UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-K

(Mark One)

or

CHINA ENERGY RECOVERY, INC.

(Exact Name of Registrant as Specified in its Charter)

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

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes     ¨          No     x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes     ¨          No     x

NOTE – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

     Yes     x          No     ¨

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     x

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

(Do not check if a smaller reporting company)

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

     Yes     ¨          No     x

The aggregate market value of the voting and non-voting common equity held by non-affiliates is $9,315,602 [as computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter.]

Number of shares outstanding of the registrant's common stock as of March 31, 2013:

31,052,006 shares of Common Stock, $0.001 par value per share

DOCUMENTS INCORPORATED BY REFERENCE

None

Table of Contents

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K and other materials we will file with the U.S. Securities and Exchange Commission (the "SEC") contain, or will contain, disclosures which are forward-looking statements. Forward-looking statements include all statements that do not relate solely to historical or current facts, such as, but not limited to, the discussion of economic conditions in market areas and their effect on revenue growth, the discussion of our growth strategy, the potential for and effect of future governmental regulation, fluctuations in global energy costs, the effectiveness of our management information systems, and the availability of financing and working capital to meet funding requirements, and can generally be identified by the use of words such as "may," "believe," "will," "expect," "project," "estimate," "anticipate," "plan" or "continue." These forward-looking statements are based on our management's current plans and expectations and are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated. These risks and uncertainties include, but are not limited to: our limited operating history; our ability to effectively market our products and services; the loss of key personnel; our inability to attract and retain new qualified personnel; our capital needs and the availability of and costs associated with potential sources of financing; adverse effects of the current turmoil in the credit markets; adverse effects of the recent depressed global economic conditions; our inability to increase manufacturing capacity to meet demand; economic conditions affecting manufacturers of energy recovery systems and the industry segments they serve; our dependence on certain customer segments; difficulties associated with managing future growth; our failure to protect our intellectual property rights; allegations of claims of infringements of intellectual property rights brought against us; the loss of our ability to sell and install energy recovery systems made by third parties or such systems manufactured by us under licenses from third parties; fluctuations in currency exchange rates; our failure to comply with applicable environmental regulations; increased competition in our industry; our exposure to litigation from performing work on our customers' properties; an increase in warranty claims; our liability for injuries caused by our products; our inability to cover damages owed by insurance; fluctuations in energy prices resulting in fluctuating demand for our products and services; risks related to our corporate structure, such as our inability to control our affiliated entities and conflicts of interest between our Chief Executive Officer’s duties to us and to our affiliated entities; the uncertainties associated with the environmental, economic, political and legal conditions in China and changes thereof; the adverse effect of governmental regulation and other matters affecting energy recovery system manufacturers; Chinese restrictions on foreign currency exchange transactions; restrictions on foreign investments in China; ineligibility for and expiration of current Chinese governmental incentives; natural disasters and health related concerns; the development of an active trading market for our common stock; the loss of coverage of our common stock by securities analysts; the failure of our complying with securities laws in private placements; our common stock being a penny stock; a sudden increase in the number of shares of our common stock in the market as a result of Rule 144 sales or conversion or exercise of derivative securities, and our failure to maintain adequate internal controls over financial reporting.

These forward-looking statements speak only as of the date of this Annual Report on Form 10-K. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. You should also read, among other things, the risks and uncertainties described in the section of this Annual Report on Form 10-K entitled "Risk Factors."

PART I

Overview of Our Business

China Energy Recovery, Inc. (the "Company," "we," "us," or "our") is headquartered in Shanghai, China, and, through its subsidiaries and affiliates, is in the business of designing, fabricating, implementing and servicing industrial energy recovery systems. The Company's energy recovery systems capture industrial waste energy for reuse in industrial processes or to produce electricity and thermal power, thereby allowing industrial manufacturers to reduce their energy costs, shrink their emissions and generate sellable emissions credits. Our manufacturing takes place at the Company's recently constructed manufacturing facility in Yangzhou, China. The Company transports the manufactured systems in parts via truck, train or ship to the customers' facilities where the system is assembled and installed. The Company primarily has sold energy recovery systems to chemical manufacturing plants to reduce their energy costs by increasing the efficiency of their manufacturing equipment. Since inception, the Company has installed over 156 energy recovery systems both in China and internationally. The Company mainly sells its energy recovery systems and services directly to end users.

Our History

Unless otherwise noted, the disclosures about our history reflect the Company's capital structure as of the time of the occurrences described and do not take into account subsequent stock splits or other adjustments to the Company's capital structure.

We incorporated in the State of Maryland in May 1998 under the name Majestic Financial, Ltd. We changed our name to Commerce Development Corporation, Ltd. in April 2002. Effective June 5, 2007, we changed our name to MMA Media Inc.

On January 24, 2008, we entered into a Share Exchange Agreement (the "Share Exchange Agreement") with Poise Profit International, Ltd., a private British Virgin Islands corporation ("Poise Profit"), and Poise Profit's shareholders pursuant to which we agreed to acquire all of the issued and outstanding shares of Poise Profit's common stock in exchange for the issuance of 41,514,179 shares of our common stock (on a post-1-for-9 stock split basis approved by our board of directors in connection with entering into the Share Exchange Agreement) to Poise Profit's shareholders (the "Share Exchange").

On January 25, 2008, we entered into and closed an Asset Purchase Agreement with MMA Acquisition Company, a Delaware corporation, pursuant to which we sold substantially all of our assets to MMA Acquisition Company in exchange for MMA Acquisition Company's assuming a substantial majority of our outstanding liabilities. Effective therewith, our parent company was Delaware-incorporated and no longer Maryland-incorporated. The transferred assets consisted of letters of intent for the proposed acquisitions of MMAWeekly.com, dated June 9, 2007, and Blackbelt TV, Inc., dated July 16, 2007, and all shares of common stock in Blackbelt TV, Inc. we owned, among other things. The total book value of the assets acquired was approximately $317,000. The assumed liabilities consisted of accounts payable, convertible debt, accrued expenses and shareholder advances of approximately $360,000.

Effective February 5, 2008, we changed our name from MMA Media, Inc. to China Energy Recovery, Inc. and conducted a 1-for-9 reverse stock split of our issued and outstanding capital stock pursuant to which each nine shares of our common stock issued and outstanding on the record date of February 4, 2008 were converted into one share of our common stock. We had 84,922,000 shares of common stock issued and outstanding immediately prior to the reverse stock split and 9,435,780 shares thereafter.

On April 15, 2008, we closed the Share Exchange pursuant to which we acquired all of the issued and outstanding shares of Poise Profit's common stock in exchange for the issuance of 41,514,179 shares of our common stock to Poise Profit's stockholders. Upon the closing of the Share Exchange, Poise Profit became our wholly-owned subsidiary and our business operations consisted of those of Poise Profit's wholly-owned subsidiary, HAIE Hi-tech Engineering (Hong Kong) Company, Limited ("Hi-tech"), incorporated in the Hong Kong Special Administrative Region of China.

Also on April 15, 2008 and as a condition to closing of the Share Exchange, we entered into Securities Purchase Agreements (the "Securities Purchase Agreement") with 25 accredited investors pursuant to which we issued and sold an aggregate of 7,874,241 units at a price per unit of $1.08 with each unit consisting of one share of our Series A Convertible Preferred Stock, par value $0.001 per share, and one warrant to purchase one-half of one share of our common stock at an exercise price of $1.29 per share (the "Financing"). Thus, at the closing of the Financing, we issued 7,874,241 shares of our Series A Convertible Preferred Stock to the investors and we also issued warrants to the investors for the purchase of an aggregate of 3,937,121 shares of our common stock for an aggregate purchase price of $8,504,181. After the April 16, 2008 1-for-2 reverse stock split described below, the warrants are exercisable into 1,968,561 shares of common stock at an exercise price of $2.58.

As a result of the closing of the Share Exchange on April 15, 2008, our new business operations consisted of those of Poise Profit's Chinese subsidiary, Hi-tech, which were subsequently transferred to CER (Hong Kong) Holdings Limited (“CER Hong Kong”) as described in Item 1 Business - Organizational Structure and Subsidiaries. CER Hong Kong is principally engaged in designing, marketing, licensing, fabricating, implementing and servicing industrial energy recovery systems capable of capturing industrial waste energy for reuse in industrial processes or to produce electricity and thermal power.

On April 16, 2008, we conducted a 1-for-2 reverse stock split of our issued and outstanding capital stock pursuant to which each two shares of our common stock issued and outstanding on the record date of April 15, 2008 were converted into one share of our common stock. We had 50,949,959 shares of common stock issued and outstanding immediately prior to the reverse stock split and 25,474,980 shares thereafter.

Starting in the summer of 2008, we began a reorganization of our corporate structure as further described under the caption "Organizational Structure and Subsidiaries" below.

Organizational Structure and Subsidiaries

After closing of the Share Exchange, our organizational structure reflected Chinese limitations on foreign investments and ownership in Chinese businesses. Generally, these limitations prevent a U.S. corporation from owning directly certain types of Chinese businesses. Instead, a U.S. corporation can obtain the benefits and risk of equity ownership of a Chinese business either by being a part-owner of a Chinese joint venture or by entering into fairly extensive and complicated contractual relationships with Chinese companies wholly-owned by Chinese owners. At that time, and still to a significant extent, our business relied on contractual relationships. However, we began a corporate reorganization process in the summer of 2008 to gradually move our assets and operations from affiliated entities with which we have only contractual relationships into wholly-owned subsidiaries. Until our reorganization is complete, our corporate structure will reflect a combination of control via direct ownership and contractual arrangements.

Poise Profit, a wholly-owned subsidiary of the Company, was incorporated on November 23, 2007 under the laws of the British Virgin Islands. Poise Profit, in turn, owns 100% of the issued and outstanding equity interests in Hi-tech and CER (Hong Kong) Holdings Limited ("CER Hong Kong"). Historically, all of our operations were conducted through Hi-tech via contractual arrangements with affiliated Chinese entities, but we have transferred all our assets and operations from Hi-tech to CER Hong Kong and its wholly-owned subsidiary CER Energy Recovery (Shanghai) Co., Ltd. ("CER Shanghai"). As part of our reorganization, CER Hong Kong was incorporated on August 13, 2008 under the laws of the Hong Kong Special Administrative Region, China and was originally jointly owned by Mr. Qinghuan Wu, one of our directors and our Chairman of the Board and Chief Executive Officer, and his spouse, Mrs. Jialing Zhou, who was first one of our directors and resigned in June 2011. On December 3, 2008, Mr. Qinghuan Wu and Mrs. Zhou transferred ownership of CER Hong Kong to Poise Profit. CER Shanghai was incorporated on November 11, 2008 by CER Hong Kong as wholly foreign-owned enterprises in Shanghai, China; and CER Yangzhou was formerly incorporated on August 28, 2009 in Yangzhou, China by CER Hong Kong as wholly foreign-owned enterprises, then changed to a domestic enterprise wholly-owned by CER Shanghai through a share transfer agreement entered into between CER Shanghai and CER Hong Kong in August 2012 (see Note 1 to our consolidated financial statements). Now CER Shanghai and CER Yangzhou are our primary operating entities in China, and they enter into the majority of all new business contracts.

Before December 3, 2008, all of our operations were conducted through Hi-tech and its affiliated companies. Hi-Tech was engaged in the marketing and sale of energy recovery systems which were designed, manufactured and installed by affiliated companies. Hi-tech had entered into contractual relationships with two entities incorporated in Shanghai, China: Shanghai Hai Lu Kun Lun Hi-tech Engineering Co., Ltd. ("Shanghai Engineering") and Shanghai Xin Ye Environmental Protection Engineering Technology Co., Ltd. ("Shanghai Environmental"). Each of Shanghai Engineering and Shanghai Environmental was considered a "variable interest entity" and their respective financial information was consolidated with Hi-tech's pursuant to the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) 810-10. Hi-tech entered into contractual relationships with Shanghai Engineering and Shanghai Environmental to comply with Chinese laws regulating foreign-ownership of Chinese companies. Shanghai Engineering is engaged in the business of designing, manufacturing and installing energy recovery systems. All manufacturing was done by Vessel Works Division pursuant to a cooperative manufacturing agreement between Shanghai Engineering and Vessel Works Division's parent, Shanghai Si Fang Boiler Factory ("Shanghai Si Fang"), as further described below. Shanghai Environmental is not an operating company but it served in the past as a vehicle for arranging sales and maximizing tax benefits. We did not use Shanghai Environmental for these purposes since our 2010 fiscal year and did not intend to do so since then, hence, we dissolved Shanghai Environmental in 2010. Shanghai Engineering was owned jointly by Mr. Qinghuan Wu, our Chairman of the Board and Chief Executive Officer, and his spouse, Mrs. Jialing Zhou, who was formerly one of our directors and resigned in June 2011.

On December 3, 2008, as a part of our reorganization, all of the material contracts between Hi-tech and Shanghai Engineering and between Hi-tech and Shanghai Environmental were transferred to CER Hong Kong. Since that date, CER Hong Kong has been engaged in the marketing and sale of energy recovery systems which are designed, manufactured and installed by its subsidiaries and affiliated companies. These material contractual relationships consist of:

From May 1, 2003 to December 31, 2010, all of Shanghai Engineering’s manufacturing activities were conducted through a Leasing and Operation Agreement, a form of cooperative manufacturing agreement, originally effective as of May 1, 2003 and subsequently renewed and amended with a state-owned enterprise, Shanghai Si Fang. Pursuant to the agreement, Shanghai Si Fang leased certain land use rights, buildings and fixed assets (lease elements) in one of its subsidiaries, Vessel Works Division, and provided management services and licensed the “Si Fang” brand and manufacturing license (non-lease elements) of Vessel Works Division to Shanghai Engineering. Because the arrangement contains both the lease and non-lease elements, the quarterly payments were allocated between the lease and non-lease deliverables. The lease elements were classified and accounted for as operating leases and the lease expense was recorded on a straight-line basis. The non-lease elements were accounted for as prepayment for management and licensing fees and the payment was amortized on a straight-line basis over each contractual period. During January to March 2011, we operated our manufacturing function simultaneously in both Vessel Works Division and CER Yangzhou. By the time the Vessel Works Division lease agreement was terminated in April, 2011, we had transferred all production to CER Yangzhou.

The following is an organizational chart setting forth the current status of the Company's subsidiaries and affiliated companies as of December 31, 2012:

Industry Overview

Global demand is increasing for innovative environmental protection and renewable energy solutions for sustainable economic growth. Modern industrial nations and emerging markets today are faced with the growing challenge of reducing and controlling air pollution emissions that present serious health risks to national populations, cross international borders, and damage the environment. Increased energy consumption has forced governments and industries to invest in improving energy efficiency and alternative forms of power generation and conservation. As the global power generation industry and manufacturing industries increase their focus on improving efficiency and mitigating the environmental impact of their processes, we believe that energy recovery systems will play a major role in improving the output that can be obtained from current supplies.

Energy recovery systems can salvage the majority of the wasted energy from excess heat that industrial manufacturing facilities and power plants release into the atmosphere in the form of hot exhaust gases or high pressure steam by converting the heat into electricity (often through steam driven generator turbines) which can be used in industrial processes, thereby lowering energy costs. In addition, energy recovery systems can also capture harmful pollutants that would otherwise be released into the environment from certain industrial processes. These reduced emissions can also help companies meet environmental regulations. Energy recovery systems may also be used in heat recovery applications whereby excess heat may be used to heat buildings and water. Examples of end-users of this type of energy recovery system include hospitals and schools that may heat their buildings and water with excess heat generated by their own large electrical equipment. This type of energy recovery system is less complicated and requires significantly less technical qualifications to build than the industrial energy recovery systems described above as it is essentially redirecting the heat generated by one system into other on-site systems. As a result, this type of energy recovery system is cheaper to build and the barriers to entry into this market are lower than in the market for industrial energy recovery systems. Our business focuses on energy recovery systems for industrial applications.

