASH AND CASH EQUIVALENTS			1,077,289				4,976,811
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD			1,268,674				538,767
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	2,345,963			$	5,515,578
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid		$	1,579			$	6,855
Interest paid		$	20,160			$	16,208

 

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

 

  

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1-

BASIS OF PRESENTATION

 

The accompanying unaudited consolidated financial statements of China Environmental Protection, Inc. (the “Company” or "China Environmental") reflect all material adjustments consisting of only normal recurring adjustments which, in the opinion of management, are necessary for a fair presentation of results for the interim periods. Certain information and footnote disclosures required under accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission, although the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended September 30, 2010.

 

The results of operations for the three and six months ended March 31, 2010 are not necessarily indicative of the results to be expected for the entire year or for any other period.

 

Note 2-

ORGANIZATION

 

China Environmental Protection, Inc. (the “Company” or "China Environmental" or "CNVP"), formerly known as T.O.D. Taste On Demand Inc., was incorporated on August 31, 2007 in the state of Nevada. On February 12, 2010, the Company entered into a share exchange agreement and acquired all of the outstanding capital stock of Dragon Path International Limited, a British Virgin Islands corporation (“Dragon Path”), through China Environmental Protection Inc., a Nevada corporation (the “Merger Sub”) wholly owned by the Company. Dragon Path is a holding company which owns 100% of the registered capital of Yixing Dragon Path Environment Technology Limited (“Yixing Dragon Path”), a limited liability company organized under the laws of the People’s Republic of China (“China” or “PRC”). Dragon Path's operations are conducted in China through Yixing Dragon Path, and through contractual arrangements with Yixing Dragon Path’s consolidated affiliated entity, Jiangsu Zhenyu Environmental Protection Technology Co. Ltd. (“Zhenyu”). Zhenyu is engaged in design, manufacture, and installation of waste water treatment equipment for environmental protection purposes in China.

 

In connection with the acquisition, the Merger Sub issued 100 shares of the common stock of the Merger Sub which constituted no more than 10% ownership interest in the Merger Sub in exchange for all the shares of the capital stock of Dragon Path (the “Share Exchange” or “Merger”). The 100 shares of the common stock of the Merger Sub were converted into approximately 16,150,000 shares of the common stock of the Company so that upon completion of the Merger, the stockholder of Dragon Path and his assignees own approximately 95% of the common stock of the Company. Upon completion of the Merger, there were 17,000,017 shares of the Company’s common stock issued and outstanding.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 2-

ORGANIZATION (continued)

 

For the accounting purposes, this acquisition was accounted for as a reverse merger since the shareholder of Dragon Path and his assignees own a majority of the outstanding shares of the Company’s common stock immediately following the share exchange and there was a change of control. Dragon Path was deemed to be the acquirer in the reverse merger. Consequently, the assets and liabilities and the historical operations that were reflected in the consolidated financial statements for periods prior to the Merger were those of Dragon Path and its subsidiaries and were recorded at the historical cost basis. After completion of the share exchange, the Company‘s consolidated financial statements included the assets and liabilities of both China Environmental and Dragon Path, the historical operations of Dragon Path and the operations of the Company and its subsidiaries from the closing date of the share exchange.

 

On March 24, 2010, the Company’s name was changed from “T.O.D. Taste on Demand, Inc.” to the Merger Sub’s name “China Environmental Protection, Inc.” to better reflect the Company’s business.

 

Dragon Path was organized under the laws of the British Virgin Island on November 5, 2009. The Articles of Incorporation authorized Dragon Path to issue 50,000 shares of common stock with a par value of $1.00 per share. Upon formation of Dragon Path, 10,000 shares of common stock was issued for $10,000 on November 18, 2009. Dragon Path established and owns 100% of the equity interest of Yixing Dragon Path, a wholly foreign-owned entity ("WFOE") incorporated under the laws of China on January 26, 2010 in Yixing City, Jiangsu Province, China, as a limited liability company with a registered capital of $100,000, of which, $20,000 was contributed on August 24, 2010, and the balance of $80,000 was contributed in January 2012.

 

Dragon Path does not conduct any substantive operations of its own. Instead, through its wholly-owned subsidiary, Yixing Dragon Path, it had entered into certain exclusive contractual agreements with Zhenyu on January 27, 2010. Pursuant to these agreements, Yixing Dragon is obligated to absorb a majority of the risk of loss from Zhenyu’s activities and entitled it to receive a majority of its expected residual returns. In addition, Zhenyu’s shareholders have pledged their equity interest in Zhenyu to Yixing Dragon, irrevocably granted Yixing Dragon an exclusive option to purchase, to the extent permitted under PRC Law, all or part of the equity interests in Zhenyu and agreed to entrust all the rights to exercise their voting power to the persons appointed by Zhenyu. Through these contractual arrangements, Dragon Path and Yixing Dragon Path hold all the variable interests of Zhenyu. Therefore, Dragon Path is the primary beneficiary of Zhenyu.

 

Based on these contractual arrangements, the management believes that Zhenyu and its 75% owned subsidiary, Jiangsu Jinyu Environmental Engineering Co,. Ltd. (“Jinyu”) should be considered as a Variable Interest Entity (“VIE”) under the provisions of Accounting Standards Codification (“ASC”) 510 “Consolidation of Variable Interest Entities. Accordingly, Yixing Dragon Path consolidates Zhenyu and its subsidiary’s results, assets and liabilities.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 2-

ORGANIZATION (continued)

 

Zhenyu was incorporated under the laws of China on March 28, 1993 in Yixing City, Jiangsu Province, China, as a limited liability company with a registered capital of RMB 1,880,000 (equivalent to approximately $227,135 on the contribution date) which was increased to RMB 16,880,000 (equivalent to approximately $2,140,116 on the contribution date) on May 17, 2000. The registered capital has been fully contributed by the owners.

 

Jinyu was incorporated under the laws of China on March 22, 2002, as a limited liability company with a registered capital of $1,200,000 which has been fully contributed by the owners, in the Yixing City, Jiangsu Province, China. Jinyu is engaged in design, manufacture, and installation of waste water treatment equipment for environmental protection purposes in China.

 

On January 28, 2010, Dragon Path acquired the 25% equity interest of Jinyu from its minority shareholder for $280,000. As a result of this transfer of ownership, Dragon Path now owns 100% interest of the Jinyu, consisting of the newly acquired 25% direct ownership and 75% indirect ownership through Zhenyu.

 

Zhenyu and Jinyu are the two of these affiliated companies that are engaged in business operations. China Environmental, Dragon Path, and Yixing Dragon Path are holding companies, whose business is to hold an equity ownership interest or a beneficial interest in Zhenyu and Jinyu. All these affiliated companies are hereafter referred to as the "Company". Currently, the Company is engaged in the business of design, manufacture, and installation of waste water treatment equipment for environmental protection purposes in China. The Company's structure is summarized in the following chart.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 2-

ORGANIZATION (continued)

 

Company Structure Flow Chart

 

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3-

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of consolidation

 

The accompanying consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America ("US GAAP"). This basis of accounting differs from that used in the statutory accounts of the Company, which are prepared in accordance with the "Accounting Principles of China " ("PRC GAAP"). Certain accounting principles, which are stipulated by US GAAP, are not applicable in the PRC GAAP. The difference between PRC GAAP accounts of the Company and its US GAAP consolidated financial statements is immaterial.

 

The consolidated financial statements include the accounts of the Company, Dragon Path, Yixing Dragon Path, Zhenyu, and Jinyu. All inter-company transactions have been eliminated upon consolidation.

 

Use of estimates

 

		The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes, and disclosure of contingent liabilities at the date of the condensed consolidated financial statements. Estimates are used for, but not limited to, the selection of the useful lives of property and equipment, provision necessary for contingent liabilities, taxes and other similar charges. Management believes that the estimates utilized in preparing its condensed consolidated financial statements are reasonable and prudent. Actual results could differ from these estimates.

Subsequent Events

 

As required by FASB ASC 855 “Subsequent Events”, the Company evaluated subsequent events through the date of issuance of these financial statements. We are not aware of any significant events that occurred subsequent to the balance sheet date but prior to the filing of this report that would have a material impact on our consolidated financial statements, except the matters disclosed in Note 16 "Subsequent Event".

 

Cash and cash equivalents

 

The Company considers all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents. The Company maintains its cash and cash equivalents with various financial institutions in the PRC which do not provide insurance for the amounts on deposit. The Company has not experienced any losses in such accounts and the management believes it is not exposed to significant risks on its cash and cash equivalents in the bank accounts.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3-

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Restricted Cash

 

Restricted cash is cash set aside to provide a guarantee for execution of contracts and is subject to withdrawal restrictions. Prior to the start of the sales of equipment or installation of waste water treatment facility projects, the Company is required to maintain certain deposits, as restricted cash, with the PRC financial institutions to provide a guarantee to the Company’s industrial or municipal clients in relation to the execution of the sales of equipment contracts or the installation contracts of waste water treatment facility projects. These deposits are non-interest bearing and normally equivalent to 5% to 10% of the contract price or the amount specifically descripted in the contracts, and are subject to withdrawal restrictions up to the completion of the sales of equipment contracts, or one year after completion of the installation projects, or for a period specifically descripted in the contacts. We record the restricted cash as current assets or non-current assets based on the term when the cash was set aside. The Company has not experienced any losses in withdrawal of the restricted cash and the management believes that no allowance is considered necessary.

