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**FORM 20-F/A**

**Amendment No. 1**

 

| **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  For the fiscal year ended December 31, 2008** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Commissionfile number 000-22113

 
| **EURO TECH HOLDINGS COMPANY LIMITED**                                                               |
|------------------------------------------------------------------------------------------------------|
| (Exact name of Registrant as specified in its charter)                                               |
|                                                                                                 |
| **EURO TECH HOLDINGS COMPANY LIMITED**                                                               |
| (Translation of Registrant’s name into English)                                                 |
|                                                                                                 |
| **British Virgin Islands**                                                                           |
| (Jurisdiction of incorporation or organization)                                                      |
|                                                                                                 |
| **18/F Gee Chang Hong Centre, 65 Wong Chuk Hong  Road, Hong Kong**                                   |
| (Address of principal executive offices)                                                             |
|                                                                                                 |
| **T.C. Leung,  FAX: 852-28734887,  18/F Gee Chang Hong Centre,  65 Wong Chuk Hong Road,  Hong Kong** |
| (Name, telephone, Email and/or Facsimile number and Address of  Company Contact Person)              |

 

Securitiesregistered or to be registered pursuant to Section 12(b) of the Act.

 

Ordinary Shares, $0.01 par value

Name of eachexchange on which registered: NASDAQ

 

Securitiesregistered or to be registered pursuant to Section 12(g) of the Act.

 
| **Not Applicable** |
|--------------------|
| (Title of Class)   |

 

Securitiesfor which there is a reporting obligation pursuant to Section 15(d) ofthe Act.

 
| ** **       |
|------------------|
| (Title of Class) |

 

Indicatethe number of issued and outstanding shares of each of the issuer’s classes ofcapital or common stock as of the close of the period covered by the annualreport. 
|   | 11,820,339  Ordinary Shares. |
|--------|------------------------------|

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. 

x Yes   o No

 

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

o Yes   x No

 

Ifthis is an annual or transitional report, indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or 15(d) ofthe Securities Exchange Act of 1934

o Yes   x No

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of thischapter) during the preceding 12 months (or for such shorter period that theregistrant was required to submit and post such files).

o Yes   o No

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act (checkone).

 

| Large Accelerated filer o |   | Accelerated filer o |   | Non-Accelerated filer x |
|---------------------------|--------|---------------------|--------|-------------------------|

 

Indicateby check mark which basis of accounting the registrant has used to prepare thefinancial statements included in this filing:

 

| U.S. GAAP x |   | International Financial Reporting Standards as issued  by the International Accounting Standards Board o |   | Other o |
|-------------|--------|----------------------------------------------------------------------------------------------------------|--------|---------|

 

If“Other” has been checked in response to the previous question, indicate bycheck mark which financial statement item the registrant has elected to follow.

o Item 17   x Item 18

 

Ifthis is an annual report, indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act)

o Yes   x No

 

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EXPLANATORY NOTE

 

As reported in Item 4A of the Annual Report on Form 20-F filed on June29, 2009 by Euro Tech Holdings Company Limited, a British Virgin Islands corporation(the “Company”), in August 2007, the Company (through its wholly-ownedsubsidiary, Euro Tech (Far East) Limited) acquired a 20% equity interest inZhejiang Tianlan Environmental Protection Technology Co. Ltd. (“BlueSky”), forapproximately US$4,648,000.

 

In connection with BlueSky acquisition, the Company is amending ourAnnual Report on Form 20-F for the fiscal year ended December 31, 2008 toinclude the requisite financial statements for both Euro Tech Holdings CompanyLimited and Zhejiang Tianlan Environmental Protection Technology Co. Ltd. Thisamendment includes only Item 18, the signature page, and the certificationspursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Exhibits 12.1, 12.2,13.1 and 13.2).