We believe that energy recovery systems represent a large-scale, environmentally friendly and economically feasible form of power generation and tool for improving energy efficiency. Compared with other alternative forms of power, such as solar, wind or biomass, we believe that energy recovery systems are dramatically more affordable for technology capable of delivering power on the scale necessary for industrial clients. In our opinion, energy recovery systems are cost competitive even with large-scale, traditional power sources such as coal, fossil fuels and nuclear power, but have the added benefit of reducing pollution and greenhouse gas emissions.

We have developed and commercialized our proprietary customized energy recovery technologies and solutions to cost-effectively reduce pollution and capture the waste heat released by our customers’ industrial processes. Our energy recovery systems can help our customers improve their energy use efficiency. For example, our energy recovery systems applied in sulfuric acid manufacturing processes can produce as much as three times the useable energy from the same fuel by recovering otherwise lost energy and reusing it in the manufacturing processes directly or to further generate electrical power, which may allow customers to slash energy expenditures by up to two-thirds. Additionally, these systems can reduce harmful emissions resulting from certain types of sulfuric acid manufacturing processes that otherwise would have been released into the atmosphere. Other benefits include our customers' ability to sell carbon credits, reduction of flue gas and equipment sizes of all flue gas handling equipment such as fans, stacks, ducts, and burners, and a reduction in auxiliary energy consumption.

The most notable target customers for our energy recovery systems are major types of industrial manufacturing facilities, such as chemical plants, petrochemical plants, paper manufacturing plants, oil refineries, etc. These types of customers generally operate manufacturing equipment that release waste heat, into which our energy recovery systems can be implemented and integrated to capture such waste heat for direct reuse or, if connected with steam-driven turbines, to produce electricity.

In March 2010, the Chinese People's Political Consultative Conference (“CPPCC”) and National People's Congress (“NPC”) convened, during which the number one proposal on low carbon: Suggestion On Promotion of Low Carbon Life and Improved Social Sustainable Development, proposed by the Jiu San Society, was highly received by the NPC and CPPCC; over 10% of the proposals of the CPPCC and NPC meetings were related to low carbon issues. The Government Work Report of 2009, issued by Premier Wen Jiabao, indicated that energy savings and environmental protection is one of the nine key job objectives of the government in 2010, which means low carbon will be a state strategy in the near future. The Government Work Report of 2011, issued by Premier Wen Jiabao, further emphasized the necessity for energy savings and environmental preservation. To positively affect world climate change and improve energy utilization/efficiency, the government is trying to develop the concept of energy savings in industrial production by encouraging the utilization of energy saving techniques and highly supporting the utilization of energy-saving equipment. The issues mentioned above imply that the energy saving industry should experience significant growth over the next few years. Furthermore, at the Copenhagen Climate Conference, Premier Wen Jiabao announced that China would decrease carbon emissions by 40%-45% by 2020, as compared with 2005, which is further evidence that the energy savings industry should experience significant growth in the near future in China, and which should benefit CER in growing its business in the domestic Chinese market.

In November 2011, the Central Economic Work Conference was held in Beijing. The conference addressed the importance of energy savings and the aim to reduce greenhouse gas emissions. This is a difficult task to accomplish and the government is trying to launch effective measures to reduce energy utilization and mitigate the release of harmful emissions.

In June 2012, the State Council issued its energy conservation and environmental protection industry development plan during the 12^th five year plan. Domestically, facing gradually reinforced restraints of resource, in order to accelerate the change of China’s economic growth mode and realize energy conservation and environmental protection binding force index, the government must speed the promotion of energy conservation and environmental protection equipment and service levels. The development of the energy conservation and environmental protection industry will be promising. According to their calculations, China’s energy-saving capacity, which is technologically feasible and economically reasonable will exceed 0.4 billion tons standard coal, which can drive investments amounting to trillions of yuan; the gross value of energy conservation service output can exceed 300 billion yuan; the scope of recycling utilization of industrial waste is huge; and the gross value of environmental service output will exceed 500 billion yuan as of 2015.

Global Market Overview

The world currently faces fundamental problems with its energy supply, which are due primarily to the reliance on fossil fuels. The economic prosperity of the wealthiest nations in the twentieth century was built on a ready supply of inexpensive fossil fuel and developing nations have continued in the twenty-first century to consume fossil fuel reserves at an ever increasing rate. This has led to worldwide reserve depletions, indicating that both oil and gas are likely to be effectively exhausted before the end of this century. Only coal reserves are expected to last into the next century. Yet even if fossil fuel supplies were unconstrained, their continued use poses its own problems. All fossil fuel combustion produces carbon dioxide, which appears to result in the warming of the earth's atmosphere with profound environmental implications across the globe.

These problems have resulted in the realization that the world must both increase the efficiency of its utilization of fossil fuels and decrease its reliance upon them. Environmental issues related to fossil fuel combustion arose first during the 1980s with the advent of acid rain, a product of the sulfur and nitrogen emissions from fossil fuel combustion. Power plants were forced by legislation and economic measures to control these emissions. However it is the recognition of global warming that presents the most serious challenge because carbon dioxide exists at much higher levels in the flue gases of power plants and major types of industrial manufacturing facilities than sulfur dioxide and nitrogen oxides.

Although renewable energy capacity offers a hedge against major price rises because most renewable technologies exploit a source of energy that is freely available, many renewable technologies today still rely on government subsidies to make them competitive. Governments may also impose penalties upon companies, such as carbon trading schemes, which discourage the use of fossil fuels or increase its costs by imposing stringent emissions limits.

Given the international concerns regarding global warming and pollution and the need to more efficiently utilize fossil fuels, we believe that there exists substantial worldwide demand and a growing market for technologies that can enable companies to generate greater amounts of energy from the same supply of fossil fuels and that also reduce the amount of harmful emissions that would otherwise be released from the combustion of those fossil fuels. These technologies, including energy recovery systems, could benefit companies by both reducing energy costs and mitigating possible emissions penalties.

China Market Overview

Booming economic growth and rapid industrialization has spurred demand for electric power in China over the previous few years. Due to the expansion of energy intensive industrial sectors such as steel, cement, coal, petrol and chemicals, China's energy consumption has been growing faster than the country's gross domestic product ("GDP") and thus causing a shortage of electricity and coal and blackouts in over 20 of the country's 32 provinces, autonomous regions and municipalities. With the rapid modernization and industrialization of the country's economy, according to the International Energy Agency, China needs to add more than 1,300 GW to its electricity-generating capacity, more than the total installed capacity currently in the United States, to meet its demands over the next several years. We predict that the result of this massive increase in electric generation capacity will be a rapid rise in harmful emissions. China has already surpassed the United States to become the world's largest emitter of greenhouse gases, and the country faces enormous challenges from the pollution brought about by its energy needs.

According to the national bureau of statistics of China, the output of sulfuric acid continuously increased in the recent years. The accumulated output in the first three quarters of 2012 was 57.545 million tons, an increase of 6.66% over the output during the same period of 2011. We see more market opportunities from the high growth of the sulfuric acid industry.

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

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

In December 2010, a Chinese senior government official reiterated at the Cancun Conference that China intends to fulfill the goal of reducing the intensity of carbon dioxide emissions per unit of GDP in 2020 by 40 to 45 percent compared with 2005 levels, in order to address global climate change. From 2001 to 2005, which represented the government’s 10^th five year plan for national economic development, China realized an annual increase of GDP of 9.8% with annual increases of energy consumption of 10.4%. From 2006 to 2010, during the government’s 11^th five year plan for national economic development, China realized an annual increase of GDP of 10.2% with annualized increases of energy consumption of 6.8%, which represented China’s rapid growth in investment of new energy and great improvements in energy utilization efficiency.

China included low-carbon targets in the 12th five-year plan for national economic development (2011-2015) to build an energy-saving, ecologically friendly society, the commission said.

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

In September 2011, the State Council issued a plan for energy savings and emissions reduction during the 12^th five year plan for national economic development. The plan addresses the importance of energy saving in industries such as coal, fossil fuels, paper manufacturing, and chemicals. The plan also specifies heat or pressure recovery as one of the projects especially encouraged and supported by the government.

In November 2011, the State Council approved the work plan for controlling greenhouse gas emissions during the 12th five year plan for national economic development at the general meeting of the State Council. The work plan emphasizes the target of reducing greenhouse gas emissions and encouraging all related departments to take actions for realization of the target.

In December 2011, the Chinese delegation announced at the Durban Conference that China intends to reduce the quantity of carbon dioxide emissions per unit of GDP in 2015 by 17 percent compared with 2010 levels. After the 12^th five year plan for national economic development, from 2011 to 2015, China will hopefully build up a regional carbon dioxide emission trading system of its own.

In August 2012, the State Council issued the work plan for energy conservation and emission reduction during the 12^th five year plan. The plan drew up the general goal that nationwide energy consumption would be reduced to 0.869 tons standard coal per ten thousand yuan GDP (calculated according to the price of 2005), or a decrease of 16% as compared with 1.034 tons in 2010 (which reduced by 32% compared to 1.276 tons in 2005).

In November 2012, the Chinese National Development and Reform Commission issued the 2012 annual report about policy of dealing with Chinese climate change and action, which said, controlling greenhouse gas emissions is an important task in coping with global climate change. In 2011, the Chinese government issued the 12^th five year control greenhouse gas emissions work plan, which integrates the 12^th five year plan to reduce carbon emissions targets into the provinces (autonomous region, municipality directly under the central government). To optimize the industrial and energy structure, vigorously developing the energy-saving and low-carbon target have achieved positive results.

In December 2012, the Central Economic Working Conference was held in Beijing. The Conference emphasized that China has to put the quality and efficiency of economic growth into the forefront next year. The Conference also announced that the concept and principle of ecological civilization should be comprehensively integrated into the process of urbanization, in order to achieve the goal of new urbanization of intensive, intelligent, green and low carbon.

Competitive Markets and Competition

Competition in the energy recovery system industry generally is divided by segment following the differentiation between low-grade energy recovery systems used for heat recovery applications (lower power extraction/generation capacity) and high-grade energy recovery systems used in industrial applications (higher power extraction/generation capacity).

Most of the players in the market are engineering firms that produce low-grade energy recovery systems for heat recovery applications mainly used by schools, hospitals and similar facilities. These products are generally undifferentiated and require lower levels of capital to develop. This type of energy recovery system is less complicated and requires significantly less technical qualifications to build than high-grade industrial energy recovery systems. As a result, this type of energy recovery system is cheaper to build and the barriers to entry into this market are lower than in the market for industrial energy recovery systems.

High-grade energy recovery systems for industrial applications, like ours, require large amounts of capital investment and high levels of expertise resulting in barriers to entry to most prospective market entrants. Because energy recovery systems of this type are highly customized based on the particular customer's need, manufacturers mainly compete based on their respective engineering capabilities. The manufacturers of industrial energy recovery systems generally fall into one of the following classifications:

Barriers to entry for the production of high grade energy recovery systems have resulted in a majority of the global sales for energy recovery systems being generated by a few large players. These industry participants focus on large scale projects leaving many intermediate opportunities for companies such as ours. The largest of these global players include Babcock-Hitachi (Japan), Foster Wheeler (USA), and Mitsubishi Heavy Industries (Japan). The major players in China include Dong Fang Boiler Group, Wuhan Boiler, Hangzhou Boiler Group, and Anshan Boiler.

We are principally engaged in designing, manufacturing, installing and servicing fully-customized energy recovery systems. While most of our competitors only offer one or two off-the-rack models, we develop products across varying specifications to best suit each customer's needs and objectives. Our products can recycle as much as 70% of the energy that would otherwise have been lost.

We believe that our products enable our customers to achieve substantial gains in energy efficiency and we continue to carry out research and development activities along with the design and engineering activities for customers’ projects to enhance efficiencies and decrease environmental impact. We employ approximately 130 highly trained engineers in our engineering team and are planning to hire more.

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

We believe we differentiate ourselves from our competitors by specializing in energy recovery systems and being one of the few players in the market capable of providing engineering, procurement and construction ("EPC") services for waste heat recovery (as further described below under the caption "Products and Technology"). As we have increased our capacity and ability to provide more EPC services, they have gradually become the major component of our revenue mix since 2010.The number of EPC contracts increased from 14 in 2011 to 16 in 2012. The revenue generated from EPC contracts decreased from 90.4% to 85.2% of the total revenue in year 2012. We believe that we are currently a dominant player in energy recovery systems to sulfuric acid manufacturers in China. We believe that energy recovery systems for sulfuric manufacturing are the most difficult to design and engineer due to the strong corrosive character of the sulfuric acid.

We completed the first phase of construction of our wholly-owned manufacturing plant in Yangzhou, China, in January 2011. From May 2011 forward, all of our production has been, and is being, carried out at the CER Yangzhou plant. Our new facility significantly boosts our production capability, which has supported significant revenue growth in 2011. Phase Two construction at the facility is now underway. When Phase Two is completed, the factory in Yangzhou will further provide us with the opportunity to expand our participation as a supplier of high-performance energy recovery systems to industries located in China and other international markets.

Design and Engineering

Our design and engineering teams are located both in Shanghai and Yangzhou, China, which includes approximately 130 engineers in total. All of the engineers engage in project design, customizing the energy recovery systems to meet the individual needs of various industries. The others manage our production processes at the facility. We believe that our engineering team is highly experienced and accomplished in its field.

Manufacturing

On August 18, 2009, CER Hong Kong entered into a series of contracts with Yangzhou (Yizheng) Automobile Industrial Park Administration Committee, a government entity of the City of Yangzhou, Jiangsu Province, China, to acquire a tract of land on which CER Hong Kong planned to build a new manufacturing facility. The planned facility is part of the Company’s business plan for expanding its production capacity and to develop additional demand for its products within China and other international markets.

In January 2011, Phase One construction of the plant was built on the land. From May 2011, we have operated all our fabrication in our own Phase One facility. The new Phase One facility is about 14,000 square meters and significantly expands our ability to accept new orders and speeds delivery of large-scale waste heat systems for new and retro-fitted industrial plants located in China and other international markets. The construction of Phase Two of the facility has lasted more than one year and is still under construction. To a significant extent, the progress of construction is associated with our ability to finance the project. We are seeking to obtain a long-term loan of $20 million from the Bank of China to be collateralized by the land use rights of Phase II and Phase I of the Plant, which are currently uncollateralized, to finance this capacity expansion. However, consummation of this loan is not certain.

As of December 31, 2012, we had approximately 420 employees, all of who are full time employees. Of these, approximately 130 are engineering and technical personnel. The experienced engineering team and sophisticated production facilities of CER enable it to deliver consistently high quality products and offer a complete solution from design and fabrication to final installation.

Marketing and Sales

We market and sell our products primarily in China, but in other countries as well, through our direct sales force, which is based in Shanghai, China. Our marketing programs include industrial conferences, trade fairs, sales training, and trade publication advertising. Our sales and marketing groups work closely with our design and engineering, and manufacturing groups to coordinate our product development activities, product launches and ongoing demand and supply planning. Primarily we sell our products directly to the end users of our energy recovery systems, but we also sell energy recovery systems to leading engineering firms who in turn sell them to their end users.