 

Accounts receivable

 

Accounts receivables consist of trade receivables resulting from sales of products during the normal course of business. The Company carries accounts receivable at the invoiced amount without bearing interest, less an allowance for doubtful accounts. Allowances for doubtful accounts are recorded as a general and administrative expense. The Company evaluates the adequacy of the allowance for doubtful accounts at least quarterly and computes the allowance for doubtful accounts based on the history of actual write-offs. The Company also performs a subjective review of specific large accounts to determine if an additional reserve is necessary. The formula for calculating the allowance closely parallels the Company’s history of actual write-offs and account adjustments based upon contractual terms. In circumstances in which we receive payment for accounts receivable which have previously been written off, we reverse the allowance and bad debt expenses.

 

Others Receivable

 

Others receivable principally includes advance to employees who are working on projects on behalf of the Company. After the work is finished, they will submit expense reports with supporting documents to the accounting department. Upon being properly approved, the expenses are debited into the relevant accounts and the advances are credited out. Cash flows from these activities are classified as cash flows from operating activities.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3-

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Inventory

 

Inventory is stated at the lower of cost or market using a weighted average method. Inventory consists of raw materials, work in process and finished goods. Raw materials consist of steel, polyresen, silicone and filtering components used in manufacturing of water treatment equipment. Cost of finished goods included direct costs of raw materials as well as direct labor used in production and an allocated portion of manufacturing overheads.

 

The management compares the cost of inventory with its market value and an allowance is made for estimated obsolescence or for writing down the inventory to its market value, if lower than cost.

 

Advance to suppliers

 

Advance to suppliers represent the payments made and recorded in advance for goods and services received. The Company makes advances to suppliers for the purchase of certain materials and equipment components. Advances to suppliers are short-term in nature and are reviewed regularly to determine whether their carrying value has become impaired. The Company considers the assets to be impaired if the collectability of the services or the goods become doubtful, or the fair value of the services or the goods ordered become lower than the purchase price.

 

Revenue recognition

 

The Company recognizes revenues in accordance with FASB ASC 605-10 “Revenue Recognition”. The Company sells waste water treatment equipment or facilities to various industrial or municipal clients through sales orders or equipment-bundled installation contracts. All of the Company’s sales and installation contracts are generally short-term in nature, range from three to six months. The Company recognizes sales based on the completed contract method. The Company recognizes revenue when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered and accepted, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting receivable is reasonably assured.  Revenue is not recognized until title and risk of loss is transferred to the customer, which generally occurs upon delivery of goods, and objective evidence exists that customer acceptance provisions have been met.  Deposits or advance payments from customers prior to satisfying the Company’s revenue recognition criteria are recorded as advance from customers.

 

Product warranty

 

The Company provides product warranty to its customers that all equipment manufactured by the Company will be free from defects in materials and workmanship under normal use for a period of one to two years from the date of shipment and installation. The Company's costs and expenses in connection with such warranties has been immaterial and the management believes that no product warranty reserve is considered necessary.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3-

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Property, plant and equipment

 

Property and equipment are recorded at cost less accumulated depreciation and any impairment losses. The cost of an asset is comprised of its purchase price and any directly attributable costs of bringing the asset to its working condition and location for its intended use. Expenditure incurred after the assets have been put into operation, such as repairs and maintenance and overhaul costs, is normally charged to expense in the year in which it is incurred.

 

In situations where it can be clearly demonstrated that the expenditure has resulted in an increase in the future economic benefits expected to be obtained from the use of the asset beyond its originally assessed standard of performances, the expenditure is capitalized as an additional cost of the asset.

 

Depreciation is computed using the straight-line method over the estimated useful lives of the assets, less any estimated residual value.  Estimated useful lives of the assets are as follows:

 

Plants and  Buildings		20 years
Machinery and office equipment		10 years
Vehicles		5 years

 

Any gain or loss on disposal or retirement of a property or equipment is recognized in the profit and loss account and is the difference between the net sales proceeds and the carrying amount of the relevant asset. When property and equipment are retired or otherwise disposed of, the asset and accumulated depreciation are removed from the accounts and the resulting profit or loss is reflected in operations.

 

Intangible asset

 

Intangible asset includes a land use right only. All land in the People’s Republic of China is government owned and cannot be sold to any individual or company. However, the government grants the user a “land use right” (the right to use the land). The land use right for a piece of land, approximately 2.62 acre (10,622 square meters), located in Gaocheng County, Yixing City, Jiangsu Province, was originally acquired by Zhenyu for RMB 7,965,000 (then equivalent to $1,063,020) from the relevant PRC land authority in April 2007. Zhenyu has the right to use the land for 50 years on which the office premises, production facilities, and warehouse of Zhenyu are located, and the land use right is amortized on a straight-line basis over a period of 50 years.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3-

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Impairment of long-lived assets

 

Long-lived assets, which include property, plant and equipment, - and finite-lived intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

 

Recoverability of long-lived assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the assets. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the assets.  Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable.

 

Refundable security deposit

 

Refundable security deposit represents the security deposits withheld by the Company’s customers to warrant against potential defects for the sales of equipment or installation of water treatment projects. Refundable security deposit normally accounts for 5% to 10% of the total contract price and generally to be refunded within one to two years after the completion of the sales or the installation, depending on the various terms included in different equipment sales contracts or waste water treatment installation project contracts.

 

The Company's costs and expenses in connection with the product warranties covered by refundable security deposit have been immaterial and the management believes that no warranty accrual is considered necessary. If a refundable security deposits or portion of the refundable security deposit has not been received upon its maturity, we reclassify the balance to the accounts receivable, and an allowance will be recorded if the collectability becomes doubtful based on the management's review, just as we do for trade accounts receivable.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3-

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Fair value of measurements

 

The Company follows the provisions of Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures. It clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

 

Level 1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.

 

Level 2-Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other then quoted prices that are observable, and inputs derived from or corroborated by observable market data.

 

Level 3-Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.

 

An asset or liability’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Availability of observable inputs can vary and is affected by a variety of factors. The Company uses judgment in determining fair value of assets and liabilities and Level 3 assets and liabilities involve greater judgment than Level 1 and Level 2 assets or liabilities.

 

The carrying amounts reported in the balance sheets for cash and cash equivalents, restricted cash, accounts receivable, other current assets, short-term loans, accounts payable, taxes payable, advance from customers, other payables, and accrued expenses, approximate their fair market value based on the short-term maturity of these instruments. The Company did not identify any assets or liabilities that are required to be measured at fair value on a recurring basis on the consolidated balance sheets in accordance with ASC 820.

 

Advertising Costs

 

The Company expenses advertising costs as incurred or the first time the advertising takes place, whichever is earlier, in accordance with the FASB ASC 720-35, “Advertising Costs". The advertising costs were immaterial for the six months ended March 31, 2011 and 2010, respectively.

 

Research and Development Costs

 

Research and development costs relating to the development of new products and processes, including significant improvements and refinements to existing products, are expensed when incurred in accordance with the FASB ASC 730, "Research and Development". Research and development costs were immaterial for the six months ended March 31, 2011 and 2010, respectively.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3-

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

China Contribution Plan

 

Full time employees of the PRC entities participate in a government mandated multi-employer defined contribution plan pursuant to which certain pension benefits, medical care, unemployment insurance, employee housing fund and other welfare benefits are provided to employees. Chinese labor regulations require the Company to pay to the local labor bureau a monthly contribution at a stated contribution rate based on the monthly basic compensation of qualified employees. The relevant local labor bureau is responsible for meeting all retirement benefit obligations; the Company has no further commitments beyond its monthly contribution. The total provisions for such contribution was $7,778 and $6,281 for the six months ended March 31, 2011 and 2010, respectively.

 

The Company made the provisions based on the number of qualified employees and the rate and base regulated by the government. However, the Company did not make full monthly contribution to these funds. In the event that any current or former employee files a complaint with the PRC government, the Company may be subject to administrative fines. The Company has not experienced any such fines. The Management believes that these fines would be immaterial and no accrual for such fines has been made in this regard.

 

Due to the CEO

 

Due to the CEO is the temporally short-term loans from our chief executive office, director, and majority shareholder, Mr. Li Boping to finance the Company’s operation due to lack of cash resources. These loans are unsecured, non-interest bearing and have no fixed terms of repayment, therefore, deemed payable on demand. Cash flows from these activities are classified as cash flows from financing activates.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3-

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Foreign currency translation

 

The Company and Dragon Path maintain its accounting records in the United States Dollars (US$), whereas Yixing Dragon Path, Zhenyu, and Jinyu maintain their accounting records in the currency of Renminbi (“RMB”), the currency of the PRC. For financial reporting purpose, RMB has been translated into USD$ as the reporting currency in accordance with FASB ASC 830, “Foreign Currency Matters”. The financial information is translated into U.S. dollars at period-end exchange rates as to assets and liabilities and average exchange rates as to revenue and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred. The effects of foreign currency translation adjustments are included as a component of accumulated other comprehensive income in stockholders’ equity.