We plan on entering into marketing partnerships and licensing deals that will enable us to reach a broader segment of the market. We believe that there is significant opportunity in international markets such as the Middle East, the United States, Europe and Latin America, and we intend to enter these markets through partnerships. Additionally, we will look to expand into new industrial sectors through partnerships with leading engineering firms that specialize in specific industry groups.

Products and Technology

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

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

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

Traditional Sulfuric Acid Production Process. The production of sulfuric acid involves highly exothermic chemical reactions. Most of the heat is released into the atmosphere through cooling towers without capturing any of the energy contained therein. Some of the heat from the production process is captured as steam, which the manufacturer can use to, for example, generate electricity. Without the use of an energy recovery system, the production of one ton of sulfuric acid will produce approximately one ton of steam.

Sulfuric Acid Production Process with Energy Recovery System. The incorporation of an energy recovery system increases the manufacturer's ability to extract energy from the production process such that the production of one ton of sulfuric acid can produce between 1.3 and 1.65 tons of steam. In so doing, 94% of the heat that would have otherwise been released to the atmosphere is utilized to provide a larger quantity of steam that can be used in industrial applications. The harnessed steam can be used for various applications, most commonly to drive generator turbines to produce electricity. Doing so decreases the manufacturer's demand for externally produced energy as the manufacturer instead can use internally produced energy resulting from the energy recovery system's increased production and utilization of steam.

Customers

We have provided approximately 150 unique customers with energy recovery systems, and more than 25 percent of these customers have purchased multiple other products and services from us such as design and implementation services. Our customers are mainly industrial manufacturers, such as chemical plants, paper manufacturers and industrial engineering firms. Our energy recovery systems are currently deployed and being deployed in a variety of international markets, including Turkey, Saudi Arabia, Egypt, Pakistan, South Korea, Vietnam and Malaysia, as well as in 20 of China's 32 provinces, including Yunnan, Jiangsu, Shandong, Sichuan, Hunan and Hubei.

Because of the nature and long life of our energy recovery systems, a majority of our sales are from new customers when comparing our customer base from year to year. However, we do receive repeat business from previous customers, especially those in China, when they are expanding their capacities or building new plants. For the years ended December 31, 2011 and 2012, our five largest customers accounted for 75% and 59% of our sales, respectively. Receivables from these five customers were 80% and 57% of total accounts receivable at December 31, 2011 and 2012, respectively. Among those customers, the two largest customers were Ningbo Xinfu and Wuxi Green. Ningbo Xinfu accounted for 20% of revenue for the year ended December 31, 2012 and 0% of receivables as of December 31, 2012. Wuxi Green accounted for 13% of revenue for the year ended December 31, 2012 and 3% of receivables as of December 31, 2012.

Intellectual Property and Other Proprietary Rights

The Chinese State IPR Office has authorized and granted the following patents to Shanghai Engineering and CER Shanghai on various components of our energy recovery systems:

CER Shanghai and CER Yangzhou have submitted the following patent applications to the Chinese State IPR Office, which are currently pending authorization:

Research and Development

We are focused on a strategy of utilizing our research and development capabilities to continuously improve the waste heat and emissions capture technology of our energy recovery systems. Our research and development efforts focus specifically on maximizing efficiency and reliability while minimizing the cost to customers. We have currently been focusing our efforts on new products with immediate demand in the markets such as capturing and reducing emissions released in various industrial processes, such as sulfur dioxide (a byproduct in sulfuric acid processes) and alkali (a byproduct in paper-making processes). We maintain strong relationships with many professional engineering firms in China that can provide technical support in the development process.

Our design and engineering teams are located both in Shanghai and Yangzhou, China, which includes approximately 130 engineers in total. The engineers are engaged in refining the core technology for our energy recovery systems, developing our intellectual property rights, enhancing energy efficiencies and decreasing environmental impact for our customers. Our engineers carry out development activities alongside the design work for our customers’ projects; hence, the expenses associated with our research and development activities are passed along to our customers as part of the prices paid for our products and services. As expenses incurred in research and development are immaterial, we do not record research and development expenses as a separate line item in our financial statements. Shanghai Engineering and CER Shanghai have a portfolio of core Chinese patents on various components of our energy recovery systems as described above.

Our Business Strategy

We have established a three-phase growth strategy:

Raw Materials and Principal Suppliers

We do not currently have any long-term supply agreements. We do not believe that we are reliant on our current suppliers. We believe that we could substitute other suppliers if needed. Our five largest suppliers (by value) supplied approximately 33% of our raw materials in 2012.

Employees

As of December 31, 2012, we had approximately 420 employees, all of who are full time employees. Of these, approximately 130 are engineering and technical personnel. We expect to continue to add additional personnel, especially engineers, in 2013 and beyond to support our anticipated growth.

None of our employees is covered by a collective bargaining agreement. Each of our managerial, sales and administrative employees has entered into a standard form of employment agreement. All of our personnel who have access to our confidential information and technical know-how have entered into a separate agreement that contains covenants not to compete for 24 months following termination of employment and to maintain the confidentiality of certain proprietary information. We believe that our employee relations are good.

Governmental Regulation

The manufacture of boilers and pressure vessels used in our energy recovery systems is subject to licensing requirements imposed by the Chinese national government, as well as regional and local governments, depending on the type of license needed. Shanghai Si Fang conducted all our manufacturing operations before 2011 and obtained all required licenses. In January 2011, CER Yangzhou also obtained all required licenses and has taken over all of our manufacturing functions since May 2011. Boilers and pressure vessels manufactured without such licenses are not allowed to be sold in China. To qualify for a license, a manufacturer must (a) be a legal entity registered with the local government; (b) have a production facility, equipment, technical expertise, and inspection and testing capabilities suitable for producing boilers and pressure vessels; (c) establish and maintain an effective quality assurance system; and (d) manufacture the boilers and pressure vessels in accordance with the requirements of the applicable safety and technical standards.

Our operations are also subject to governmental regulations applicable to any business such as general permitting, licensing and registration. For example, the installation of energy recovery systems at our clients' locations requires a construction project building permit from the applicable regional government.

Compliance with Environmental Laws

We belong to what is known as the "machinery manufacturing industry" in China which industry is considered not to generate exhaust gas, waste liquor or waste residue during manufacturing. Therefore, generally, our manufacturing operations are not subject to any material environmental regulations.

The installation and construction of our energy recovery systems at our clients' locations are subject to environmental laws applicable to construction projects generally. As part of the procedure for obtaining a construction project building permit, we must submit an environmental impact statement for each construction project which assesses the pollution the projects is likely to produce, its impact on the environment, and which stipulates preventive and curative measures. The issuance of a building permit is conditioned on the approval of the environmental impact statement.

There are emissions standards applicable to the operation of coal-burning, oil-burning or gas-fired boilers (China National General Standard GWPB 3-1999). We do not believe that these emission standards are applicable to the boilers included within our energy recovery systems because our boilers are not independently emitting any emissions as they are being heated by industrial processes as opposed to by coal, oil or gas.

Item 1A.     Risk Factors

There are numerous and varied risks that may prevent us from achieving our goals, including those described below. You should carefully consider the risks described below and the other information included in this Annual Report on Form 10-K, including our financial statements and related notes. Our business, financial condition and results of operations could be harmed by any of the following risks. If any of the events or circumstances described below were to occur, our business, financial condition and results of operations could be materially adversely affected. As a result, the trading price of our common stock could decline, and investors could lose part or all of their investment.

Risks Related to Our Business

Our business could be adversely affected if the economic and credit market conditions weaken or if there is a downturn in the global economy. The global financial crisis and economic downturn have adversely affected economies and businesses around the world, including in the PRC.

Financial and credit markets worldwide experienced unprecedented deterioration in 2008 and early 2009. Due to the global economic downturn and a concurrent decrease in consumer demand, the PRC experienced a slowdown in its economic growth during 2008 and 2009. Consumption in general was adversely affected during that downturn in the global economy.

Although the PRC economy has recovered during 2010 and 2011, we experienced another slowdown in economic growth during 2012, and it is uncertain whether such decline will continue for the foreseeable future. This instability in macroeconomic conditions has had, and is expected to continue to have, an adverse impact on our business and operations. These factors may also lead to intensified competition for market share.

Improvements in the economy and general business conditions will to a certain extent depend on the extent to which government policies succeed in addressing fundamental weaknesses in the markets, restoring consumer confidence and increasing market liquidity in an adequate and timely manner. Any recurring weakness in the global economy or in the economy of the PRC may materially and adversely affect our revenues. This financial and economic situation may have a negative impact on third parties with whom we do, or may do, business. Any of these factors may affect our results of operations, financial condition and liquidity.

Our independent registered public accounting firm has expressed substantial doubt about our ability to continue as a going concern.

The report of our independent auditors dated April 16, 2013 on our consolidated financial statements for the period ended December 31, 2012 included an explanatory paragraph indicating that there is substantial doubt about our ability to continue as a going concern. As indicated in Note 1 to our consolidated financial statements, we have a negative working capital balance and negative operating cash flow. Our ability to continue as a going concern will be determined by our ability to obtain additional sales orders, raise more funds and/or curtail capital expenditures. Our consolidated financial statements do not include any adjustments that might result from our inability to continue as a going concern.

Our limited operating history may not serve as an adequate basis to judge our future prospects and results of operations.

Our limited operating history and the unpredictability of our industry make it difficult for investors to evaluate our business and future operating results. An investor in our securities must consider the risks, uncertainties and difficulties frequently encountered by companies in new and rapidly evolving markets. The risks and difficulties we face include challenges in accurate financial planning as a result of limited historical data and the uncertainties resulting from having had a relatively limited time period in which to implement and evaluate our business strategies as compared to companies with longer operating histories.

Our dependence on a limited number of customer segments may cause significant fluctuations or declines in our revenues.

We currently sell a substantial portion of our energy recovery systems to companies in either the chemical or paper manufacturing sectors. Consequently, any one of the following events may cause material fluctuations or declines in our revenues and have a material adverse effect on our results of operations:

Our dependence on one related party for a large percentage of our sales volume may lead to significant year-over-year fluctuations in our sales revenues and levels of profitability.

For the year ended December 31, 2011 and 2012, the related party accounted for 36% and 7% of the Company’s sales, respectively. Though the transaction follows business practice, we may not be granted such agreements or be able to get orders with such revenue amounts in the future, which could adversely affect our revenue and further adversely affect our operating results.

We may rely on a relatively small number of customers for a significant portion of our revenues for the foreseeable future. The loss of sales to or inability to collect from these customers would have a significant negative impact on our business. Failure to develop or maintain our customer relationships with these customers may have an adverse effect on our revenue, profitability, and cash flows.

We have a substantial amount of accounts receivable, which if not paid when due will have an adverse impact on our financial condition.

We have a substantial amount of accounts receivable, some of which are from a related party. If these are not paid when due, we will suffer a substantial loss of income which will have an adverse impact on our financial condition. Additionally, while these amounts remain unpaid, we have to finance our business from other sources, as our other income is not sufficient to cover all of our operating expenses. To finance our expenses, we rely on borrowings from institutional and private lenders. The expense of the borrowed capital will reduce our profit and reduce our ultimate business margins.

We may be adversely affected by volatile market and industry trends, in particular, the demand for our energy recovery systems may decline, which may reduce our revenues and earnings.

We are highly affected by the market and industry trends. During late 2008 and 2009, as well as the just past year 2012, our industry experienced a decline in demand due to decreases in expenditures on energy recovery systems and the availability of financing for buyers of energy recovery systems as a result of the global financial crisis.

The demand for energy recovery systems is also influenced by macroeconomic factors such as the global credit market, as well as government regulations and policies concerning energy savings and environmental protection. If any negative market and industry trends recur in the future, the price or demand of our energy recovery systems could decrease and our business and results of operations may be materially and adversely affected.

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

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

If we are unable to manage these risks, we may be unable to expand our business into new countries or industries, or expansion may become costlier than expected.

The success of our business depends on our ability to attract highly qualified personnel without whom we would be unable to maintain the quality of our services, and our ability to retain them, including senior management and other key personnel who may terminate their employment with us at any time causing us to lose experienced personnel and to expend resources in securing qualified replacements.

We depend substantially on the current and continued services and performance of our senior management and other key personnel. Loss of the services of any of such individuals would adversely impact our operations. In addition, we believe that our technical personnel represent a significant asset and provide us with a competitive advantage over many of our competitors and that our future success will depend upon our ability to hire and retain these key employees and our ability to attract and retain other skilled financial, engineering, technical and managerial personnel. As our industry continues to grow, we expect increased competition for qualified personnel. In the event that we are unable to retain or attract the same level of qualified personnel as in the past on the current terms of employment, we may face higher labor costs or lower productivity. If our productivity or the quality of the services we provide decrease, our business may suffer negative consequences such as a reduction in our rate of securing and completing customer engagements. Increased costs of labor and reduced throughput would negatively affect our profitability.

We have employment agreements with those persons in senior positions that we believe are important to our current and future business operations, which agreements we believe will help us retain their services. There is no guarantee that we will be able to retain the services of these, or other, individuals in our company, on reasonable terms or at all. We do not have an employment agreement with our Chief Executive Officer, who is also the Chairman of the board of directors and a significant shareholder. We do not currently maintain any "key man" life insurance with respect to any of such individuals.

Our inability to obtain capital, use internally generated cash, or use shares of our capital stock or debt to finance future expansion efforts could impair the growth and expansion of our business.

Historically, we have relied on equity and debt offerings, bank borrowings and operating cash flows to finance our capital expenditure and working capital requirements. Reliance on internally generated cash or debt to finance our operations or complete business expansion efforts could substantially limit our operational and financial flexibility. The extent to which we will be able or willing to use shares of capital stock to consummate expansions will depend on the market value of our capital stock from time to time and the willingness of potential investors, sellers or business partners to accept it as full or partial payment. Using shares of capital stock for this purpose also may result in significant dilution to our then existing stockholders. To the extent that we are unable to use capital stock to make future expansions, our ability to grow through expansions may be limited by the extent to which we are able to raise capital for this purpose through debt or equity financings. Raising external capital in the form of debt could also require periodic interest payments that could hinder our financial flexibility in the future. Besides, our ability to obtain external financing is subject to a number of uncertainties, including:

No assurance can be given that we will be able to obtain the necessary capital to finance a successful expansion program or our other cash needs. If we are unable to obtain additional capital in a timely manner or on commercially acceptable terms, or at all, we may be required to reduce the scope of any planned expansions. In addition to requiring funding for expansion, we may need additional funds to implement our internal growth and operating strategies or to finance other aspects of our operations.

Our failure to (a) obtain additional capital on acceptable terms, (b) use internally generated cash, or (c) use shares of capital stock to make future expansions may materially and adversely affect our growth prospects and future profitability. For example, the tightening of PRC credit markets and interest rate increases in China since 2010 may limit the availability of financing to us, or at all, or increase the costs of such financing. In addition, the incurrence of debt would result in increased interest rate risk, divert cash for working capital and capital expenditures to service debt obligations and could result in operating and financial covenants that restrict our operations and our ability to pay dividends to our shareholders, if any. A shortage of such funds could in turn impose limitations on our ability to plan for, or react effectively to changing market conditions or to expand through organic and acquisitive growth, thereby reducing our competitiveness.

Our negative working capital could impair the operational and financial flexibility of our business.