 

The exchange rates used for foreign currency translation were as follows (USD$1 = RMB):

 

Period Covered		Balance Sheet Date Rates				Average Rates
Three Months ended March 31, 2011			6.57010				6.62863
Three Months ended March 31, 2010			6.82590				6.82740
Year ended September 30, 2010			6.69810				6.82135
Year ended September 30, 2009			6.82630				6.83400

 

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US dollars at the rates used in translation.

 

Statement of Cash Flows

 

In accordance with ASC 230 "Statement of Cash Flows", cash flows from the Company's operations are calculated based upon the local currencies. As a result, amounts related to assets and liabilities reported on the statements of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheets.

 

Value-added tax

 

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

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3-

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Sales Tax

 

The Company derives revenue from waste water treatment facility installation projects, which is subject to the sales tax in the PRC. The sales tax is generally approximately 5% of the gross sales price and is included into the costs of revenue.

 

Sales Tax Affixation

 

Sales tax affixation is in connection with the sales tax and the VAT payment. Sales tax affixation is approximately 9% of the sales tax, or approximately 9% of the VAT payment. Sales tax affixation was paid whenever the sales tax or the VAT was paid. The Company presents the sales tax affixation in the costs of revenue.

 

Income taxes

 

The Company accounts for income taxes in accordance with ASC 740 “Income Taxes”. Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the financial statements or income tax returns. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted rates expected to apply to taxable income in the years in which those differences are expected to be recovered or settled. The 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.

 

The Company adopted a new FASB guidance, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. The new FASB guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The new FASB guidance also provides guidance on de-recognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition. In accordance with the new FASB guidance, the Company performed a self-assessment and concluded that there were no significant uncertain tax positions requiring recognition in its consolidated financial statements.

 

The Company accounts for income taxes in interim periods in accordance with FASB ASC 740-270, "Interim Reporting". The Company has determined an estimated annual effective tax rate. The rate will be revised, if necessary, as of the end of each successive interim period during the Company's fiscal year to its best current estimate. The estimated annual effective tax rate is applied to the year-to-date ordinary income (or loss) at the end of the interim period.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3-

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Segment Reporting

 

FASB ASC 820, “Segments 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. The Company currently operates in two principal business segments, sales of waste water treatment equipment and equipment-bundled installation of waste water treatment facility.

 

Comprehensive income

 

FASB ASC 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 comprehensive income, as presented in the accompanying consolidated statements of changes in owners' 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.

 

Earnings per share

 

The Company computes earnings per share (“EPS”) in accordance with the ASC 260, “Earnings per share” which requires companies with complex capital structures to present basic and diluted EPS. Basic EPS is measured as net income divided by the weighted average common shares outstanding for the period. Diluted EPS is similar to basic EPS but presents the dilutive effect on a per share basis of potential common shares (e.g., convertible securities, options and warrants) as if they had been converted at the beginning of the periods presented, or issuance date, if later. Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS. There are no potentially dilutive securities outstanding (options and warrants) for the six months ended March 31, 2011 and 2010, respectively.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3-

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Concentration of credit risk

 

Financial instruments that potentially subject the Company to concentration of credit risk consist primarily of accounts receivables and other receivables.  The Company does not require collateral or other security to support these receivables.  The Company conducts periodic reviews of its clients' financial condition and customer payment practices to minimize collection risk on accounts receivables.

 

Amendment to the articles of incorporation

 

Effective on February 12, 2010, The Company filed with the Nevada Secretary of State a Certificate of Amendment to its Articles of Incorporation. The amendment effected

 

(1)

a reverse stock split of the Company's common stock in the ratio of 1:4.61896118. The number of common stocks issued and outstanding immediately after the reverse stock split was 850,017. All share and per share information included in these consolidated financial statements have been adjusted to reflect this reverse stock split.

 

(2)

an increase of the par value of the preferred stock and the common stock from $0.001 per share to $0.01 per share.

 

(3)

a decrease of the number of the authorized common stock from 160,000,000 to 34,639,823.

 

Recent accounting pronouncements

 

In January 2011, the FASB temporarily deferred the disclosures regarding troubled debt restructurings which were included in the disclosure requirements about the credit quality of financing receivables and the allowance for credit losses which was issued in July 2010. In April 2011, the FASB issued additional guidance and clarifications to help creditors in determining whether a creditor has granted a concession, and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The new guidance and the previously deferred disclosures are effective July 1, 2011 applied retrospectively to January 1, 2011. Prospective application is required for any new impairments identified as a result of this guidance. The Management does not expect the adoption of this new guidance will have a material effect on the Company’s financial position, results of operations, and cash flows.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 4-

ACCOUNTS RECEIVABLE

 

Accounts receivable consists of the following:

 

		March 31,				September 30,
		2011				2010
		(unaudited)
Accounts receivable		$	15,707,327			$	3,760,751
Less: Allowance for doubtful accounts			(10,973,291	)			(2,945,185	)
Accounts  receivable, net		$	4,734,036			$	815,566

 

Bad debt expense charged to operations was $8,028,106 and $68,163 for the six months ended March 31, 2011 and 2010, respectively.

 

Note 5-

INVENTORY

 

The inventory consists of the following

 

		March 31,				September 30,
		2011				2010
		(unaudited)
Finished goods		$	1,333,386			$	2,576,575
Work-in-process			122,306				2,300,589
Raw materials			270,275				4,168,226
Total		$	1,725,967			$	9,045,390

 

No allowance for obsolete inventories was charged to operations for the three months ended December 31, 2010 and 2009.

 

Note 6-

PROPERTY, PLANT AND EQUIPMENT

 

The detail of property, plant and equipment is as follows:

 

		March 31,				September 30,
		2011				2010
		(unaudited)
Building and warehouses		$	1,711,681			$	1,678,971
Machinery and equipment			268,062				262,940
Office equipment and furniture			84,181				78,336
Motor vehicles			146,237				143,442
Sub total			2,210,161				2,163,689
Less: accumulated depreciation			(706,732	)			(627,331	)
Total property, plant and equipment, net		$	1,503,429			$	1,536,358

 

Depreciation expense charged to operations was $66,589 and $65,737 for the six months ended March 31, 2011 and 2010, respectively. Depreciation expense with respect to production equipment that was charged to cost of sales was $31,392 and $30,207 for the six months ended March 31, 2011 and 2010. The remainder, depreciation expense attributable to equipment used in administration, was $35,197 and $35,530 for the six months ended March 31, 2011 and 2010, respectively, and was included in general and administration expenses.

 

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 7-

INTANGIBLE ASSET-LAND USE RIGHT

 

The following is a summary of land use right, less amortization:

 

		March 31,				September 30,
		2011				2010
		(unaudited)
Land use right		$	1,212,310			$	1,189,143
Less: Amortization			(92,944	)			(79,276	)
Land use right, net		$	1,119,366			$	1,109,867

 

Amortization expense charged to operations was $12,016 and $11,666 for the six months ended March 31, 2011 and 2010, respectively. Amortization expense with respect to the area where the production facility is located was charged to cost of revenues was $4,624 and $4,489 for the six months ended March 31, 2011 and 2010, respectively. The remainder, amortization expense attributable to the area where the administration facility is located , was $7,392 and $7,177 for the six months ended March 31, 2011 and 2010, respectively, and was included in general and administration expenses.

 

Note 8-

SHORT-TERM BANK LOAN

 

Short-term bank loans represent amounts due to a local bank and are due on the dates indicated below. These loans generally can be renewed with the bank. Short-term bank loans consisted of the following:

  

				March 31,				September 30,
				2011				2010
				(unaudited)
a)		Loan payable to China Construction Bank		$	-			$	746,480
		1 year term from 12/3/2009 to 12/2/2010
		a fixed interest rate of 0.487% per month
b)		Loan payable to China Construction Bank			761,023				-
		1 year term from 12/6/2010 to 12/5/2011
		a fixed interest rate of 0.487% per month
		Total		$	761,023			$	746,480

 

a)

The loan payable to China Construction Bank is one year term from December 3, 2009, to December 2, 2010 with a fixed interest rate of 0.4867% per month. The Company pledged a land use right in an amount of approximately $0.28 million as well as a building in an amount of approximately $0.52 million as collateral for the loan. This loan was paid back in December 2010.

 

b)

The loan payable to China Construction Bank is one year term from December 6, 2010, to December 5, 2011 with a fixed interest rate of 0.4867% per month. The Company pledged a land use right in an amount of approximately $0.28 million as well as a building in an amount of approximately $0.52 million as collateral for the loan.