As of December 31, 2012, our working capital position reflected an excess of current liabilities over current assets of approximately $36.4 million, which primarily was driven by an excess of customer deposits (cash inflows in the form advance payments received on projects) over prepayments to suppliers for purchases of material inputs (also advance payments / cash outflows for anticipated inventory or production inputs). However, excluding such advance payments, the excess current liabilities approximated $27 million. The negative working capital position magnifies the importance of continuing to obtain new customer projects and grow profits and operational cash flows to reach a steady state. Currently the availability of funding is difficult to obtain, and when available it is expensive: for example, in the current financial environment, borrowed capital from financial institutions generally available to the company may carry interest rates in the 7% per annum range and borrowed capital from non-institutional sources generally is available at rates in the 12 to 15% range. While management believes our project backlog (EPC projects already contracted with customers) at December 31, 2012 for projects to be executed in 2013 supports the operations of the business, we may, in the short term, be required to collateralize existing assets to obtain additional borrowings or rely upon future customer advance payments on longer-term projects to maintain a desired level of financial flexibility.

Our future success substantially depends on our ability to significantly increase our manufacturing capacity. Our ability to achieve our capacity expansion goals is subject to a number of risks and uncertainties.

Our future success depends on our ability to significantly increase our manufacturing capacity. If we are unable to do so, we may be unable to expand our business, decrease our average cost, maintain our competitive position and improve our profitability. In January 2011, Phase One construction of the manufacturing facility in Yangzhou was completed. The Phase One facility is about 14,000 square meters. Many pieces of advanced equipment have been installed in the new factory. Phase Two commenced operations in June 2011 and is still under construction. Our ability to establish additional manufacturing capacity for future expansion is subject to significant risks and uncertainties regarding funding. We may be unable to raise the necessary capital to complete the remaining phase of construction of our manufacturing plant in Yangzhou or further initiate construction of any new manufacturing facilities. We may be unable to acquire the appropriate permits to allow construction of a new manufacturing facility, or engage a company qualified to construct our manufacturing facility at a reasonable price, or at all.

We may not be able to manage our expansion of operations effectively and if we are unable to do so, our profits may decrease.

The trend towards mitigating the effect of global warming and the enactment of new environmental protection policy has increased the demand for our products and services. As we continue to grow, we must continue to improve our operational and financial systems, procedures and controls, increase our manufacturing capacity and output, and expand, train and manage our growing employee base. In order to fund our on-going operations and our future growth, we need to have sufficient internal sources of liquidity or access to additional financing from external sources. Furthermore, our management will be required to maintain and strengthen our relationships with our customers, suppliers and other third parties. As a result, our continued expansion has placed, and will continue to place, significant strains on our management personnel, systems and resources. We will also need to further strengthen our internal control and compliance functions to ensure that we will be able to comply with our legal and contractual obligations and minimize our operational and compliance risks. Our current and planned operations, personnel, systems, internal procedures and controls may not be adequate to support our future growth. If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities, execute our business strategies or respond to competitive pressures. As a result, our results from operations may decline. In addition, we may experience underutilization of our expanded production capacities if there is insufficient demand for our products.

Our failure to protect our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights or defend against third-party allegations of infringement may be costly.

We rely primarily on patent, trademark, trade secret, copyright law and other contractual restrictions to protect our intellectual property. For example, Shanghai Engineering and CER Shanghai hold six and eleven patents in China, respectively. Nevertheless, these afford only limited protection and the actions we take to protect our intellectual property rights may not be adequate. In addition, implementation of China's intellectual property-related laws has historically been lacking, primarily because of ambiguities in China's laws and difficulties in enforcement. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries. As a result, third parties may infringe or misappropriate our proprietary technologies or other intellectual property rights, which could have a material adverse effect on our business, financial condition or operating results. In addition, policing unauthorized use of proprietary technology can be difficult and expensive. Litigation may be necessary to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of the proprietary rights of others. We cannot assure you that the outcome of such potential litigation will be in our favor. Such litigation may be costly and may divert management attention as well as expend our other resources away from our business. An adverse determination in any such litigation will impair our intellectual property rights and may harm our business, prospects and reputation. In addition, we have no insurance coverage against litigation costs and would have to bear all costs arising from such litigation to the extent we are unable to recover them from other parties. The occurrence of any of the foregoing could have a material adverse effect on our business, results of operations and financial condition.

We may be exposed to infringement or misappropriation claims by third parties, which, if determined adversely to us, could cause us to pay significant damage awards.

Our success also depends largely on our ability to use and develop our technology and know-how without infringing the intellectual property rights of third parties. The validity and scope of claims relating to our technology patents involve complex scientific, legal and factual questions and analysis and, therefore, may be highly uncertain. We may be subject to litigation involving claims of patent infringement or violation of intellectual property rights of third parties. The defense and prosecution of intellectual property suits, patent opposition proceedings and related legal and administrative proceedings can be both costly and time consuming and may significantly divert the efforts and resources of our technical and management personnel. An adverse determination in any such litigation or proceeding to which we may become a party could subject us to significant liability to third parties, require us to seek licenses from third parties, to pay ongoing royalties, or to redesign our products or subject us to injunctions prohibiting the manufacture and sale of our products or the use of our technologies. Protracted litigation could also result in our customers or potential customers deferring or limiting their purchase or use of our products until resolution of such litigation.

Although we sell a substantial portion of our products outside of China through the local contractors, the patents protecting parts of our energy recovery systems are issued in China. Our business, results of operations and financial condition could be materially and adversely affected if our sales outside China were to be restricted by intellectual property claims by third parties.

As of today, the Chinese State IPR Office has authorized and granted six and eleven patents to Shanghai Engineering and CER Shanghai, respectively, on various components of our energy recovery systems. We do not have, and have not applied for, any patents for our proprietary technologies outside of China although we have sold, and expect to continue to sell, a portion of our products outside of China through the local contractors. Because the protection afforded by our patents is effective only in China, others may independently develop substantially equivalent technologies, or otherwise gain access to our proprietary technologies, and obtain patents for such intellectual properties in other jurisdictions, including the countries to which we sell our products. If any third parties are successful in obtaining patents for technologies that are substantially equivalent or the same as the technologies we use in our products in any of our markets before we do and enforce their intellectual property rights against us, our ability to sell products containing the allegedly infringing intellectual property in those markets will be materially and adversely affected. If we are required to stop selling such allegedly infringing products, obtain a license and pay royalties for the relevant intellectual properties, or redesign such products with non-infringing technologies, our business, results of operations and financial condition may be materially and adversely affected.

We also sell or install other types of energy recovery systems manufactured by a third party and our inability to continue to do so may make us less competitive in the market and decrease our revenues.

We do not manufacture all types of the energy recovery systems that we sell or install. In the sulfuric acid industry, our proprietary energy recovery systems are used for high and middle temperature applications. We also sell and/or install low temperature energy recovery systems manufactured by a third party specifically for sulfuric acid manufacturing facilities. Also, in the future, we may sell or install energy recovery systems that we manufacture under licenses from third parties owning the proprietary rights to such energy recovery systems. These energy recovery systems allow us to serve the low temperature market segment in the sulfuric acid manufacturing sector that we are unable to serve with our own proprietary energy recovery systems. Our current arrangement with this third party is on a project-by-project basis. If we are unable to continue offering these energy recovery systems to our customers, we may be unable to serve the low temperature market segment in the sulfuric acid manufacturing sector, thereby harming our competitive position and likely decreasing our revenues.

Fluctuations in exchange rates could adversely affect our business and your investment.

A portion of our sales is currently denominated in U.S. dollars, with the remainder in Renminbi, while our costs and expenses are denominated in U.S. dollars and Renminbi. Therefore, fluctuations in currency exchange rates could have a material adverse effect on our financial condition and results of operations. Fluctuations in exchange rates, particularly among the U.S. dollar and Renminbi, affect our gross and net profit margins and could result in foreign exchange and operating losses.

Our financial statements are expressed in U.S. dollars but our functional currency is Renminbi. The value of your investment in our stock will be affected by the foreign exchange rate between U.S. dollars and Renminbi. To the extent we hold assets denominated in U.S. dollars, any appreciation of the Renminbi against the U.S. dollar could result in a change to our income statement. On the other hand, a decline in the value of Renminbi against the U.S. dollar could reduce the U.S. dollar equivalent amounts of our financial results, the value of your investment in our company and the dividends we may pay in the future, if any, all of which may have a material adverse effect on the prices of our stock.

The change in value of the Renminbi against the U.S. dollar and other currencies is affected by, among other things, changes in China's political and economic conditions. On July 21, 2005, the Chinese government changed its policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in approximately 24% appreciation of the Renminbi against the U.S. dollar as of December 31, 2012 since the change in policy. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the Chinese government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar. For example, to the extent that we need to convert U.S. dollars we received in a financing into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we receive from the conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us.

We do not believe that our energy recovery systems are subject to emission standards applicable to fuel-burning boilers but if they were to be subject to such emission standards, we may incur additional costs in complying with them which may negatively impact our profitability.

There are emissions standards applicable to the operation of coal-burning, oil-burning or gas-fired boilers (China National General Standard GWPB 3-1999). We do not believe that these emission standards are applicable to the boilers included within our energy recovery systems because our boilers are not independently emitting any emissions as they are being heated by industrial processes as opposed to by coal, oil or gas. If our energy recovery systems were to become subject to these emission standards, we may need to change the design of our energy recovery systems to bring them into compliance with the emission standards which may increase our costs and negatively impact our profitability.

We operate in a competitive industry with several established and more horizontally integrated companies. It may be difficult to sustain our market share in the event of a decline in market conditions.

Our industry is competitive and rapidly changing. Future competitors may include international engineering companies and large domestic engineering companies. These competitors may have a material advantage in their financial, technical and marketing resources. Competition in the energy recovery industry may increase in the future, which could result in reduced pricing power and declining margins. Our failure to adapt to changing market conditions and to compete successfully with future competitors may materially and adversely affect our financial condition, results of operations and liquidity.

In our course of business, we expose ourselves to possible litigation associated with performing services on our customers' properties.

We perform installation services on our customers' properties and doing so can result in claims of property damage, breach of contract, harassment, theft, and other such claims. These claims may become time consuming and expensive, which would adversely affect our financial condition and the reputation of our business.

We are subject to risks related to warranty claims whereby we may not be able to collect the full purchase price of sold products or which are greater than anticipated due to the unenforceability of liability limitations.

We warrant the majority of our products for periods of one or two years. Defects may not become apparent until after the products have been sold and installed. As a normal practice in the industry, we allow our customers to retain 5% to 10% of the contract prices as retainage during the warranty period for any future warranty claims. When a warranty claim occurs and we determine that the product in question is defective, we repair the product at our expense, which could increase our costs and adversely affect our business. Also, if we are unable to repair the product to the customer's satisfaction or for other reasons, we may not have the right or be able to collect the whole or part of the retainage at the end of the warranty period. Further, our standard warranties contain limits on damages and exclusions of liability for consequential damages and for misuse, alteration, accident or mishandling after the sale and installation. If these limitations are ineffective or found to be unenforceable, we may be subject to greater than anticipated warranty claims.

We have limited insurance coverage and may incur losses resulting from product liability claims or business interruptions.

While we historically have not been subject to any product liability claims, we are exposed to risks associated with such claims in the event that the use of the products we sell results in injury. We do not have any product liability insurance and may not have adequate resources to satisfy a judgment in the event of a successful claim against us. The successful assertion of product liability claims against us could result in potentially significant monetary damages and require us to make significant payments. In addition, because the insurance industry in China is still in its early stages of development, business interruption insurance available in China offers limited coverage compared to that offered in many other countries. We do not have any business interruption insurance. Any business disruption or natural disaster could result in substantial costs and diversion of resources.

A drop in the price of conventional energy sources may decrease the demand for our energy recovery systems and may negatively impact our sales and profitability.

Our energy recovery systems capture industrial waste energy which then can be reused in industrial processes or used to produce electricity and thermal power. An energy recovery system is expensive to purchase and install. We believe that our customers make purchasing decisions based on the economic feasibility of installing one of our energy recovery systems relative to using conventional energy and other alternative energy sources. Decreases in the prices of oil and other fossil fuels, utility electric rates, and other alternative energy sources could cause the demand for energy recovery systems to substantially decline, which would negatively impact our profitability. A significant decrease in energy prices globally could cause a slowdown in our order volume and delays in acceptance of international orders.

If we do not generate the anticipated demand for our energy recovery systems, we may not continue to realize the necessary sales levels needed to reach or maintain profitability.

The market for energy recovery systems is relatively new and still evolving. The success of our products and services will depend on the cost effectiveness and the relative performance of our systems relative to conventional and other alternative energy technologies. If our products and services do not capture the necessary industry market share, we may not be able to generate sufficient revenue or sustain profitability.

Mr. Qinghuan Wu, one of our directors and our Chairman of the Board and Chief Executive Officer, may have potential conflicts of interest with us, which may adversely affect our business, and beneficially owns a significant number of shares of our common stock, which will have an impact on all major decisions on which our stockholders may vote and which may discourage an acquisition of our Company.

Mr. Qinghuan Wu, who is our Chairman of the Board and Chief Executive Officer, is also an Executive Director of Shanghai Engineering. Shanghai Engineering is owned jointly by Mr. Qinghuan Wu and his spouse, Mrs. Jialing Zhou, who was formerly one of our directors and resigned in June 2011. Conflicts of interest may arise between his duties to our company and his duties to Shanghai Engineering, or his interest as an owner of Shanghai Engineering. As Mr. Qinghuan Wu is a director and executive officer of our company, he has a duty of loyalty and care to us under Delaware law when there are any potential conflicts of interest between our company and Shanghai Engineering. We cannot assure you that when conflicts of interest arise, Mr. Qinghuan Wu will act completely in our interests or that conflicts of interest will be resolved in our favor. In addition, Mr. Qinghuan Wu could violate his legal duties by diverting business opportunities from us to others. If we cannot resolve any conflicts of interest between us and Mr. Qinghuan Wu, we would have to rely on legal proceedings, which could disrupt our business.

Further, the design, manufacturing and installation of energy recovery systems are conducted by Shanghai Engineering. We do not own Shanghai Engineering but instead rely on contractual arrangements between our wholly-owned subsidiary CER Hong Kong and it to control the Company and to participate in its profitability. Shanghai Engineering, in turn, utilizes the manufacturing capacity of CER’s Yangzhou facility for the construction of equipment to be sold to end customers. The agreements constituting these contractual arrangements provide that CER Hong Kong may assign them to other parties, in some cases freely, and that Shanghai Engineering may assign them to other parties with CER Hong Kong's consent. Mr. Qinghuan Wu, as an owner and member of management of Shanghai Engineering, and as our Chairman of the Board and Chief Executive Officer, has the power to direct the operations of Shanghai Engineering and CER Hong Kong and to cause them to terminate, fail to renew, assign or consent to the assignment of the agreements constituting these contractual arrangements, even if contrary to Mr. Qinghuan Wu's duties to us. If these agreements were terminated, not renewed or assigned to a party unaffiliated with us, and we were unable to enter into satisfactory substitute agreements with other design firms, manufacturers, installers and sales firms, we would likely be unable to continue to design, manufacture, install and sell energy recovery systems and our stockholders would hold stock in a company without meaningful business operations.

Currently, Mr. Qinghuan Wu directly owns approximately 37% of our currently outstanding common stock (including the shares escrowed in the Share Exchange; and beneficially together with his spouse approximately 64%). In addition, he is also our Chairman of the Board and Chief Executive Officer. The interests of Mr. Qinghuan Wu may differ from the interests of other stockholders. As a result, Mr. Qinghuan Wu has the ability to significantly impact all corporate actions requiring stockholder approval, including the following actions:

Mr. Qinghuan Wu's beneficial stock ownership may discourage potential investors from investing in shares of our common stock due to the lack of influence they could have on our business decisions, which in turn could reduce our stock price.

If we fail to implement effective internal controls required by the Sarbanes-Oxley Act of 2002, to remedy any material weaknesses in our internal controls that we may identify, such failure could result in material misstatements in our financial statements, cause investors to lose confidence in our reported financial information and have a negative effect on the trading price of our common stock.

Section 404 of the Sarbanes-Oxley Act of 2002 requires management of public companies to develop and implement internal controls over financial reporting and evaluate the effectiveness thereof.

In 2012, we continued to strengthen our internal control, reviewed corporate governance practices, and have improved the financial reporting systems in place. During our assessment of the effectiveness of our disclosure controls and procedures and internal controls over financial reporting as of December 31, 2011, we found that some of our accounting staff lacked sufficient accounting skills and experience necessary to fulfill our public reporting obligations according to accounting principles generally accepted in the United States and the SEC's rules and regulations. We also lack qualified resources to perform our internal audit functions properly. We did take some actions (further described in Item 9A, Controls and Procedures) to remediate these weaknesses in 2012; however, our assessment of internal controls over financial reporting as of December 31, 2012 led to the conclusion that internal control over financial reporting continues to not be effective. With further remediation activities planned, we are planning to remediate this matter by the end of 2013.

Any failure to complete our assessment of our internal controls over financial reporting, to remediate any material weaknesses that we may identify, including those identified above, or to implement new or improved controls, or difficulties encountered in their implementation, could harm our operating results, cause us to fail to meet our reporting obligations or result in material misstatements in our financial statements. Inadequate disclosure controls and procedures and internal controls over financial reporting could also cause investors to lose confidence in our public disclosures and reported financial information, which could have a negative effect on the trading price of our common stock.

Further, because some members of the management team have limited or no experience operating a publicly-traded company, we are continuing to recruit, hire, train and retain additional financial reporting, internal controls and other personnel to develop and implement appropriate internal controls and reporting procedures. This may be time consuming, difficult and costly for us.

Our Amended and Restated Certificate of Incorporation authorizes our board of directors to create new series of preferred stock without further approval by our stockholders, which could adversely affect the rights of the holders of our common stock or delay or prevent a change in control.

Our board of directors has the authority to fix and determine the relative rights and preferences of our preferred stock. Our board of directors also has the authority to issue preferred stock without further stockholder approval. As a result, our board of directors could authorize the issuance of a series of preferred stock that would grant to holders the preferred right to our assets upon liquidation, the right to receive dividend payments before dividends are distributed to the holders of common stock and the right to the redemption of the shares, together with a premium, prior to the redemption of our common stock. In addition, our board of directors could authorize the issuance of a series of preferred stock that has greater voting power than our common stock or that is convertible into our common stock, which could decrease the relative voting power of our common stock or result in dilution to our existing stockholders. In addition, issuing preferred stock could have the effect of delaying or preventing a change in control.

Risks Related to Doing Business in China

Our business is exposed to risks associated with the economic, environmental and political conditions in China because the substantial majority of our assets are located in China and the majority of our revenues are derived from our operations in China.

Because our headquarters and manufacturing facilities are located in China, our business is disproportionately exposed to the economic, environmental and political conditions of the region. The country's political and economic systems are very different from more developed countries and uncertainties may arise with changing governmental policies and measures. China also faces many social, economic and political challenges that may produce instabilities in both its domestic arena and in its relationship with other countries. These instabilities may significantly and adversely affect our performance. In addition, as the Chinese legal system develops, there can be no assurance that changes in laws and regulations and their interpretation or their enforcement will not have a material adverse effect on our business operations. As a large portion of our target customers are also located in China and are subject to the aforementioned risks, our business may also be adversely affected by the effects of the conditions within the region upon them.

Adverse changes in political and economic policies of the Chinese government could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our products and materially and adversely affect our competitive position.

A majority of our business operations and sales are conducted and made in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese economy differs from the economies of most developed countries in many respects, including:

While the Chinese economy has grown significantly in the past 20 years, the growth has been uneven, both geographically and among various sectors of the economy. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall Chinese economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.

The Chinese economy has been transitioning from a planned economy to a more market-oriented economy. Although in recent years the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of the productive assets in China is still owned by the Chinese government. The continued control of these assets and other aspects of the national economy by the Chinese government could materially and adversely affect our business. The Chinese government also exercises significant control over Chinese economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Efforts by the Chinese government to slow the pace of growth of the Chinese economy could result in decreased capital expenditures by companies in our target markets for energy recovery systems, which in turn could reduce demand for our products.

Any adverse change in the economic conditions or government policies in China could have a material adverse effect on the overall economic growth and the level of investments and expenditures in China, which in turn could lead to a reduction in demand for our products and consequently have a material adverse effect on our businesses.

Natural disasters, acts of war, political unrest and epidemics, which are beyond our control, may cause damage, loss or disruption to our business.

Natural disasters, acts of war, political unrest and epidemics, which are beyond our control, may adversely affect the economy, infrastructure and livelihood of the people of the PRC. Some cities in the PRC are particularly susceptible to floods, earthquakes, sandstorms and droughts. Our business, financial condition and results of operations may be materially and adversely affected if such natural disasters occur. Political unrest, acts of war, and terrorist attacks may cause damage or disruption to us, our employees, our facilities and our markets, any of which could materially and adversely affect our sales, overall operating results and financial condition. The potential for war or terrorists attacks may also cause uncertainty and cause our business to suffer in ways that we cannot currently predict. In addition, certain Asian countries, including the PRC, have encountered epidemics such as SARS, incidents of the avian flu or the H1N1 flu. Past occurrences of epidemics have caused different degrees of damage to the national and local economies in the PRC. A recurrence of an outbreak of SARS, avian flu, the H1N1 flu or any other similar epidemic, could cause a slowdown in the levels of economic activity generally, which could in turn adversely affect our results of operations.

Uncertainties with respect to the Chinese legal system could have a material adverse effect on us.

We conduct substantially all of our business through subsidiaries and affiliated entities in China. These entities are generally subject to laws and regulations applicable to foreign investment in China. China's legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since 1979, Chinese legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since these laws and regulations are relatively new and China's legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.

The majority of our revenues and expenses are denominated in Renminbi. If our revenues denominated in Renminbi increase or expenses denominated in Renminbi decrease in the future, we may need to convert a portion of our revenues into other currencies to meet our foreign currency obligations, including, among others, payment of dividends declared, if any, in respect of our common stock.

Due to the recent global financial crisis, the Chinese government has strengthened measures to control exchange of Renminbi into foreign currencies and outbound payments by, among other things, requiring prior approval from the Chinese State Administration of Foreign Exchange ("SAFE") before taking such actions in some cases. As a result, it has become more difficult for us to exchange Renminbi into foreign currencies and to make payments to entities and individuals outside of China. In some cases we need SAFE's prior approval to do so. If these measures are not loosened in the near future, our ability to pay dividends in foreign currencies is restricted and if we are unable to obtain SAFE's prior approval when needed, we will not be able to pay dividends in foreign currencies at all. We cannot assure you that the Chinese government will not further restrict access to foreign currencies for current account transactions in the future.

Foreign exchange transactions by our subsidiaries and affiliated entities continue to be subject to significant foreign exchange controls and require the approval of China's governmental authorities, including the SAFE. In particular, if our subsidiaries and affiliated entities borrow foreign currency loans from us or other foreign lenders, these loans must be registered with the SAFE, and if we finance our subsidiaries and affiliated entities by means of additional capital contributions, these capital contributions must be approved by certain government authorities including the Chinese Ministry of Commerce or its local counterparts. These limitations could affect the ability of our subsidiaries and affiliated entities to obtain foreign exchange through debt or equity financing.

Our business benefits from certain Chinese government incentives. Expiration of, or changes to, these incentives could have a material adverse effect on our operating results.

The Chinese government has provided various incentives to technology companies, including our affiliate Shanghai Engineering, in order to encourage development of the high-tech industry. Such incentives include reduced tax rates and other measures. For example, Shanghai Engineering has been qualified as a "high or new technology enterprise." As a result, we are entitled to a preferential enterprise income tax rate of 15% so long as Shanghai Engineering continues to maintain its "high or new technology enterprise" status. A new Enterprise Income Tax ("EIT") law replaced the old laws for Domestic Enterprises ("DEs") and Foreign Invested Enterprises ("FIEs") in 2008. The key changes are: (a) the new standard EIT rate of 25% replaces the 33% rate originally applicable to both DEs and FIEs, except for companies with high or new technology enterprise status, which will pay a reduced rate of 15%, and (b) companies established before March 16, 2007 will continue to enjoy tax holiday treatment approved by local government for a grace period of the next five years or until the tax holiday term is completed, whichever is sooner. These companies will pay the standard tax rate as defined in point (a) above during the grace period. Because Shanghai Engineering was established before March 16, 2007, it is qualified to continue enjoying the reduced tax rate as described above. Any increase in our enterprise income tax rate in the future could have a material adverse effect on our financial condition and results of operations.

Registered public accounting firms in China, including our independent registered public accounting firm, are not inspected by the U.S. Public Company Accounting Oversight Board, which deprives us and our investors of the benefits of such inspection.

Auditors of companies whose shares are registered with the U.S. Securities and Exchange Commission and traded publicly in the United States, including our independent registered public accounting firm, must be registered with the U.S. Public Company Accounting Oversight Board (“the “PCAOB”) and are required by the laws of the United States to undergo regular inspections by the PCAOB to assess their compliance with the laws of the United States and professional standards applicable to auditors. Our independent registered public accounting firm is located in, and organized under the laws of, the PRC, which is a jurisdiction where the PCAOB, notwithstanding the requirements of U.S. law, is currently unable to conduct inspections without the approval of the Chinese authorities, which approval has not been granted for auditors such as our independent registered public accounting firm. This lack of PCAOB inspections in China prevents the PCAOB from fully evaluating audits and quality control procedures of our independent registered public accounting firm. As a result, we and investors in our common stock are deprived of the benefits of such PCAOB inspections.

The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our independent registered public accounting firm’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections, which could cause investors and potential investors in our stock to lose confidence in our audit procedures and reported financial information and the quality of our financial statements.

Proceedings instituted recently by the SEC against five PRC-based accounting firms, including our independent registered public accounting firm, could result in financial statements being determined to not be in compliance with the requirements of the Securities Exchange Act of 1934.

In December 2012, the SEC instituted proceedings under Rule 102(e)(1)(iii) of the SEC’s Rules of Practice against five PRC-based accounting firms, including our independent registered public accounting firm, alleging that these firms had violated U.S. securities laws and the SEC’s rules and regulations thereunder by failing to provide to the SEC the firms’ work papers related to their audits of certain PRC-based companies that are publicly traded in the United States. Rule 102(e)(1)(iii) grants to the SEC the authority to deny to any person, temporarily or permanently, the ability to practice before the SEC who is found by the SEC, after notice and opportunity for a hearing, to have willfully violated any such laws or rules and regulations. While we cannot predict the outcome of the SEC’s proceedings, if our independent registered public accounting firm were denied, temporarily or permanently, the ability to practice before the SEC, and we are unable to find timely another registered public accounting firm which can audit and issue a report on our financial statements, our financial statements could be determined to not be in compliance with the requirements for financial statements of public companies with a class of securities registered under the Securities Exchange Act of 1934, as amended, or the Exchange Act. Such a determination could ultimately lead to the SEC revoking the registration of our common stock under the Exchange Act pursuant to Section 12(j) thereof, in which event broker-dealers thereafter would be prohibited from effecting transactions in, or inducing the purchase or sale of, our common stock in the United States.

Frequent press reports in the United States questioning the VIE structure used by us and other Chinese companies publicly-traded in the United States appear to have created concern among investors, and may cause such an effect in the future.

In recent years various prominent Western news outlets have questioned the use by Chinese companies that are publicly-traded in the United States of VIE structures as a means of complying with Chinese laws prohibiting or restricting foreign ownership of certain businesses in China, including businesses we are engaged in such as energy-saving related industry. Some of such news reports have also sought to draw a connection between recent widely reported accounting issues at certain Chinese companies and the use of VIE structures. Such news reports appear to have had the effect of causing concern among investors in several Chinese companies, including us, that are publicly-traded in the United States. While we are not aware of any causal connection between the recently reported accounting scandals and the use of VIE structures, it is possible that investors in our common stock will believe that such a connection exists. Any of such circumstances could lead to further loss of investor confidence in Chinese companies such as ours and cause fluctuations in the market prices of our common stock and, if such prices were to drop sharply, could subject us to shareholder litigation, which could cause the price for our shares to drop further.

The contractual arrangements between our subsidiaries and our VIE may result in adverse tax consequences.

PRC laws and regulations emphasize the requirement of an arm’s length basis for transfer pricing arrangements between related parties. The laws and regulations also require enterprises with related party transactions to prepare transfer pricing documentation to demonstrate the basis for determining pricing, the computation methodology and detailed explanations. Related party arrangements and transactions may be subject to challenge or tax inspection by PRC tax authorities.

Under a tax inspection, if our transfer pricing arrangements between the China-based subsidiaries and VIE are judged as tax avoidance, or related documentation does not meet the requirements, our China-based subsidiaries and VIE may be subject to material adverse tax consequences, such as transfer pricing adjustment. A transfer pricing adjustment could result in a reduction, for PRC tax purposes, of adjustments recorded by VIE, which could adversely affect us by (i) increasing VIE’s tax liabilities without reducing our subsidiaries’ tax liabilities, which could further result in interest and penalties being levied on us for unpaid taxes; or (ii) limiting the ability of our PRC companies to maintain preferential tax treatment and other financial incentives.

Our contractual arrangements with Shanghai Engineering and its respective shareholders may not be as effective in providing control over Shanghai Engineering as direct ownership of these companies.

We provide our engineering design services to our customer through Shanghai Engineering, a VIE. Our contractual arrangements with Shanghai Engineering and its respective shareholders provide us with effective control over Shanghai Engineering. See “Item 1. Business - Organizational Structure and Subsidiaries.” As a result of these contractual arrangements, we are considered to be the primary beneficiary of Shanghai Engineering and accordingly, we consolidate the results of operations, assets and liabilities of Shanghai Engineering in our consolidated financial statements. These contractual arrangements may not be as effective in providing us with control over Shanghai Engineering as direct ownership of Shanghai Engineering. In addition, Shanghai Engineering or its respective shareholders may breach the contractual arrangements. In any such event, we would have to rely on legal remedies under PRC law. These remedies may not always be effective, particularly in light of uncertainties in the PRC legal system. See “Item 1A. Risk Factors - Risks Related to Doing Business in China - uncertainties with respect to the Chinese legal system could have a material adverse effect on us.”

The shareholders, directors and officers of our VIE may have potential conflicts of interest with us, which may materially and adversely affect our business and financial condition.

Shanghai Engineering is jointly owned by Mr. Qinghuan Wu, one of our directors and our Chairman of the Board and Chief Executive Officer and his spouse, Mrs. Zhou jialing, who was formerly one of our directors and resigned in June 2011. Conflicts of interest between their role as shareholders of the VIE and their duties to our company may arise. In addition, both of them are also directors and executive officers of the VIE. PRC laws provide that a director or certain members of senior management owes a fiduciary duty to the company he directs or manages. These individuals must therefore act in good faith and in the best interests of the relevant VIE and must not use their respective positions for personal gain. These laws do not require them to consider our best interests when making decisions as a director or member of management of the relevant VIE. Conflict may arise between these individuals’ fiduciary duties as director and officer of the VIE and our company.