 

Interest expense for the above short term loans totaled $20,160 and $16,208 for the six months ended March 31, 2011 and 2010, respectively. We remitted interest payment upon receiving the bank's monthly notice. The interest amount in the bank's notice may be different from the amount calculated based on the interest rate descripted in the loan agreements.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 9-

TAXES PAYABLE

 

The taxes payable consists of the following:

 

		March 31,				September 30,
		2011				2010
		(unaudited)
Income tax payable		$	1,977,225			$	1,725,048
VAT payable			2,279				32,438
Sales taxes and sales taxes affixation payable			1,648				-
Other taxes payable			11,223				11,009
Total taxes payable		$	1,992,375			$	1,768,495

 

Note 10-

SEGMENT REPORTING

 

The Company currently operates in two principal business segments, sales of waste water treatment equipment and equipment-bundled installation of waste water treatment facility, which are determined based upon differences in products and services. The Company does not allocate any operating expenses or assets to its two business segments as management does not use this information to measure the performance of the operating segments. Certain costs of revenues are shared between business segments. Also, no measures of assets by segment are reported and used by the chief operating decision maker. Hence, the Company has not made disclosure of total assets by reportable segments.

 

The summarized information by business segment follows:

 

		For the Six Months Ended
		March 31,
		2011				2010
		(unaudited)				(unaudited)
REVENUE
Sales of Installation projects		$	24,850,263			$	17,145,371
Sales of equipment			714,492				1,049,179
Total revenue		$	25,563,122			$	18,194,550
COST OF SALES
Cost of installation projects		$	17,229,686			$	11,743,602
Cost of equipment			523,035				718,994
Total costs of revenue		$	17,751,088			$	12,462,596
GROSS PROFITS
Sales of Installation projects		$	7,620,577			$	5,401,769
Sales of equipment			191,457				330,185
Total gross profit		$	7,812,034			$	5,731,954

 

		March 31,				September 30,
		2011				2009
		(unaudited)
TOTAL ASSETS OF THE COMPANY		$	14,614,820			$	23,934,172

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 11-

CORPORATE INCOME TAXES

 

Dragon Path is registered in the BVI. Under the current laws of the BVI, the Company is not subject to tax on income or capital gains. Additionally, upon payments of dividends by the Company to its shareholders, no BVI withholding tax will be imposed. Dragon Path had no income during the period.

 

PRC Income Tax

 

The Company's PRC subsidiaries, Yixing Dragon Path, Zhenyu, and Jinyu are governed by the Income Tax Law of the People’s Republic of China concerning private-run enterprises, which are generally subject to income tax at statutory rate on income reported in the statutory financial statements after appropriate tax adjustments. The PRC companies are subject to effective income tax rate of 25% beginning from January 1, 2008.

 

The following table reconciles the U.S. statutory rates to the Company’s effective tax rate:

 

		For the Six Months Ended
		March 31,
		2011				2010
U.S. Statutory income tax rate			35.00	%			35.00	%
Foreign income not recognized in the U.S.			-35.00	%			-35.00	%
China Statutory income tax rate			25.00	%			25.00	%
Net operating loss carry-forward			-7.38	%			0.00	%
Effective tax rate			17.62	%			25.00	%

 

The Company and its majority owned subsidiary, Yixing Dragon, Zhenyu, and Jinyu suffered operating losses in the prior years' operations. For the Chinese income tax purpose, these operating losses can be carried forward in in a 5-year period and be available to reduce future years' taxable income. The Management believes that the realization of the deferred tax asset arising from the operating losses of Jinyu is the best interest to the Company's business operations to offset future taxable income. Since there is no certainty that Yixing Dragon will generate taxable income in the future, the Management established a 100% valuation allowance for the operation losses carried forward by Yixing Dragon Path and no deferred tax assets have been recorded as a result of these losses. Beginning from October 2010, since there is no certainty that Zhenyu will generate taxable income in the future, the Management established a 100% valuation allowance for the operation losses carried forward by Zhenyu and no deferred tax assets have been recorded as a result of these losses.

 

Deferred income tax reflects the net effects of temporary difference between the carrying amounts of assets and liabilities for financial statements purposes and the amounts used for income tax purposes, and operating loss carry-forward.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 11-

CORPORATE INCOME TAXES (continued)

 

The components of deferred tax assets consist of the following:

 

Name of the companies		Zhenyu				Jinyu				Total
Net deferred tax assets @ September 30, 2009		$	-			$	39,465			$	39,465

Income (loss) before income tax
Zhenyu		$	4,163,258
Jinyu			(46,967	)
Total		$	4,116,291

Deferred tax benefit (expense) utilized			-				11,742				11,742
Other comprehensive income, net of tax:
effects of foreign currency conversion			-				5				5
Deferred tax assets @ March 31, 2010 (unaudited)		$	-			$	51,212			$	51,212
Deferred tax assets @ September 30, 2010		$	-			$	98,514			$	98,514

Income (loss) before income tax
Zhenyu		$	(1,845,366	)
Jinyu			1,348,542
Total		$	(496,824	)

Deferred tax benefit (expense) utilized			-				(99,547	)			(99,547	)
Other comprehensive income, net of tax:
effects of foreign currency conversion							1,033				1,033
Deferred tax assets @ March 31, 2009 (unaudited)		$	-			$	-			$	-

 

Income taxes consist of the following:

 

		For the Six Months Ended March31,
		2010
		(unaudited)
Name of the companies		Zhenyu				Jinyu				Total
Income (loss) before income tax provision		$	4,163,258			$	(46,967	)		$	4,116,291
Current income tax expense			1,040,814				-				1,040,814
Deferred income tax expense (benefit)			-				(11,742	)			(11,742	)
Total provision for income taxes		$	5,204,072			$	(58,709	)		$	1,029,072

 

		For the Six Months Ended March31,
		2011
		(unaudited)
Name of the companies		Zhenyu				Jinyu				Total
Income (loss) before income tax provision		$	(1,845,366	)		$	1,348,542			$	(496,824	)
Current income tax expense			-				237,589				237,589
Deferred income tax expense (benefit)			-				99,547				99,547
Total provision for income taxes		$	-			$	337,136			$	337,136

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 11-

CORPORATE INCOME TAXES (continued)

 

Accounting for Uncertainty in Income Taxes

 

The tax authority of the PRC Government conducts periodic and ad hoc tax filing reviews on business enterprises operating in the PRC after those enterprises complete their relevant tax filings. Therefore, the Company’s tax filings results are subject to change. It is therefore uncertain as to whether the PRC tax authority may take different views about the Company’s tax filings, which may lead to additional tax liabilities.

 

The Company adopted the provisions of Accounting for Uncertainty in Income Taxes on January 1, 2007. The provisions clarify the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with the standard “Accounting for Income Taxes,” and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The provisions of Accounting for Uncertainty in Income Taxes also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

 

Based on the Company’s evaluation, the Company has concluded that there are no significant uncertain tax positions requiring recognition in its financial statements.

 

The Company may from time to time be assessed interest or penalties by local tax jurisdictions. In the event it receives an assessment for interest and/or penalties, it will be classified in the financial statements as tax expense.

 

Note 12-

EXTRAORDINARY ITEM

 

In October 2010, one of our subsidiaries, Zhenyu, executed an agreement with Jiangsu Guangyang Dongli Environmental Protection Equipment Co., Ltd. ("Jiangsu Guangyang"), pursuant to which both parties will jointly work on an installation of a waste water treatment plant, located in Yingjiang City, Yunnan Province, the PRC. The sales price of this project is RMB 600,000,000 (then equivalent to approximately $89,995,230) and the municipal client will not make any payment until the project is 30% completed. While Zhenyu owns 15% interest in the project, Jiangsu Guangyang owns 75% interest in the project and is in charge of the installation of the project. In according to the agreement, Zhenyu made payment of RMB 30,000,000 (equivalent to approximately $4,525,822) to Jiangsu Guangyang in October 2010.

 

In March 2011, an earthquake occurred in Yingjiang County and the earth quake triggered landslides. Our ongoing installation project was buried. Since the installation project was not insured, no insurance compensation can be claimed. Jiangsu Guangyang and Zhenyu are in discussion with the municipal client for the compensation and the Management believes that the compensation, if any, will be minimal.

 

Since Zhenyu usually works on installation projects alone and earthquake has not occurred in the location, we treat the loss as an extraordinary item. Also, because there is not taxable income in the current period and it is uncertain that Zhenyu will generate taxable income in the future, no income tax benefit has been recorded as a result of this loss.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 13-

CONCENTRATION OF RISKS

 

Two major customers accounted for approximately 81.79% of our revenue in the six months ended March 31, 2011, with each customer individually accounting for 43.34% and 38.45%, respectively. Four major customers accounted for approximately 70.96% of our revenue in the six months ended March 31, 2010, with each customer individually accounting for 20.09%, 17.61%, 17.07%, 16.19%, and 16.19%, respectively.

 

Three vendors provided approximately 86.81% of the Company’s purchases for the six months ended September 30, 2011, with each vendor individually accounting for 41.83%, 30.56%, and 14.41%, respectively. Three major vendors provided approximately 37.47% of the Company’s purchases for six months ended March 31, 2010, with each vendor individually accounting for 16.37%, 10.63%, and 10.46%, respectively.