We cannot assure you that when conflicts of interest arise, both of them will act in the best interests of our company or that conflicts of interest will be resolved in our favor. Currently, we do not have arrangements to address potential conflicts of interest between them and our company and a conflict could result in both of them as directors and officers of our company violating fiduciary duties to us. In addition, both of them may breach or cause the VIE to breach or refuse to renew the existing contractual arrangements that allow us to effectively control the VIE and receive economic benefits from them. If we cannot resolve any conflicts of interest or disputes between us and the shareholders of the VIE, we would have to rely on legal proceedings, which could result in disruption of our business, and there would be substantial uncertainty as to the outcome of any such legal proceedings.

Risks Related to our Common Stock

There is not an active trading market for our common stock, and if a market for our common stock does not develop, our investors may be unable to sell their shares.

Our common stock is currently quoted on the Pink Sheets trading system. The Pink Sheets is not a listing service or exchange, but is instead a dealer quotation service for subscribing members. The Pink Sheets tend to be highly illiquid, in part because there is no national quotation system by which potential investors can track the market price of shares except through information received or generated by a limited number of broker-dealers that make markets in particular stocks. There is a greater chance of market volatility for securities that trade on the Pink Sheets as opposed to a national exchange or quotation system. This volatility may be caused by a variety of factors including:

In addition, the value of our common stock could be affected by:

In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These market fluctuations may also significantly affect the market price of our common stock.

In a volatile market, you may experience wide fluctuations in the market price of our securities. These fluctuations may have an extremely negative effect on the market price of our securities and may prevent you from obtaining a market price equal to your purchase price when you attempt to sell our securities in the open market. In these situations, you may be required either to sell our securities at a market price which is lower than your purchase price, or to hold our securities for a longer period of time than you planned. An inactive market may also impair our ability to raise capital by selling shares of capital stock and may impair our ability to acquire other companies or technologies by using common stock as consideration.

Because we do not intend to pay any dividends on our common stock, purchases of our common stock may not be suited for investors seeking dividend income.

We do not currently anticipate declaring and paying dividends to our stockholders in the near future. It is our current intention to apply any net earnings in the foreseeable future to the internal needs of our business. Prospective investors seeking or needing dividend income or liquidity from our common stock should, therefore, not purchase our common stock. There can be no assurance that we will ever have sufficient earnings to declare and pay dividends to the holders of our shares, and in any event, a decision to declare and pay dividends is at the sole discretion of our board of directors, who currently do not intend to pay any dividends on our common shares for the foreseeable future.

Securities analysts may not continue to cover our common stock, and this may have a negative impact on our common stock's market price.

The trading market for our common stock will depend, in part, on the research and reports that securities analysts publish about us and our business. We do not have any control over these analysts. If securities analysts do not cover our common stock, the lack of research coverage may adversely affect its market price. If we are covered by securities analysts, and our stock is downgraded, our stock price would likely decline. If one or more of these analysts ceases to cover us or fails to publish regular reports on us, we could lose visibility in the financial markets, which could cause our stock price or trading volume to decline.

We have raised substantial amounts of capital in private placements, and if we fail to comply with the applicable securities laws, ensuing rescission rights or lawsuits would severely damage our financial position.

Our private placements consist of securities that were not registered under the Securities Act of 1933, as amended (the "Securities Act"), or any state "blue sky" law as a result of exemptions from such registration requirements. Such exemptions are highly technical in nature and if we inadvertently failed to comply with any of such exemptive provisions, investors could have the right to rescind their purchase of our securities and also sue for damages. If any investors were to successfully seek such rescission or prevail in any such suit, we could face severe financial demands that could have significant, adverse affects on our financial position. Future financings may involve sales of our common stock at prices below prevailing market prices on the exchange on which our common stock is quoted or listed at that time, as well as the issuance of warrants or convertible securities at a discount to market price.

The application of the "penny stock" rules could adversely affect the market price of our common stock and increase your transaction costs to sell those shares.

The SEC has adopted regulations which generally define a "penny stock" to be an equity security that has a market price of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to specific exemptions. The last reported trade of our common stock on the Pink Sheets was at a price below $5.00 per share, and, accordingly, our common stock is currently considered a penny stock. The SEC's penny stock rules require a broker-dealer, before a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document that provides information about penny stocks and the risks in the penny stock market. The broker-dealer must also provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and the salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer's account. In addition, the penny stock rules generally require that before a transaction in a penny stock, the broker-dealer make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's agreement to the transaction. These rules may restrict the ability of brokers-dealers to sell our common stock and may affect the ability of investors to sell their shares, until our common stock no longer is considered a penny stock.

Sales of a significant number of shares of common stock in the public market could lower the market price of our common stock.

A significant amount of common stock is subject to issuance upon the conversion of our Series A Convertible Preferred Stock and upon exercise of warrants to purchase common stock. The conversion, exercise and sale of these financial instruments could depress the market price of our common stock.

As of December 31, 2012, we had 200,000 shares of our Series A Convertible Preferred Stock currently exercisable into 105,882 shares of common stock outstanding. Also, all of the warrants issued in the Financing, currently exercisable into 3,241,709 shares of common stock, remain outstanding.

Sales of a significant number of shares of our common stock in the public market after the conversion or exercise of these securities could lower the market price of our common stock.

Item 1B. Unresolved Staff Comments

Not applicable.

Item 2. Properties

Our corporate headquarters is currently located at Building #26, No. 1388 Zhangdong Road, Zhangjiang Hi-tech Park, Shanghai, China. The telephone number of our corporate headquarters is +86 (0)21 2028-1866.

The office building housing our corporate headquarters was purchased in early 2011. On March 30, 2011, CER Shanghai exercised the purchase option with Shanghai Zhangjiang Integrated Circuit Industrial Zone Development Co., Ltd. The total purchase price of the building is RMB 48,526,172 (approximately $7,498,264), which represents the price of the building.

On August 18, 2009, CER Hong Kong entered into a series of contracts with Yangzhou (Yizheng) Automobile Industrial Park Administration Committee, a government entity of the City of Yangzhou, Jiangsu Province, China, to acquire a tract of land on which CER Hong Kong planned to build a new manufacturing facility. The planned facility was part of the Company’s business plan for expanding its production capacity and to develop additional demand for its products within China and from overseas. Phase One construction of the plant was completed in January 2011. Phase Two is under construction.

Item 3. Legal Proceedings

We are not a party to any pending material legal proceedings and are not aware of any threatened or contemplated proceeding by any governmental authority against us.

Item 4. Mine Safety Disclosures

Not applicable.

PART II

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock has been quoted since May 20, 2010 under the symbol "CGYV.PK" on the Pink Sheets. Prior to May 20, 2010, the common stock was quoted on the OTC:BB under symbol “CGYV.OB” until trading was terminated because of a delinquency in the Company’s filing of financial reports described in our past reports on Form 10-K and other SEC filings. The following table sets forth, for the periods indicated, the high and low bid prices of our common stock as reported on the OTC:BB and Pink Sheets and adjusted for stock splits.

As of March 31, 2013, the last reported sales price on the Pink Sheets for our common stock was $0.15 per share. These over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

Stockholders

As of March 31, 2013, we had approximately 111 shareholders of record of our common stock. However, we currently believe that there are approximately an additional 800 shareholders who beneficially hold their shares through street name.

Dividends

We have not declared any cash dividends on our common stock since our inception and do not anticipate paying such dividends in the foreseeable future. We plan to retain any future earnings for use in our business. Any decisions as to future payments of dividends will depend on our earnings and financial position and such other facts as the board of directors deems relevant.

Recent Sales of Unregistered Securities

None.

Securities Authorized for Issuance under Equity Compensation Plans

The following table sets forth, as of December 31, 2012, certain information related to our compensation plans under which shares of our common stock are authorized for issuance. See Note 13 to the financial statements for greater details regarding equity compensation plans.

Item 6. Selected Financial Data

Not applicable.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the results of operations and financial condition for the fiscal years ended December 31, 2011 and 2012 should be read in conjunction with our financial statements and the notes to those financial statements that are included elsewhere in this report.  Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations, and intentions.  Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the Risk Factors, Cautionary Statement Regarding Forward-Looking Information, and Business sections in this report.  We use words such as "anticipate," "estimate," "plan," "project," "continuing," "ongoing," "expect," "believe," "intend," "may," "will," "should," "could," and similar expressions to identify forward-looking statements.

Overview

On January 24, 2008, we entered into a Share Exchange Agreement (the "Share Exchange Agreement") with Poise Profit International, Ltd. ("Poise Profit") and the shareholders of Poise Profit. Pursuant to the Share Exchange Agreement, we acquired 100% of the issued and outstanding shares of Poise Profit's common stock in exchange for the issuance of 41,514,179 (pre reverse split) shares of our common stock to the shareholders of Poise Profit. The share exchange (the "Share Exchange") transaction was consummated on April 15, 2008.

As a result of the Share Exchange, our business operations consist of those of Poise Profit's Chinese subsidiary, Hi-tech, which were subsequently transferred to CER Hong Kong on December 3, 2008. CER Hong Kong is principally engaged in designing, marketing, licensing, fabricating, implementing and servicing industrial energy recovery systems capable of capturing industrial waste energy for reuse in industrial processes or to produce electricity and thermal power.

CER Hong Kong carries out its operations through its subsidiaries CER Shanghai and CER Yangzhou and an affiliated entity (variable interest entity (“VIE”)) with which CER Hong Kong has a contractual relationship, Shanghai Engineering. Effective as of May 1, 2003, Shanghai Engineering's manufacturing activities were carried out by Vessel Works Division located in Shanghai, China, through a lease agreement with Vessel Works Division's owner, which was terminated in April 2011. From May 2011, all of our production is carried out in CER Yangzhou, where we completed the first phase of construction of the plant in January 2011. The term “Company” refers to the group of companies described above.

CER, Poise Profit, CER Hong Kong, Hi-tech, Shanghai Engineering, CER Shanghai, and CER Yangzhou are collectively hereinafter referred to as the “Group”.

The energy recovery systems that we produce capture industrial waste energy for reuse in industrial processes or to produce electricity and thermal power, which allow industrial manufacturers to reduce a portion of their energy costs, shrink their emissions and potentially generate sellable emissions credits. We have primarily sold energy recovery systems to chemical manufacturing plants to reduce their energy costs by increasing the efficiency of their manufacturing equipment and help control their pollution output. We have installed more than 156 energy recovery systems throughout China and in a variety of international markets.

In September 2011, the State Council issued the work plan for fulfilling the target of energy savings and emissions reduction during the PRC’s 12^th five year plan for national economic development. The work plan addressed the importance of energy savings in industries such as coal, fossil fuels, paper manufacturing, and chemicals. The work plan also specified heat or pressure recovery as one of the projects especially encouraged and supported by the government.

Facing a possible large market opportunity and potential government support, we decided to enlarge our production capacity by setting up a new production base. Our plan is to establish CER Yangzhou as a world-class international manufacturing facility of waste heat equipment, in both products and technology. We plan to make highly efficient energy-saving products, using advanced manufacturing processes and equipment, We intend for this manufacturing facility to embody a completely new look of a modern factory, thus making the Company more competitive, while promoting the development of the local economy and further exploiting the manufacturing advantages in renewable energy equipment and waste heat recovery core equipment. In January 2011, Phase One construction of the plant was completed. The Phase One facility is about 14,000 square meters. Many pieces of advanced equipment have been installed in the new factory. The new facility significantly expands our ability to accept new orders and will speed delivery of large-scale waste heat systems for new and retro-fitted industrial plants located in China and other international markets. Phase Two is under construction.

With Phase One of the new facility completed, we are prepared to expand our customer base and enter into more sectors. We expect to incur separate (unrelated to any particular customer project) research and development expenditures to support an expansion into new sectors, such as coke refining and cement, including adding more specialized skills to our engineering and design team. We are also planning on entering into marketing partnerships and licensing deals that should enable us to reach a broader segment of the market. We believe that there is significant opportunity in international markets and we intend to enter these markets through partnerships.

Coming through the world economic crisis, we took more orders than anticipated from existing and new customers in 2011. The main reason is that we focused more attention and efforts on EPC contracts, which contributed to higher revenue. On January 8, 2011, CER signed an EPC contract for a major waste heat recovery system with Zhenjiang Kailin Clean Heat Energy Co., Ltd. (“Zhenjiang Kailin”), a related party of CER. The contract was valued at RMB 300 million (approximately $46 million). This project was fully completed by June 30, 2012.

During 2012, given the downturn of macro-economic environment in China, many potential customers have tightened or delayed their spending on capital expenditures. We are now facing more intense market competition. Furthermore, as we do not want to accept low-margin orders now, newly secured orders have significantly decreased in 2012. Since we are finishing previous sales orders gradually and getting fewer new ones, our operating and financial condition are subjected to an unprecedented pressure and challenge. Overall, we just completed a very difficult year. But in the event the Chinese economy improves in the forthcoming year, with the government supporting in the energy-saving and environmental protection industry and our new manufacturing facility in operation, we anticipate that we can obtain more EPC contracts and have positive results in the next few years.

Critical Accounting Policies and Estimates

While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements in this Annual Report on Form 10-K, we believe that the accounting policies described below are the most critical to aid you in fully understanding and evaluating this management discussion and analysis. Management believes that there are certain accounting estimates and management judgments that have greater influence on the financial statements, including the process of determining percentage completion on EPC project contracts, provision for impairment loss of receivables, provisioning for inventory, measurement of deferred taxes and related valuation allowances, and various fair value measurements. The most critical policies are discussed further herein and in Note 2 to the consolidated financial statements.

Revenue Recognition

The Company derives revenues principally from

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

Sales of the Company's energy recovery systems and related products are essentially product sales. The products consist mainly of waste heat boilers and other related equipment manufactured according to specific customers' specifications. Once manufactured, the Company ships the products to its customers in their entirety in one batch. The Company’s service arrangement also includes a limited warranty to its customers pursuant to which the customers retain between 5% and 10% of the particular contract price as retainage during the limited warranty period (usually 12-24 months). The Company generally recognizes revenues including retainage from product sales when (i) persuasive evidence of an arrangement exists, which is generally represented by a contract between the Company and the customer; (ii) products are shipped; (iii) title and risks of ownership have passed to the customer, which generally occurs at the time of delivery; (iv) the customer accepts the products upon a quality inspection performed by them; (v) the purchase price is agreed to between the Company and the customer; and (vi) collectability is reasonably assured. Net revenues represent the invoiced value of products, less returns and discounts, and are net of value-added tax.

In providing design services, the Company designs energy recovery systems and other related systems based on a customer's requirements and the deliverable consists of engineering drawings. The customer may elect to engage the Company to manufacture the designed system or choose to present the Company's drawings to other manufacturers for manufacturing and installation. The Company recognizes revenues from design services when the services are provided, the design drawings are delivered, invoices are issued and collectability is reasonably assured. The Company generally delivers the drawings in one batch.

In conjunction with sales to Zhenjiang Kailin, the Company provided guarantees to a third party which provided financing to Zhenjiang Kailin in November 2011, March 2012 and October 2012. The Company initially accounts for the guarantees at fair value as deferred revenue based on the quote guarantee fee percentage for loans with similar terms from financial institutions. The guarantee liabilities are amortized to revenue according to applicable U.S. GAAP accounting requirements as the underlying guarantees payment obligation is satisfied by Zhenjiang Kailin’s payments to its lenders. As of December 31, 2012, the deferred revenue related to CER’s guarantees for Zhenjiang was $246,608. As of December 31, 2012, Zhenjiang Kailin has made all required payments to CGN Energy in compliance with the payment schedule (Note 16).