 

Note 14-

COMMITMENTS AND CONTINGENCIES

 

Operating Lease

 

Our subsidiary, Jinyu leased a land use right for a piece of land, approximately 0.52 acre (2,100 square meters), located in Gaocheng County, Yixing City, Jiangsu Province, for a three-year period from March 22, 2011 to March 21, 2014, from the local government. The annual rent is RMB 50,000 (then equivalent to $7,140) and payable quarterly. The lease can not be automately renewed. The parties will negotiate a new lease if both parries desire to do so when the lease expires. Jinyu's office premises, production facilities, and warehouse are located in this piece of land. The rental expense was $4,526 and $4,394 for the six months ended March 31, 2011 and 2010, respectively. The future lease payments for the lease are as following at March 31, 2011.

 

The Year Ending September 30,		Future Lease Payment
2011		$	3,805
2012			7,610
2013			7,610
2014			3,805
		$	22,830

 

The Company’s assets are located in PRC and revenues are derived from operations in PRC.

 

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

 

The Company’s sales, purchases and expenses transactions are denominated in RMB and all of the Company’s assets and liabilities are also denominated in RMB. The RMB is not freely convertible into foreign currencies under the current law. In China, foreign exchange transactions are required by law to be transacted only by authorized financial institutions at exchange rates set by the People’s Bank of China, the central bank of China. Remittances in currencies other than RMB may require certain supporting documentation in order to affect the remittance.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 14-

COMMITMENTS AND CONTINGENCIES (continued)

 

Lack of Insurance

 

The Company does not carry any business interruption insurance, products liability insurance or any other insurance policy except for a limited property insurance policy. As a result, the Company may incur uninsured losses, increasing the possibility that the investors would lose their entire investment in the Company.

 

The Company could be exposed to liabilities or other claims for which the Company would have no insurance protection. The Company does not currently maintain any business interruption insurance, products liability insurance, or any other comprehensive insurance policy except for property insurance policies with limited coverage. As a result, the Company may incur uninsured liabilities and losses as a result of the conduct of its business. There can be no guarantee that the Company will be able to obtain additional insurance coverage in the future, and even if it can obtain additional coverage, the Company may not carry sufficient insurance coverage to satisfy potential claims. If an uninsured loss should occur, any purchasers of the Company’s common stock could lose their entire investment.

 

Because the Company does not carry products liability insurance, a failure of any of the products marketed by the Company may subject the Company to the risk of product liability claims and litigation arising from injuries allegedly caused by the improper functioning or design of its products. The Company cannot assure that it will have enough funds to defend or pay for liabilities arising out of a products liability claim. To the extent the Company incurs any product liability or other litigation losses, its expenses could materially increase substantially. There can be no assurance that the Company will have sufficient funds to pay for such expenses, which could end its operations and the investors would lose their entire investment.

 

Control by Principal shareholders

 

The directors, executive officers, their affiliates, and related parties own, directly or indirectly, beneficially and in the aggregate, the majority of the voting power of the outstanding capital of the Company. Accordingly, directors, executive officers and their affiliates, if they voted their shares uniformly, would have the ability to control the approval of most corporate actions, including approving significant expenses, increasing the authorized capital and the dissolution, merger or sale of the Company's assets.

 

Contingent Liability from Prior Operation

 

Prior to the reverse merger with Dragon Path International Limited on February 12, 2010, the Company was a development stage company and was engaged in the business of developing a device that will allow drinkers of bottled water to choose a few flavors as they pour the water from the bottle in the glass. Management believes that there are no valid outstanding liabilities from prior operations. If a creditor were to come forward and claim a liability, the Company has committed to contest such claim to the fullest extent of the law. No amount has been accrued in the financial statements for this contingent liability.

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 15-

CONDENSED PARENT COMPANY FINANCIAL INFORMATION

 

Basis of Presentation

 

The condensed parent company financial statements have been prepared in accordance with Rule 12-04, Schedule I of Regulation S-X, as the restricted net assets of the subsidiaries of China Environmental Protection, Inc. exceed 25% of the consolidated net assets of China Environmental Protection, Inc. The ability of the Company’s Chinese operating subsidiaries to pay dividends may be restricted due to the foreign exchange control policies and availability of cash balances of the Chinese operating subsidiaries. Because substantially all of the Company’s operations are conducted in China and a substantial majority of its revenues are generated in China, a majority of the Company’s revenue being earned and currency received are denominated in Renminbi (RMB). RMB is subject to the exchange control regulation in China, and, as a result, the Company may be unable to distribute any dividends outside of China due to PRC exchange control regulations that restrict its ability to convert RMB into US Dollars.

 

The condensed parent company financial statements have been prepared using the same accounting principles and policies described in the notes to the consolidated financial statements, with the only exception being that the parent company accounts for its subsidiaries using the equity method. Refer to the consolidated financial statements and notes presented above for additional information and disclosures with respect to these financial statements.

 

CHINA ENVIRONMENTAL PROTECTION, INC.

CONDENSED PARENT COMPANY BALANCE SHEETS

(Dollars in Thousands)

 

		March 31,				September 30,
		2011				2010
		(unaudited)
ASSETS
Investment in subsidiaries, at equity in net assets			2,820				8,097
Total Assets		$	2,820			$	8,097
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities			-				-
Commitments and Contingencies			-				-
Shareholders' Equity:
Preferred stock, $0.01 par value. 10,000,000 shares authorized; Authorized 10,000,000 shares; none issued as of March 31, 2011 and September 30, 2010, respectively			-				-
Common stock, $0.01 par value; authorized 34,639,823 shares; Issued and outstanding- 17,170,015 shares as of March 31, 2011 and September 30, 2010, respectively			172				172
Additional paid-in capital			2,961				2,961
Retained earnings			(497	)			4,890
Accumulated other comprehensive income (loss)			184				74
Total Shareholders' equity (deficit)		$	2,820			$	8,097

 

 

CHINA ENVIRONMENTAL PROTECTION, INC. AND SUBSIDIARIES

(FORMERLY T.O.D. TASTE ON DEMAND INC)

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 15-

CONDENSED PARENT COMPANY FINANCIAL INFORMATION (continued)

 

CHINA ENVIRONMENTAL PROTECTION, INC.

CONDENSED PARENT COMPANY STATEMENT OF OPERATIONS

(Dollars in Thousands)

 

		For the Six Months Ended
		March 31,
		2011				2010
		(unaudited)				(unaudited)
Operating Expenses		$	-			$	-
Equity in undistributed income of subsidiaries			(5,387	)			3,139
Net Income		$	(5,387	)		$	3,139

 

CHINA ENVIRONMENTAL PROTECTION, INC.

CONDENSED PARENT COMPANY STATEMENT OF CASH FLOWS

(Dollars in Thousands)

 

		For the Six Months Ended
		March 31,
		2011				2010
		(unaudited)				(unaudited)
Cash Flows from Operating Activities
Net income		$	(5,387	)		$	3,139
Adjustments to reconcile net income (loss) provided by cash flows from operations Equity in undistributed income of subsidiaries			5,387				(3,139	)
Net cash provided by operating activities			-				-
Increase (decrease) in cash			-				-
Cash at beginning of period			-				-
Cash at end of period		$	-			$	-

 

Note 16-

SUBSEQUENT EVENT

 

Litigation

 

On March 16, 2012, Ms. Ping Ye, the alleged former CFO of the Company, filed a complaint in the United States District Court, Eastern District of Pennsylvania, asserting breach of contract, unjust enrichment, fraud and conversion claims against the Company. All these claims arise from the Company’s non-payment under an alleged oral contract for Ms. Ping Ye’s services in 2010-2011. Ms. Ping Ye’s claim is for $240,000 in cash and 250,000 shares of stock options in the Company. Although Ms. Ping Ye has not yet correctly served the Complaint on the Company, it is expected that she will do so soon. The parties are currently discussing settlement. If this case cannot settle, and if Ms. Ping Ye correctly serves the Complaint on the Company, we will contest the Complaint. Although the outcome of this matter is currently not determinable, management does not expect that the ultimate costs to resolve this matter will have a material adverse effect on its consolidated financial position, results of operations, or cash flows. 

 

Discontinued Operation-Zhenyu

 

On July 1, 2011, Yixing Dragon Path, Zhenyu and shareholders of Zhenyu, agreed to terminate certain contractual agreements that the parties entered into on January 17, 2010 (collectively, “VIE Agreements”), and entered into a series of agreements, namely, the Termination Agreement on Consulting Services Agreement, Termination Agreement on Operating Agreement, Termination Agreement on Option Agreement, Termination Agreement on Voting Rights Proxy Agreement and Termination Agreement on Equity Pledge Agreement (collectively, “Termination Agreements”). Pursuant to the Termination Agreements, all the VIE Agreements were terminated in their entirety and of no further force or effect, effective July 1, 2011. Accordingly, the Company ceased consolidating Zhenyu in its consolidated financial statements beginning from July 1, 2011. In connection with the termination of the VIE Agreements, Zhenyu agreed to transfer its 75% equity interest in Jinyu and its shares in five patents which are co-owned by Zhenyu and Jinyu to Yixing Dragon Path. Therefore Jinyu becomes a wholly owned subsidiary of the Company and will continue to be consolidated into the Company’s consolidated financial statements.

 

Change in Fiscal Year-end

 

On December 16, 2011, the Board of Directors of the Company approved a change in the Company’s fiscal year-end from September 30 to December 31 of each year. This change to the calendar year reporting cycle began January 1, 2012.

 

 

Item 2. Management Discussion and Analysis of Financial Conditions and Results of Operations.

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this document. The following discussion contains forward-looking statements. China Environmental Protection, Inc. is referred to herein as “we”, “us”, “our”, or the “Company.” The words or phrases “would be,” “will allow,” “expect to”, “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” or similar expressions are intended to identify forward-looking statements. Such statements include, among others, those statements concerning our expected financial performance, our corporate strategy and operational plans. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including, but not limited to, (a) those risks and uncertainties related to general economic conditions in China, including regulatory factors that may affect such economic conditions; (b) whether we are able to manage our planned growth efficiently and operate profitable operations, including whether our management will be able to identify, hire, train, retain, motivate and manage required personnel or that management will be able to successfully manage and exploit existing and potential market opportunities; (c) whether we are able to generate sufficient revenues or obtain financing to sustain and grow our current operations; and (d) whether we are able to successfully fulfill our primary requirements for cash which are explained below under “Liquidity and Capital Resources”. Unless otherwise expressly required by applicable law, we do not undertake, and we specifically disclaim any obligation, to update any forward-looking statements or the inform set forth in this Quarterly Report to reflect occurrences, developments, unanticipated events or any other circumstances after the date of such statement and/or this Form 10-Q. For additional information regarding these risks and uncertainties, see “Risk Factors” in the company’s Current Report on Form 8-K filed with SEC on February 12, 2010. Our consolidated financial statements have been prepared in accordance with U.S. GAAP. In addition, our consolidated financial statements and the financial data included in this document reflect the Merger and have been prepared as if our current corporate structure had been in place throughout the relevant periods.

 

Organizational History

 

China Environmental Protection, Inc.(the “Company”), formerly known as T.O.D. Taste On Demand Inc., was incorporated in the State of Nevada on August 31, 2007.

 

On February 12, 2010, the Company, through an acquisition by China Environmental Protection, Inc., a Nevada corporation (the “Merger Sub”) wholly owned by the Company, and then the merger of the Merger Sub with and into the Company (the “Merger”), acquired all of the outstanding capital stock of Dragon Path International Limited, a British Virgin Islands corporation (“Dragon Path”). Dragon Path is a holding company whose only asset is 100% of the registered capital of Yixing Dragon Path Environment Technology Limited (“Yixing Dragon Path”), a limited liability company organized under the laws of the People’s Republic of China (“China” or “PRC”) on January 26, 2010. Substantially all of Dragon Path's operations are conducted in China through Yixing Dragon Path, and through contractual arrangements with Yixing Dragon Path’s consolidated affiliated entity in China, Jiangsu Zhenyu Environmental Protection Technology Co. Ltd. (“Zhenyu”), a limited liability company incorporated under the laws of PRC on December 28, 1993. Zhenyu is engaged in design, manufacture, and installation of waste water treatment equipment for environmental protection purposes, as well as providing high-quality after-sales services.

 

Before the closing of the Merger, the Company effected a 4.61896118 for 1 reverse split of our outstanding common stock, so that after such split there were approximately 850,000 shares of our common stock issued and outstanding.

 

In connection with the acquisition, the Merger Sub issued 100 shares of the common stock of the Merger Sub which constituted no more than 10% ownership interest in the Merger Sub in exchange for all the shares of the capital stock of Dragon Path (the “Share Exchange” or “Merger”). The 100 shares of the common stock of the Merger Sub were converted into approximately 16,150,000 shares of our common stock. As a result, upon completion of the Merger, the shareholders of Dragon Path owned approximately 95% of the common stock of the Company.

 

Upon completion of the Merger, there were 17,000,017 shares of the Company’s common stock issued and outstanding.

 

As a result of these transactions, persons affiliated with Zhenyu now own securities that in the aggregate represent approximately 95% of the equity in the Company. In addition, in connection with the change of control contemplated by the Share Exchange, the directors and officers of the Company resigned from their positions and new directors and officers affiliated with Zhenyu controlled the Board of Directors of the Company.

 

As part of the Merger, the Company’s name was changed from “T.O.D. Taste on Demand Inc.” to “China Environmental Protection, Inc.” on February 12, 2010.

 

 

The transaction has been accounted for as a reverse merger under the purchase method of accounting since there was a change of control. Accordingly, Dragon Path is treated as the continuing entity for accounting purposes.

 

Dragon Path, which was organized under the laws of the British Virgin Island on November 5, 2009, owns 100% of the equity interest of Yixing Dragon Path, a wholly foreign-owned entity incorporated under the laws of the PRC on January 26, 2010.

 

Dragon Path does not conduct any substantive operations on its own. Instead, through its subsidiary, Yixing Dragon Path, it had entered into certain exclusive contractual agreements with Zhenyu. Pursuant to these agreements, Yixing Dragon Path is obligated to absorb a majority of the risk of loss from Zhenyu’s activities and entitled it to receive a majority of its expected residual returns. In addition, Zhenyu’s shareholders have pledged their equity interest in Zhenyu to Yixing Dragon Path, irrevocably granted Yixing Dragon Path an exclusive option to purchase, to the extent permitted under PRC Law, all or part of the equity interests in Zhenyu and agreed to entrust all the rights to exercise their voting power to the persons appointed by Zhenyu. Through these contractual arrangements, the Company and Yixing Dragon Path hold all the variable interests of Zhenyu. Therefore, the Company is the primary beneficiary of Zhenyu.

 

Zhenyu owns 75% of Jiangsu Jinyu Environmental Engineering Co., Ltd. (“Jinyu”), a sino-foreign joint venture established under the laws of PRC on June 7, 2004, with registered capital of $1,120,000. Jinyu primarily engages in the design, manufacture and installation of environmental protection equipment and engineering projects (or systems) for waste water treatment, as well as providing after-sales services to customers. Jinyu is located in Yixing City, the same location of Zhenyu. On January 28, 2010, before the closing of the Merger, the minority shareholder of Jinyu transferred the remaining 25% of the interest in Jinyu to Dragon Path in exchange for $280,000. As a result, Dragon Path assumed 100% control of Jinyu, partly through direct equity interest ownership and partly through Zhenyu. Based on these contractual arrangements, the Company believes that Zhenyu and its subsidiary and affiliates should be considered as Variable Interest Entity (“VIE”) under the provisions of Accounting Standards Codification (“ASC”) 510 “Consolidation of Variable Interest Entities. Accordingly, the Company consolidates Zhenyu and its subsidiary’s results, assets and liabilities.

 

Our corporate structure is set forth in the diagram below:

 

 

 

Our Business Overview

 

We conduct our business in China primarily through our variable interest entity Zhenyu and its 75% owned subsidiary Jinyu. We believe we are a well-recognized China-based water treatment equipment supplier and project contractor. Holding five national patents and through sixteen years of development, we believe we have a relatively strong market share in waste water treatment sector in China and are ranked among top six of Yixing City’s best environmental protection enterprises based on Yixing Municipal Government’s ranking of 2009 outstanding environment protection enterprises (Yizhengfa Document No.[2010]18). We believe Yixing is the country’s production base for environmental protection equipment. We are headquartered in Yixing, Jiangsu, with total building areas of 7,800 square meters. As of March 31, 2011, we have 171 employees in total.

 

We carry out our business based on two models: (i) equipment sales from customer orders; and (ii) project installation which includes the design, manufacturing and installation of waste water treatment equipment. We acquire our product orders and projects through a transparent auction bid process. In terms of pricing strategy, we have a flexible pricing policy to target different market segments and different customers.

 

Our key products include ZFP-1380 Rotating Disc Aeration equipment, ZYXG Series of Sludge Suction Scraper, ZYSR Series of Surface Scraper and other water treatment equipment, which can be divided into four categories: circulating water treatment, water purification, waste water treatment and municipal waste water treatment.

 

Discussion of Operation Result

 

Operation Results for the Three Months Ended March 31, 2011 and 2010

 

Revenues

 

For the three months ended March 31, 2011, we reported revenues of $25,106,685 as compared to $10,838,405 for the three months ended March 31, 2010, an increase of $14,268,280, or 131.63%. The increase was attributable to the increase in the installation project sales, as new customers were brought in by existing customers.

 

Revenues from installation projects were $24,850,263 for the three months ended March 31, 2011, an increase of $14,012,591, or 129.30% as compared to $10,837,672 for the comparable period in 2010. Revenues from sales of equipment were $256,422 for the three months ended March 31, 2011, an increase of $255,689, or 34,882.54% as compared to $733 for the comparable period in 2010. The increase in revenues from both segments was mainly attributable to the factor cited above.