Due to delay and certain technical issues encountered by CER and Zhenjiang Kailin’s accident that occurred in the operation of the waste heat recovery system the Company built for Zhenjiang Kailin, the Company agreed to extend Zhenjiang Kailin’s payment schedules without interest in May and July 2012, The Company considered that the extensions of repayment without interest were effectively sales concessions CER granted to Zhenjiang Kailin as a result of the project being delayed and technical issues encountered and recorded the discount impact of $1,709,299 for the outstanding accounts receivable as a deduction of revenue. The effective interest rate of the receivable based on the revised payment term was 10.65% based on the terms and credit risk of Zhenjiang Kailn at that time. The discount impact is accreted as interest income in the subsequent reporting periods. For the year ended December 31, 2012, the accretion recorded as interest income was $926,209. As a result of the deteriorating domestic market demand and Zhenjiang Kailin’s financial condition, CER performed an impairment analysis on the remaining outstanding balance due from Zhenjiang Kailin as of December 31, 2012 and recorded provision for impairment loss of $3,397,541. Consequently, the Company will cease to accrete interest income subsequent to December 31, 2012. The Company will reassess the provision for impairment of receivable together with unearned interest income of $783,090 at each reporting period and records additional provision for impairment or recovery of the receivable to Selling, General and Administrative Expenses in the subsequent reporting periods (Note 3 and 16).

Consolidation of Variable Interest Entities

In accordance with U.S. GAAP, variable interest entities are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability. Each variable interest entity with which the Company is affiliated must be evaluated to determine who the primary beneficiary of the risks and rewards of ownership of the variable interest entity. The primary beneficiary is required to consolidate the variable interest entity's financial information for financial reporting purposes.

We have concluded that Shanghai Engineering is a variable interest entity and that CER Hong Kong is the primary beneficiary thereof. Pursuant to the contractual arrangements described elsewhere in this filing on Form 10-K, the Company recovered (recovers) substantially all of the profits of its VIE through service fees charged (particularly under the consulting and service agreements) and has the unilateral ability to do so through its wholly owned subsidiaries. Accordingly, through such contractual arrangements, the Company (as applicable, through wholly-owned subsidiaries) has the power to direct the activities most significant to the economic performance of the VIE and absorbs all, or substantially all, of the profits or losses; therefore, the Company is the primary beneficiary of such arrangements. Under the requirements of the FASB’s accounting standard regarding VIE, CER Hong Kong consolidates the financial statements of Shanghai Engineering. As all companies are under common control (see Note 1 to our consolidated financial statements), the consolidated financial statements have been prepared as if the arrangements by which these entities became variable interest entities had occurred retroactively. We have eliminated inter-company items from our consolidated financial statements.

Fair Value Measurements

The accounting standard regarding fair value measurements defines financial instruments and requires fair value disclosures for those financial instruments. The fair value standard also establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosure requirements for fair value measurements.  The carrying amounts reported in the accompanying consolidated balance sheets for current assets and current liabilities such as cash, restricted cash, accounts and notes receivable, short term loans, accounts payable, and other payables qualify as financial instruments. Management concluded the carrying values of these financial instruments are reasonable approximations of their respective fair values because of the short period of time between the origination of such instruments and their expected realization and the current market rates of interest.  The three levels of the valuation hierarchy are defined as follows:

The measurement basis for current assets and current liabilities such as cash, restricted cash, accounts and notes receivable, long term accounts receivable, short term loans, accounts payable, and other payables is carrying value, which approximates fair value. All such current assets and liabilities with the exception of cash and restricted cash (Level 1) and short term loans (Level 2) would be classified as Level 3 measurements due to the presence of Company-specific unobservable inputs. The following table presents information about the company’s fair value financial liabilities classified as Level 2 and Level 3 as of December 31, 2011 and December 31, 2012.

A summary of changes in the Level 2-classified guaranty contract liability related to Zhejiang Kailin project (Note 16) for the year ended December 31, 2011 and 2012 is as follows:

A summary of changes in the Level 3-classified derivative liabilities related to stock purchase warrants and a loan for the year ended December 31, 2011 and 2012 is as follows:

For assumptions used for the fair value measurement of the Level 2 guaranty contract liability and Level 3 derivative liabilities, please see Note 16 and Note 13, respectively.

Liability for Warrants

The Company follows the provisions of the Accounting Standards Codification regarding instruments that are indexed to an entity’s own stock.  The related accounting standard specifies that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to the Company’s own stock and (b) classified in stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument.  It provides a two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the scope exception within the standards.

Classification of Current/Non-Current Receivables

In view of the recent global economic slowdown, we have reviewed our receivable balances and reassessed each balance and its collectability during the forthcoming 12 months. Upon assessment, we have reclassified certain of these outstanding balances to non-current assets where we have arrangements with the customers to bill and collect a portion of the receivable after 12 months. 

Provision for impairment loss of receivables due from Zhenjiang Kailin

The Company assesses at the end of each reporting period whether there is objective evidence that a receivable is impaired. Impairment loss is measured as the difference between the assets’ carrying amount and the present value of estimated future cash flows discounted at the receivable based on the effective interest rate for similar loans Zhenjiang Kailn might obtain from third party financial institutions at the time the receivable originated. And the impairment loss will be recorded as provision for impairment loss of receivables in balance sheets and Selling, General and Administrative Expenses in statements of income. The Company will reassess the provision for impairment of receivable at each reporting period and records additional provision for impairment or recovery of the receivable to Selling, General and Administrative Expenses in the subsequent reporting periods.

As a result of the deteriorating domestic market demand and Zhenjiang Kailin’s financial condition, CER performed an impairment analysis on the remaining outstanding balance due as of December 31, 2012. In March 2013, Zhenjiang Kailin provided a commitment letter to CER for a total repayment of RMB 77 million (approximately equivalent to $12.4 million) in the following 7 years, including an annual minimum repayment of RMB 10 million (approximately equivalent to $1.6 million) from 2013 to 2018 and RMB 17 million (approximately equivalent to $2.8 million) in 2019 in accordance with its business forecasts to fully repay the outstanding payment due to CER. Although CER acknowledged the receipt of the commitment letter, it was not a legally enforceable agreement between CER and Zhenjiang Kailin, and CER can continue to assert its rights under the repayment schedule disclosed above.

Based on the impairment analysis CER performed, including the assessment of Zhenjiang Kailin’s business forecast, CER expected that Zhenjiang Kailin will be able to fully repay all outstanding amount over the next 7 years with an annual minimum repayment of RMB 10 million from 2013 to 2018 and RMB 17 million in 2019. A provision for impairment loss on long term receivable of $3,397,541 was recorded based on the management’s best estimate of future cash flow, i.e., Zhenjiang Kailin will repay RMB 10 million or RMB 17 million annually over the next 7 years, discounted at the long term receivable’s effective interest rate of 10.65% obtained in May 2012. The impairment loss has been included in the Selling, General and Administrative (“SG&A”) Expenses of the CER’s financial statements. The Company will reassess the provision for impairment of receivable at each reporting period and record any changes as an adjustment to the provision for impairment loss and corresponding SG&A expense.

Recent Accounting Pronouncements

In December 2011, the FASB issued ASU 2011-11, “Disclosures about Offsetting Assets and Liabilities”. The update under ASU 2011-11 requires an entity to disclose both gross and net information about instruments and transactions eligible for offset in the statements of financial position as well as instruments and transactions executed under a master netting or similar arrangement and was issued to enable users of financial statements to understand the effects or potential effects of those arrangements on their financial position. The update under ASU 2011-11 is required to be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. In January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities”. The amendments clarify that the scope of ASU 2011-11 applies to derivatives accounted for in accordance with ASC 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with ASC 210-20-45 or ASC 815-10-45 or subject to an enforceable master netting arrangement or similar agreement. The effective date is the same as the effective date of ASU 2011-11. The Company is currently evaluating the impact on its financial statements of adopting this update. 

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”. This update does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, this update requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. This update is effective prospectively for reporting periods beginning after December 15, 2012 for public entities. The Company is currently evaluating the impact on its financial statements of adopting this update.

In February 2013, the FASB issued ASU 2013-04, “Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date”. This update provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this update is fixed at the reporting date, except for obligations addressed within existing guidance in U.S. GAAP. The guidance requires an entity to measure those obligations as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. The guidance in this update also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2014, and interim periods and annual periods thereafter. This update should be applied retrospectively to all prior periods presented for those obligations resulting from joint and several liability arrangements within the update’s scope that exist at the beginning of an entity’s fiscal year of adoption. An entity may elect to use hindsight for the comparative periods (if it changed its accounting as a result of adopting the amendments in this Update) and should disclose that fact. Early adoption is permitted. The Company is currently evaluating the impact on its financial statements of adopting this update.

In March 2013, the FASB issued ASU 2013-05, “Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity”. This update provides that when a reporting entity (parent) ceases to have a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business (other than a sale of in substance real estate or conveyance of oil and gas mineral rights) within a foreign entity, the parent is required to apply the guidance in Subtopic 830-30 to release any related cumulative translation adjustment into net income. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. For an equity method investment that is a foreign entity, a pro rata portion of the cumulative translation adjustment should be released into net income upon a partial sale of such an equity method investment. However, this treatment does not apply to an equity method investment that is not a foreign entity. In those instances, the cumulative translation adjustment is released into net income only if the partial sale represents a complete or substantially complete liquidation of the foreign entity that contains the equity method investment. Additionally, the amendments in this update clarify that the sale of an investment in a foreign entity includes both (1) events that result in the loss of a controlling financial interest in a foreign entity (that is, irrespective of any retained investment) and (2) events that result in an acquirer obtaining control of an acquiree in which it held an equity interest immediately before the acquisition date (sometimes also referred to as a step acquisition). Accordingly, the cumulative translation adjustment should be released into net income upon the occurrence of those events. This update is effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013. Early adoption is permitted. The Company is currently evaluating the impact on its financial statements of adopting this update.

Results of Operations

Comparison of the Fiscal Years Ended December 31, 2011 and December 31, 2012

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

Revenues. Our revenues include revenues from sales of energy recovery systems and EPC contracts. Revenues increased to $92,461,713 for the year ended December 31, 2012 as compared to $90,987,247 for the year ended December 31, 2011, an increase of $1,474,466 or 2%. This increase was mainly due to the net impact of the increase from third parties and the decrease from one related party. Although the average revenue recognized per EPC contract decreased by $950,835, from $5,873,126 per contract in 2011 to $4,922,291 per contract in 2012, and the average revenue recognized per product contract decreased by $35,084, from $438,174 per contract in 2011 to $403,090 per contract in 2012, the number of EPC contracts increased by 2 from 14 in 2011 to 16 in 2012, and the number of product contracts increased by 14 from 20 in 2011 to 34 in 2012. The significant increases in the number of EPC and product contracts from third parties was mainly due to the expansion of production as a result of the completion of the construction in Phase One of our Yangzhou manufacturing facility from the first half year of 2011 and enhanced capacities to obtaining more sales orders. In addition, one significant contract was signed with Ningbo Xinfu, for an amount of $27.6 million. For the year ended December 31, 2012, revenues from this contract amounting to $18.4 million were recognized and accounted for 23% of the total EPC revenues. The increase of product contract was mainly a result of the price strategy of the Company, which reduced selling price and attract more orders since the beginning of this year.

As for the related party, one significant EPC contract signed with Zhenjiang Kailin in mid-2010 lasting more than one year from early 2011 to mid-2012, which lead to more than $32 million of revenue for the year ended December 31, 2011, accounting for 36% of the total revenue at that time, whereas only $6 million was recognized in 2012 due to the project being completed as of June 30, 2012, which lead to less revenue in related parties.

Cost of Revenues. Cost of revenues decreased to $77,482,545 for the year ended December 31, 2012, as compared to $77,731,325 for the year ended December 31, 2011, a decrease of $248,780, or 0.3%. The decrease is mainly due to the Company strengthened the supervision and control on distribution of raw materials, which lead to the cost of revenues having a slight decrease in spite of an increased in revenue for the year ended December 31, 2012 compared to 2011. As a percentage of revenues, cost of revenues decreased by 1.6% from 85.4% for the year ended December 31, 2011 to 83.8% for the year ended December 31, 2012. The largest driver of total gross margin is that we shifted production into our new manufacturing facility and began to incur anticipated lower costs related to our new facility which lowers the cost of revenue. The gross profit margin on EPC contracts increased from 14.1% for the year ended December 31, 2011 to 14.9% for the year ended December 31, 2012, an increase of 0.8%, mainly due to three large EPC contracts with Wuxi Gelin, Ningbo Xinfu and Beijing Guodian, primarily undertaken in 2012, which made up 50% of total EPC revenue, having a higher margin of around 16%. Furthermore, there were several relatively smaller project carried out in the current year bearing a higher margin in excess of 20%. In addition, one significant EPC contract for customer Zhenjiang Kailin, commencing from early 2011 to mid-2012, which made up 36% of total revenue for the year ended December 31, 2011, bore a relatively lower profit margin of 14% (excluding the impact of discounted revenue and penalty at that time) considering the contract value is relatively high. In addition, the gross profit margin on product sales increased from 19.2% to 23.9% owing to two export contracts which had higher margins.

The following table sets forth the analysis of cost of revenues and margin:

Gross Profit. Gross profit was $14,979,168 for the year ended December 31, 2012 as compared to $13,255,922 for the year ended December 31, 2011, an increase of $1,723,246 or 13%. The gross margins were 14.6% and 16.2%, respectively, for the years ended December 31, 2011 and 2012. The higher gross profit is mainly due to the higher margin from EPC and product contracts in 2012.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $13,153,371 for the year ended December 31, 2012, as compared to $9,991,632 for the year ended December 31, 2011, an increase of $3,161,739 or 32%. Selling, general and administrative expenses, as a percentage of revenue, increased from 11.0% for the year ended December 31, 2011 to 14.2% for the year ended December 31, 2012, an absolute increase of 3.2%. This operating leverage effect resulted from the larger business and sales volume of 2012 compared to 2011. The following table sets forth the principal changes in selling, general and administrative expenses:

The absolute decrease is mainly due to the following reasons:

Income from Operations. As a result of the above, income from operations totaled $1,825,797 for the year ended December 31, 2012 as compared to income of $3,264,290 for the year ended December 31, 2011, a decrease of $1,438,493 or 44%. As a percentage of revenues, income from operations represents 2.0% of total revenue for the year ended December 31, 2012, as compared to income from operations represents 3.6% of total revenue for the year ended December 31, 2011. The change is mainly attributable to the increase in the selling, general and administrative expenses.

Other Income (Expenses), net. Other expenses were $490,215 for the year ended December 31, 2012, as compared to other expenses of $527,980 for the year ended December 31, 2011, an absolute decrease of $37,765, as further described in the next three paragraphs.

Change in fair value of warrants and derivative liabilities. This resulted from the valuation of warrants and derivative liabilities. The $1,696,440 gain recognized in 2011 was due to significant declines in the Company's stock price; whereas a smaller gain of $44,080 was recognized in 2012 due to small increases in the Company's stock price as the related contracts approached maturity.

Non-operating Income/(Expense). Non-operating income/(expense) consists primarily of foreign exchange losses on purchasing transactions and subsidy income.

During the year ended December 31, 2011, CER purchased imported equipment via advance payments to suppliers through the holding company CER Hong Kong, which then resold the equipment to mainland PRC inter-company subsidiaries (CER Shanghai and CER Yangzhou). With RMB appreciation against the US dollar from RMB 6.62 to $1 to RMB 6.30 to $1 over the year ended December 31, 2011, an exchange loss of $1.3 million was realized for the year ended December 31, 2011 due to the large amount of import transactions related to CER Yangzhou, whereas due to the slight appreciation of RMB against USD over the year ended December 31, 2012, an exchange gain of $126,136 was realized for the year ended December 31, 2012.