 

Cost of Revenue

 

For the three months ended March 31, 2011, our cost of revenue was $17,229,686 as compared to cost of revenue of $7,461,235 for the three months ended March 31, 2010, an increase of $9,768.451, or 131%. The increase in cost of revenue was primarily due to increase in sales.

 

Gross Profit

 

For the three months ended March 31, 2011, our gross profit was $7,638,328, an increase of $4,261,664 or 126.21% as compared to $3,376,664 for the comparable period in 2010. Our overall gross profit as a percentage of revenues decreased to 24.12% for the three months ended March 31, 2011 as compared to 31.12% for the comparable period in the prior year. The decrease in our gross profit and gross profit margin was mainly due to the fact that we lowered our profits in order to win the contacts for installation projects from the government.

Operating Expenses

 

Our operating expenses, which include selling, general and administrative expense, totaled $7,884,843 for the three months ended March 31, 2011, an increase of $6,821,295, or 641.37% as compared to $1,063,548 for the three months ended March 31, 2010. The increase in our operating expenses was mainly attributable to the increase in the bad debt expenses, as we were not able to collect certain portion of accounts receivable resulted from the installation project sales.

 

The Company carries accounts receivable at the invoiced amount without bearing interest, less an allowance for doubtful accounts. Allowances for doubtful accounts are recorded as a general and administrative expense. The Company evaluates the adequacy of the allowance for doubtful accounts at least quarterly and computes the allowance for doubtful accounts based on the history of actual write-offs. The Company also performs a subjective review of specific large accounts to determine if an additional reserve is necessary. The formula for calculating the allowance closely parallels the Company’s history of actual write-offs and account adjustments based upon contractual terms. In circumstances in which we receive payment for accounts receivable which have previously been written off, we reverse the allowance and bad debt expenses.

 

 

Other Income (Expenses)

 

Other income (expenses) primarily includes interest income (expenses), bargain purchase gain and other income (expenses). Total net other expenses amounted to $11,613 for the three months ended March 31, 2011, which primarily included interest expenses, as compared to other income of $41,415 for the three months ended March 31, 2010.

 

Income Taxes

 

The Company and its subsidiary and affiliated entities, Yixing Dragon Path, Zhenyu, and Jinyu suffered operating losses in the prior years' operations. For the Chinese income tax purpose, these operating losses can be carried forward in in a 5-year period and be available to reduce future years' taxable income. The Management believes that the realization of the deferred tax asset arising from the operating losses of Zhenyu and Jinyu is the best interest of the Company's business operations. Since there is no certainty that Yixing Dragon Path will generate taxable income in the future, the Management established a 100% valuation allowance for the operation losses carried forward by Yixing Dragon Path and no deferred tax assets have been recorded as a result of these losses. Beginning from October 2010, since there is no certainty that Zhenyu will generate taxable income in the future, the Management established a 100% valuation allowance for the operation losses carried forward by Zhenyu and no deferred tax assets have been recorded as a result of these losses. For the three months ended March 31, 2010 and March 31, 2011, we recorded income tax of $575,752 and $333,318, respectively. The decrease in income tax was mainly due to the decrease in our operating income.

 

Net Income

 

We reported a net loss of $5,117,268 for the three months ended March 31, 2011 as compared to a net income of $1,778,779 for the three months ended March 31, 2010. Such decrease in our net income was primarily attributable to the loss in connection with a project that was buried in landslides triggered by an earthquake in March 2011. Please see Note 12 Extraordinary Item of the financial statements for more information.

 

Other Comprehensive Income

 

Our business operations are conducted exclusively in the PRC, and, therefore, our functional currency is the RMB. The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into USD at the rates used in translation.

 

For financial reporting purpose, RMB has been translated into USD as the reporting currency in accordance with FASB ASC 830, “Foreign Currency Matters”. The financial information is translated into U.S. dollars at period-end exchange rates as to assets and liabilities and average exchange rates as to revenue and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred. The effects of foreign currency translation adjustments are included as a component of accumulated other comprehensive income in stockholders’ equity.

 

Translation adjustments resulting from this process amounted to other comprehensive income of $6,326 for the three months ended March 31, 2011, as compared to other comprehensive expense of $23,757 for the three months ended March 31, 2010. The balance sheet amounts with the exception of equity at March 31, 2011 were translated at 6.5701 RMB to 1.00 USD as compared to 6.8259 RMB to 1.00 USD at March 31, 2010. The equity accounts were stated at their historical rate. The average translation rates applied to our income statements for the periods ended March 31, 2011 and 2010 were 6.6286 RMB and 6.8274 RMB, respectively.

 

Operation Results for the Six Months Ended March 31, 2011 and 2010

 

Revenues

 

For the six months ended March 31, 2011, we reported revenues of $25,564,755 as compared to $18,194,550 for the six months ended March 31, 2010, an increase of $7,368,572, or 40.50%. The increase was attributable to the following factors: (i) the transition of our major business from equipment sales to equipment installation projects; and (ii) new customers brought in by existing customers.

 

Revenues from installation projects were $24,850,263 for the six months ended March 31, 2011, an increase of $7,704,892, or 44.94% as compared to $17,145,371 for the comparable period in 2010. The increase was mainly attributable to the factors cited above.

 

 

Revenues from sales of equipment were $714,492 for the six months ended March 31, 2011, a decrease of $334,687, or 31.90% as compared to $1,049,179 for the comparable period in 2010. The decrease mainly resulted from the transition of our business focus from equipment sales to equipment installation projects.

 

Cost of Revenue

 

For the six months ended March 31, 2011, our cost of revenue was $17,752,721 as compared to cost of revenue of $12,462,596 for the six months ended March 31, 2010, an increase of $5,290,125, or 42.43%. The increase in cost of revenue is primarily due to increase in sales.

 

Gross Profit

 

For the six months ended March 31, 2011, our gross profit was $7,812,034, an increase of $2,080,080 or 36.29%, as compared to $5,731,954 for the six months ended March 31, 2010. Our overall gross profit as a percentage of revenues was 30.56% for the six months ended March 31, 2011 as compared to 31.48% for the comparable period in 2010. The increase in our gross profit was mainly due to the increase in sales.

 

Operating Expenses

 

Our operating expenses, which include selling, general and administrative expenses, totaled $8,321,701 for the six months ended March 31, 2011, as compared to $1,600,054 for the six months ended March 31, 2010. The increase in our operating expense was mainly attributable to the increase in the bad debt expenses. The Company carries accounts receivable at the invoiced amount without bearing interest, less an allowance for doubtful accounts. Allowances for doubtful accounts are recorded as a general and administrative expense. The Company evaluates the adequacy of the allowance for doubtful accounts at least quarterly and computes the allowance for doubtful accounts based on the history of actual write-offs. The Company also performs a subjective review of specific large accounts to determine if an additional reserve is necessary. The formula for calculating the allowance closely parallels the Company’s history of actual write-offs and account adjustments based upon contractual terms. In circumstances in which we receive payment for accounts receivable which have previously been written off, we reverse the allowance and bad debt expenses.

 

Other Income (Expenses)

 

Other income (expenses) primarily includes interest income (expenses), bargain purchase gain and other income (expenses). Total net other expenses amounted to $14,301, including interest expense of $20,160, offset by interest income of $216, other income of $1,117 and governmental subsidy of $4,526 for the six months ended March 31, 2011 as compared to other income of $35,908 for the comparable period in 2010, which mostly include gain on bargain purchase of $52,016 offset by interest expenses of $16,208.

 

Income Taxes

 

The Company and its subsidiary and affiliated entities, Yixing Dragon Path, Zhenyu, and Jinyu suffered operating losses in the prior years' operations. For the Chinese income tax purpose, these operating losses can be carried forward in in a 5-year period and be available to reduce future years' taxable income. The Management believes that the realization of the deferred tax asset arising from the operating losses of Zhenyu and Jinyu is in the best interest of the Company's business operations. Since there is no certainty that Yixing Dragon Path will generate taxable income in the future, the Management established a 100% valuation allowance for the operation losses carried forward by Yixing Dragon Path and no deferred tax assets have been recorded as a result of these losses. Beginning from October 2010, since there is no certainty that Zhenyu will generate taxable income in the future, the Management established a 100% valuation allowance for the operation losses carried forward by Zhenyu and no deferred tax assets have been recorded as a result of these losses. For the six months ended March 31, 2011 and 2010, we recorded income tax provision of $337,136 and $1,029,072 respectively. The decrease in income tax was mainly due to the decrease in income before income taxes as a result of the substantial increase in bad debt expenses.

 

Net Income

 

We reported a net loss of $5,386,926, for the six months ended March 31, 2011, as compared to net income of $3,138,514 for the six months ended March 31, 2010. Such decrease in our net income was primarily attributable to loss in connection with a project that was buried in landslides triggered by an earthquake in October 2010. Please see Note 12 Extraordinary Item of the financial statements for more information.

 

Other Comprehensive Income

 

We operate exclusively in the PRC and the functional currency of our operating subsidiary is the Chinese Renminbi (”RMB”). The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into USD at the rates used in translation.

 

 

For financial reporting purpose, RMB has been translated into USD as the reporting currency in accordance with FASB ASC 830, “Foreign Currency Matters”. The financial information is translated into U.S. dollars at period-end exchange rates as to assets and liabilities and average exchange rates as to revenue and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred. The effects of foreign currency translation adjustments are included as a component of accumulated other comprehensive income in stockholders’ equity.

 

Translation adjustments resulting from this process amounted to other comprehensive income of $109,757 and other comprehensive expense of $20,388 for the six months ended March 31, 2011 and 2010, respectively. The balance sheet amounts with the exception of equity at March 31, 2011 were translated at 6.5701 RMB to 1.00 USD as compared to 6.82590 RMB to 1.00 USD at March 31, 2010. The equity accounts were stated at their historical rate. The average translation rates applied to the income statements accounts for the periods ended March 31, 2011 and 2010 were 6.62863 RMB and 6.8274 RMB, respectively.

 

Liquidity and Capital Resources

 

As of the date of this report, we have financed our operations primarily through cash flows from operations and borrowings from banks in the PRC. As of March 31, 2011, we had negative working capital of $2,945,453. Based on our current operating plan, we believe that our existing resources, including cash generated from operations as well as our bank loans, will be sufficient to meet our working capital requirement for our current operations. To fully implement our business plan and continue our growth, however, we believe we will require additional capital. Total current assets decreased to $8,849,659 as of March 31, 2011 from $18,786,916 as of September 30, 2010. The primary changes in our current assets during this period were from changes in cash, accounts receivables, and inventory.

 

The increase in our cash and cash equivalents from $1,268,674 at September 30, 2010 to $2,345,963 at March 31, 2011 was due substantially to our withdrawal of restricted cash, which decreased from $5,844,020 at September 30, 2010 to $0 at March 31, 2011. The increase in our accounts receivable from $815,566 at September 30, 2010 to $4,734,036 at March 31, 2011 resulted primarily from increased sales activities related to several equipment-bundled installation projects. The decrease in inventory, primarily in raw materials and finished goods, from $9,045,390 as of September 30, 2010 to $1,725,967 as of March 31, 2011 was due primarily to delivery of several installation projects in the six months ended March 31, 2011 and fewer ongoing installation projects for the six months ended March 31, 2011.

 

Our total current liabilities as of March 31, 2011 totaled $11,795,112 as compared to $15,837,295 at September 30, 2010. The decrease in current liabilities was primarily due to the decrease in our advance from customers as we delivered several installation projects in the six months ended March 31, 2011.

 

Discussion of Cash Flow

 

Comparison of cash flows results for the six months ended March 31, 2011 to the six months ended March 31, 2010, is summarized as follows:

 

		For the Six Months Ended March 31
		2011				2010
Cash flow from (used) operating activities		$	186,231			$	3,245,520
Cash flow from (used) investing activities			(4,280	)			(375,366	)
Cash flow from (used) financing activities		$	877,145			$	2,112,082

 

Operating Activities

 

Cash flows provided by operating activities for the six months ended March 31, 2011 amounted to $186,231, a decrease of $3,059,289, or 94.26% as compared to $3,245,520 for the comparable period in 2010.The decrease was mainly attributable to increase in accounts receivable.

 

Investing Activities

 

Net cash used in investing activities amounted to $4,280 for the six months ended March 31, 2011, which represented purchase of property and equipment. Cash flows used in investing activities amounted to $375,366 for the six months ended March 31, 2010.

 

Financing Activities

  

Net cash provided by financing activities amounted to $877,145 for the six months ended March 31, 2011, which was the due from CEO. Net cash provided by financing activities for the six months ended March 31, 2010 amounted to $2,112,082 which represented proceeds from bank loans of $439,404 and shareholder capital contribution of $295,000, as well as the due from CEO of $1,377,678.

  

 

Off Balance Sheet Arrangements

 

As of the date of this report, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The term “off-balance sheet arrangement” generally means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party, under which we have: (i) any obligation arising under a guarantee contract, derivative instrument or variable interest; or (ii) a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.

 

Critical Accounting Policies

 

See “Note 2. Summary of Significant Accounting Policies” in “Item 1. Financial Statements” herein for a discussion of the critical accounting pronouncements adopted in this Quarterly Report on Form 10-Q.

 

Recent Accounting Pronouncements

 

See“ Note 2. Summary of Significant Accounting Policies” in “Item 1. Financial Statements” herein for a discussion of the new accounting pronouncements adopted in this Quarterly Report on Form 10-Q.

 

Item 3. Quantitative and Qualitative Disclosure About Market Risk.

 

Not applicable.

 

Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”). The evaluation of our disclosure controls and procedures included a review of our processes and the effect on the information generated for use in this Quarterly Report on Form 10-Q. In the course of this evaluation, we sought to identify any material weaknesses in our disclosure controls and procedures and to confirm that any necessary corrective action, including process improvements, was taken. The purpose of this evaluation is to determine if, as of the Evaluation Date, our disclosure controls and procedures were operating effectively such that the information, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) was recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) was accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

As of March 31, 2011, the Company’s Chief Executive Officer and its Chief Financial Officer have concluded that, as of that date, the Company’s controls and procedures were not effective due to some significant deficiencies (as defined in Public Company Accounting Oversight Board Standard No. 2) in the Company’s internal controls over financial reporting. This is due to the fact that the Company lacks sufficient personnel with the appropriate level of knowledge, experience and training in the application of US generally accepted accounting principles (“GAAP”) standards, especially related to complicated accounting issues. This could cause the Company to be unable to fully identify and resolve certain accounting and disclosure issues that could lead to a failure to maintain effective controls over preparation, review and approval of certain significant account reconciliation from Chinese GAAP to US GAAP and necessary journal entries.

 

The Company has a relatively small number of professionals in bookkeeping and accounting functions, which prevents the Company from appropriately segregating duties within its internal control systems. The inadequate segregation of duties is a weakness because it could lead to the untimely identification and resolution of accounting and disclosure matters or could lead to a failure to perform timely and effective reviews.

 

Based on the control deficiency identified above, we have designed and plan to implement, or in some cases have already implemented, the specific remediation initiatives described below:

 

·

We are evaluating the roles of our existing accounting personnel in an effort to realign the reporting structure of our internal auditing staff in China that will test and monitor the implementation of our accounting and internal control procedures.

 

·

We are in the process of completing a review and revision of the documentation of the Company’s internal control procedures and policies.

 

 

·

We will begin implementation an initiative and training in China to ensure the importance of internal controls and compliance with established policies and procedures are fully understood throughout the organization and will provide additional U.S. GAAP training to all employees involved with the performance of or compliance with those procedures and policies.

 

·

We will implement a formal financial reporting process that includes review by our Chief Executive Officer and the full Board of Directors of financial statements prior to filing with the SEC.

 

·

We have engaged third-party financial consultants to review and analyze our financial statements and assist us in improving our reporting of financial information. Management plans to enlist additional qualified in-house accounting personnel and third-party accounting personnel as required to ensure that management will have adequate resources in order to attain complete reporting of financial information disclosures in a timely matter.

 

The remedial measures being undertaken may not be fully effectuated or may be insufficient to address the significant deficiencies we identified, and there can be no assurance that significant deficiencies or material weaknesses in our internal control over financial reporting will not be identified or occur in the future. If additional significant deficiencies (or if material weaknesses) in our internal controls are discovered or occur in the future, among other similar or related effects: (i) the Company may fail to meet future reporting obligations on a timely basis, (ii) the Company’s consolidated financial statements may contain material misstatements, and (iii) the Company’s business and operating results may be negatively impacted.

 

Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were not operating effectively.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting for the quarter ended March 31, 2011 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

None.

 

Item 1A. Risk Factors.

 

Not applicable.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

None.

 

Item 3. Defaults Upon Senior Securities.

 

None.

 

Item 4. Mine Safety Disclosures

 

Item 5. Other Information.

 

None.

 

Item 6. Exhibits.

 

No	Description
3.1	Articles of Incorporation as filed with the Secretary of State of Nevada. Incorporated by reference to Exhibit 3.1 to the Registrant’s registration statement on Form SB2 filed on January 30, 2008.
3.2	Certificate of Amendment to Articles of Incorporation
3.3	Bylaws. Incorporated by reference to Exhibit 3.1 to the Registrant’s registration statement on Form SB2 filed on January 30, 2008.

 

 

31.1	Certification of Principal Executive Officer Pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act Of 1934*
31.2	Certification of Principal Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act Of 1934*
32.1	Certification of Principal Executive Officer furnished 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 Principal Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**

 

* Filed herewith.

 

** Furnished herewith.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

	CHINA ENVIRONMENTAL PROTECTION, INC.
Date: October 26, 2012	/s/Boping Li
	Boping Li
	Chief Executive Officer and Chairman
Date: October 26, 2012	/s/Yuqiang Wu
	Yuqiang Wu
	Chief Financial Officer