Meanwhile, CER recognized a subsidy income of $998,686 received by CER Yangzhou from a research and development fund administered by the Yizheng industrial park in 2011 compared to only $179,314 in 2012. In addition, CER recognized a subsidy income of $139,439 received by CER Shanghai and Shanghai Engineering from transformation and upgrading fund administered by the Shanghai local bureau of finance in 2012. The subsidy income is not tied to any specific element of the business, and cannot be reclaimed by the research and development fund.

Interest Expense, net. Interest expense, net, decreased to $866,261 for the year ended December 31, 2012, as compared to $1,801,056 for the year ended December 31, 2011, a decrease of $934,795 or 52%. This decrease was mainly due to slightly lower average long term loan balances borrowed mostly for trade financing and working capital and interest income recorded for Zhenjiang Kailin accounts receivable accretion, which is further described in Note 15.

Income From Operations Before Income Taxes. As a result of the foregoing, income before provision for income taxes was $1,335,582 for the year ended December 31, 2012, as compared to an income of $2,736,310 for the year ended December, 2011, a decrease of $1,400,728 or 51%.

Income Tax Expense. The normal applicable income tax rate for the operating entities in China is 25%. Pursuant to the PRC income tax laws, Shanghai Engineering and CER Shanghai are subject to enterprise income tax at a statutory rate of 15% and 12.5%, respectively, as the high technology entities. For the year ended December 31, 2012, the Company incurred $1,238,289 of income tax provision, as compared to an income tax provision of $740,642 for the year ended December 31, 2011, an absolute change of $497,647. The change was mainly resulted from lager income before income taxes and CER (Hong Kong) tax provision.

For the quarter ended March 31, 2012, the Group’s Hong Kong subsidiary, CER (Hong Kong), had, for the first time, estimated taxable profits earned in the PRC. CER (Hong Kong) also has estimated taxable profits in the PRC for the year ended December 31, 2012. As such, CER (Hong Kong) is likely to be regarded under the PRC tax laws as having permanent establishment for business activities carried out in the PRC, and would be subject to PRC tax at the standard EIT rate of 25%. For the year ended December 31, 2012, CER (Hong Kong) recognized taxes, included in the consolidated tax provision, of $773,186. The primary reason for CER (Hong Kong)’s generation of taxable income was the non-deductibility, under PRC tax law, of a $1.5 million expense incurred for a penalty payment to an EPC construction contract related party customer which is further described in Note 16 and income tax for the intra-entity sales of the subsidiary’s shares further described in Note 1. This tax provision, as well as increases in PRC tax expense for the Group’s profitable subsidiaries, were primarily responsible for the significant increase in the Group’s effective tax rate for the year ended December 31, 2012 as compared to the year ended December 31, 2011.

Net Income. As a result of the foregoing, we incurred net income of $97,293, for the year ended December 31, 2012 as compared to net income of $1,995,668 for the year ended December 31, 2011, an absolute decrease of $1,898,375 or 95%.

Liquidity and Capital Resources

Our principal sources of liquidity have been cash provided by operations and borrowings from banks and other lenders including related parties. Our principal uses of cash have been to finance working capital, facility expansions, and other capital expenditures. We anticipate these uses will continue to be our principal uses of cash in the future.

As at December 31, 2012, we had cash of $1.1 million and a working capital deficit of $36.4 million ($24.2 million as of December 31, 2011). Current liabilities exceeded current assets by $27 million after excluding advances from customers and advances to suppliers. The primary driver of the increased working capital deficit was the $15 million extension of payment terms of accounts receivable for customers Zhenjiang Kailin and Jiangsu SOPO (resulting in a reclassification of current receivables to noncurrent receivables), which are described in Notes 3 and 16 to the consolidated financial statements. Meanwhile, fewer new EPC orders were secured during the year ended December 31, 2012 resulting in $24 million and $12 million decreases in customer deposits and advance to suppliers, respectively, compared to the year-end of 2011. We have been in an overall all-in net current liability position since 2010 and have operated our business with such a net current liability position for three years while continuing to grow our customer base, contract backlog, and business. Three years of operating history provides historical evidence that we can utilize advances received from our customers to fund operations. Except for the Zhenjiang Kailin EPC project and Jiangsu SOPO dock project (see Note 3(b)), we generate cash from operations predominantly from advances from our EPC customers before we make advances to our suppliers. This provides a window of time for us to utilize the advances from customers as short term financing with free interest to contribute to operating cash flows.

Given the downturn of macro-economic environment in China, many potential customers have tightened or delayed their spending on capital expenditures. We were facing more intense market competition in 2012. As we do not want to accept low-margin orders now, newly secured orders have significantly decreased in 2012. As of December 31, 2012, the secured backlog for the coming year decreased from $50 million to $45 million mainly due to the execution of the contracts signed in 2012. Besides, one big domestic EPC project amounting to $28 million and several product contracts amounting to $8 million were under proposal status.

For the Zhenjiang Kailin project and SOPO dock project, we did not request significant advances from those customers, due to these close business relationships we have (see Note 16). We made such arrangements to balance our respective interests and keep long term strategic relationships. Subsequent to the first quarter of 2012, Jiangsu SOPO and CER entered into an agreement to revise the payment schedule of outstanding receivables related to the SOPO dock project into 36 monthly installments of 3 years, starting from May 2012 and SOPO has made payments on schedule in the past 8 months, as further described in Note 3. Similarly, subsequent to the first quarter of 2012, Zhenjiang Kailin and CER also entered into an agreement to revise the payment schedule of outstanding receivables related to the Zhenjiang Kailin project, such that remaining payments related to the project are now due in December 2012, June 2013, September 2013, and December 2013. In October 2012, Zhenjiang Kailin repaid part of the first installment of $3,178,098 through a financing arrangement with CGN. The remaining $1,637,202 which was originally due by December 31, 2012 was defaulted. In March 2013, Zhenjiang Kailin issued a commitment letter to CER for a total repayment of RMB 77 million (approximately equivalent to $12.4 million) in the following 7 years, including an annual minimum repayment of RMB 10 million (approximately equivalent to $1.6 million) from 2013 to 2018 and RMB 17 million in 2019 in accordance with its business forecasts. For more information, refer to Note 16.

Our forecasted cash flows for the forthcoming twelve months, which consider a range of possible outcomes, indicate that is possible that our cash resources may be exhausted. However, the Company believes it is able to, and will, adjust and control capital expenditures and financing inflows in order to influence the core assumptions underlying this forecast, alleviate this pressure, and to raise sufficient funds for the Company to continue as a going concern. The key assumptions include, but are not limited to the following:

We expect that net cash outflows from operations may be negative for the forthcoming twelve months, which takes into account the current macroeconomic environment and depressed margins, expected progress billings, expected margins, cash received in advance from customers, and cash to be expended for supplier advances, and the extension of payment terms on key receivables. By the end of December 2012, the Company has secured backlog of $45 million, one potential order of $28 million and several product contracts of $8 million in proposal stage. With or without taking the potential orders into consideration, net operating cash flow is expected to be negative $8 million and negative $18 million in the subsequent four quarters of 2013, respectively.

Capital expenditures to continue and complete construction of Phase II of our Yangzhou plant will require significant cash resources in the forthcoming 12 months, possibly as much as $20 million. Phase II is a capacity expansion project aligned to our goal to grow and fulfill EPC orders in the future. To a significant extent, higher future profit margins and ability to handle higher project and product volumes depend on the completion of this facility.

Management has significant ability to eliminate or delay capital expenditures (other than $8.3 million firmly committed as disclosed in the Contractual Obligations table in this section). Such actions would be taken if key developments threatening our cash flow assumptions occur (such as further reductions in forecasted operating cash flows, any inability to refinance existing debt, or any delay of long-term financing for Phase II of construction of the CER Yangzhou plant). Under a scenario where the in-progress financing with Bank of China is not obtained, management has the ability and business intention to use the land use rights of Phases I (completed) and II (in process) as collateral pledges to secure further borrowings.

As at 31 December 2012, the total interest-bearing debt balance was $23.5 million, including short-term bank loan of $20.3 million and product financing of $3.2 million (Note 7). Except for the $3.2 million product financing from China Greatwall Industry Corporation (“Greatwall”) which were secured by equivalent worth of equipment, all other debt was secured by tangible assets (mainly buildings and land use rights), bank acceptance notes, and was guaranteed by Mr. Wu (the controlling shareholder and CEO of CER). Management has obtained a letter of support from Mr. Wu to demonstrate his continuing commitments to CER by providing personal guarantees on all bank loans in 2013. With the support of Mr. Wu and tangible assets, management has confidence in servicing most of the existing debts in 2013. To the extent that factors underlying our core assumptions deteriorate further, we are able to eliminate or delay projected capital expenditures, and will consider further collateralization of existing available assets to try to obtain new financings, in an effort to have sufficient cash resources.

Given the uncertainties described above, we are considering all alternatives available to address our cash needs. There can be no assurance we will be able to satisfactorily address our cash needs, and if we are unable to do so it would have a material adverse effect on us and our financial condition and would raise substantial doubt about our ability to continue as a going concern.

To improve our existing cash and liquidity position, we are continuing our efforts to improve the collection of receivables, examine costs in an attempt to control or reduce expenses and use non-cash compensation, such as stock grants, where appropriate, all of which should have a positive effect on our working capital and increase our cash resources. Notwithstanding our existing resources for operations on a going forward basis at current operating levels, we will continue to need capital for our expansion plans, including funding for the ongoing expansion of our manufacturing facility in Yangzhou, China. If these organic (inherent to CER only) sources are insufficient to satisfy our cash requirements, we may seek to issue debt securities or additional equity or to obtain additional bank borrowings. The issuance of convertible debt securities or additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financial covenants that would restrict our operations and the placement of liens over some or all of our assets. We cannot assure that financing will be available in amounts or on terms acceptable to us, if at all.

The accompanying financial statements have been prepared assuming the Group will continue as a going concern. However, as of December 31, 2012, the Group reported a negative working capital balance of $36.4 million and had negative cash flows of $2.5 million for the year ended December 31, 2012. The Group expects such negative working capital to continue into the foreseeable future and will need to obtain new sales orders and additional financing to fund its daily operations. These factors raise substantial doubt about the Group’s ability to continue as a going concern. In order to continue its operations, the Group must obtain additional sales orders to achieve profitable operations, raise more funds, and/or curtail its capital expenditures. The Group implemented plans to postpone spending for capital expenditures and has been and continues to be in negotiations with several domestic banks in China and state-owned companies for additional financing. There can be no assurance, however, that such financing will be successfully completed or completed on terms acceptable to the Group. The Group’s plans of operations, even if successful, may not result in cash flow sufficient to finance and maintain its business. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Please refer to Note 7 – Short Term Loans for additional information.

On March 8, 2013, Bank of China Jiangsu Branch approved CER's application for a loan facility of RMB 130 million (equivalent to approximately $21 million). The effective duration of the loan facility will be five years and CER Yangzhou's land use right and fixed assets will be pledged as collateral. The interest rate will be 20% above the People’s Bank of China’s benchmark rate, which at the current time is 6% within one year, 6.15% from one to three years, and 6.4% from three to five years. It is anticipated that the formal agreement of this loan facility will be arranged and signed off in April 2013.

Cash Flows

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

Operating Activities

Net cash provided by operating activities was $1,848,537 for the year ended December 31, 2012 versus $6,863,131 for the year ended December 31, 2011. The change of cash flows in operating activities was due to the net impact of cash inflows from lower advances on inventory purchases, and inventories; offset by cash outflows for decrease in accounts payable, advances from customers and increase in accounts receivable.

In summary, the cash outflows required were lower than the cash inflow generated from operating activities, which led to the net cash provided by operating activities.

Investing Activities

Net cash used in investing activities was $8,401,342 for the year ended December 31, 2012 compared to net cash used in investing activities of $12,229,249 for the year ended December 31, 2011, a decrease of $3,827,907. The change was mainly due to the lower levels of expenditures incurred for the construction of Phase II of CER Yangzhou plant, and the purchase of an office building in Shanghai in the first half of 2011.

Financing Activities

Net cash provided by financing activities was $4,052,837 for the year ended December 31, 2012 versus net cash provided by financing activities was $5,797,700 for the year ended December 31, 2011, a decrease of $1,744,863. The Company drew down cash of $30,744,479 from short term loans, repaid $21,681,692 of short term loans and $5,000,000 of a convertible note in 2012. In 2011, the Company repaid $3,803,621 of long-term loans and $10,703,605 of short-term loans according to the loan repayment schedule, while it drew down $20,304,926 from short term loans and via discounting of letters of credit.

Capital Resources

The Company’s major capital injections have historically been through borrowings from banks or financial institutions, which are listed in Note 7 to the Company’s Consolidated Financial Statements.

According to common practice of PRC banks, borrowers presenting proper collateral, especially real estate, with good credit, can usually get financing. Due to such unique practices and risk aversion in the banking industry, it is commonplace for short term financing to be secured by a borrower’s long term assets. The Company does not have any over collateralized assets and anticipates that its asset base, coupled with its credit standing and turnover in existing short term borrowings, will be sufficient to incur new borrowings as needed to meet the range of expected cash flow from financing activities.

Tabular Disclosure of Contractual Obligations

The following table sets forth our contractual obligations as of December 31, 2012:

Off-Balance Sheet Arrangements

As of December 31, 2012, we have entered into three financial guarantees to guarantee the payment obligations of one related party Zhenjiang Kailin. CER and Zhenjiang Kailin agreed to engage CGN Energy to provide financing for the portion of the project contract price. CER sold certain equipment integral to the project to CGN Energy. As the financing party, CGN Energy resold the equipment to Zhenjiang Kailin via a structured payment arrangement. If there is any default by Zhenjiang Kailin, CGN Energy must first look for recourse from Zhenjiang Kailin’s pledge for payment of its structured note with CGN Energy; then to Jiangsu SOPO, a third party customer of CER and related party of Zhenjiang Kailin; and finally to CER Yangzhou, which provided CGN Energy with an unconditional and irrevocable guarantee with joint responsibility to ensure that Zhenjiang Kailin will fulfill the duties and responsibilities to pay CGN Energy on time under the waste heat power generation project contract.

The three guarantees consisted of the following:

As of December 31, 2012, Zhenjiang Kailin has made all required payments to CGN Energy in compliance with the payment schedule.

Except for the above, we have not entered into any derivative contracts that are indexed to our shares and classified as stockholder's equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Not applicable. 

Item 8. Financial Statements and Supplementary Data

CHINA ENERGY RECOVERY, INC.

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of

China Energy Recovery, Inc.:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income and comprehensive income, of shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of China Energy Recovery, Inc. and its subsidiaries (collectively, the “Company”) at December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company had accumulated deficits, a negative working capital balance and negative cash flow that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ PricewaterhouseCoopers Zhong Tian CPAs Limited Company

PricewaterhouseCoopers Zhong Tian CPAs Limited Company

Shanghai, the People’s Republic of China

April 16, 2013

CHINA ENERGY RECOVERY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS OF DECEMBER 31, 2011 AND 2012

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

CHINA ENERGY RECOVERY, INC.

CONSOLIDATED STATEMENTS OF  INCOME

AND COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2012

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

CHINA ENERGY RECOVERY, INC. 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

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

CHINA ENERGY RECOVERY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2012