 

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**TABLE OFCONTENTS**

 
|     |       | PART III         | ** ** | ** ** |
|----------|------------|-----------------------|------------|------------|
|     | ** ** |                  |       |       |
| ITEM 18. |       | FINANCIAL  STATEMENTS |       | 1          |
|     |       |                  |       |       |
| ITEM 19. |       | EXHIBITS              |       | 1          |

 

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**PART III**

 

**ITEM 18.****      ****FINANCIAL STATEMENTS**

 

The following financialstatements are filed as part of this annual report on Form 20-F/A.

 
| Euro Tech Holdings Company Limited                                              |
|---------------------------------------------------------------------------------|
|                                                                            |
| Report of Independent Registered Public Accounting  Firm                        |
|                                                                            |
| Consolidated balance sheets                                                     |
|                                                                            |
| Consolidated statements of income                                               |
|                                                                            |
| Consolidated statements of cash flows and changes in  shareholders’ equity |
|                                                                            |
|                                                                            |
| Zhejiang Tianlan Environmental Protection Technology  Company Limited           |
|                                                                            |
| Report of Independent Registered Public Accounting  Firm                        |
|                                                                            |
| Consolidated balance sheets                                                     |
|                                                                            |
| Consolidated statements of income                                               |
|                                                                            |
| Cash flows and changes in shareholders’ equity                             |

 

**ITEM 19.****      ****EXHIBITS**

 

List of Exhibits

 

1

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                                     |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                |
| 12.1                 |       | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 *                                                         |
|                 |       |                                                                                                                                                                |
| 12.2                 |       | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 *                                                         |
|                 |       |                                                                                                                                                                |
| 13.1                 |       | Certification of the  Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *  |
|                 |       |                                                                                                                                                                |
| 13.2                 |       | Certification of the  Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 * |

 

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| * |   | Filed Herewith |
|---|--------|----------------|

 

2

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**SIGNATURES**

 

Pursuant to therequirements of Section 12 of the Securities Exchange Act of 1934, theregistrant certifies that it meets all of the requirements for filing on Form 20-F/Aand has duly caused this annual report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|                      | **EURO  TECH HOLDINGS COMPANY LIMITED**            |
|---------------------------|----------------------------------------------------|
|                      | (Registrant)                                       |
|                      |                                               |
|                      |                                               |
|                      | /s/ T.C. Leung                                     |
|                      | T.C. Leung,                                        |
|                      | Chief Executive Officer  and Chairman of the Board |
|                      |                                               |
|                      |                                               |
| Dated: June 28, 2010 |                                               |

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 
| **AUDITED CONSOLIDATED BALANCE SHEETS**                                     |
|-----------------------------------------------------------------------------|
|                                                                        |
| **AS OF DECEMBER 31, 200****8****AND 200****7****AND**                      |
| ** **                                                                  |
| **CONSOLIDATED STATEMENTS OF INCOME,**                                      |
|                                                                        |
| **CONSOLIDATED CASH FLOWS AND CHANGES IN  SHAREHOLDERS’ EQUITY**       |
| ** **                                                                  |
| **FOR THE YEARS ENDED DECEMBER 31, 200****8****, 200****7****AND 200****6** |
|                                                                        |
| **TOGETHER WITH REPORT OF INDEPENDENT REGISTERED**                          |
|                                                                        |
| **PUBLIC ACCOUNTING FIRM**                                                  |

 

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**Report of Independent Registered Public Accounting Firm**

 

To the Board of Directors and shareholders of

Euro Tech Holdings Company Limited

 

We have audited the accompanying consolidatedbalance sheets of Euro Tech Holdings Company Limited as of December 31,2008 and 2007 and the related consolidated statements of operations, shareholders’equity and cash flows for the years ended December 31, 2008, 2007 and2006. These financial statements are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

We conducted our audit in accordance with standardsof the Public Company Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement.  The Company is not required to have, nor werewe engaged to perform, an audit of its internal control over financialreporting.  The audit includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, theconsolidated financial position of Euro Tech Holdings Company Limited as of December 31,2008 and 2007 and the results of its consolidated operations and cash flows forthe years ended December 31, 2008, 2007 and 2006, in conformity withgenerally accepted accounting principles in the United States of America.

 

 

/s/ BDOLimited

 

 

Hong Kong, June 26,2009

 

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**EURO TECH HOLDINGS COMPANY LIMITED**

 

**CONSOLIDATED BALANCE SHEETS**

**AS OF DECEMBER 31**

 
| ** **                                                                                                                                             | ** ** | **Note**             | ** ** | **200****8**     | ** ** | **200****7**     | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                                                             | ** ** | ** **           | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Assets                                                                                                                                                 |       |                 |       |             |       |             |       |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Current assets:                                                                                                                                        |       |                 |       |             |       |             |       |
| Cash and cash equivalents                                                                                                                              |       |                 |       | 7,146            |       | 9,387            |       |
| Restricted  cash                                                                                                                                       |       |                 |       | 388              |       | 332              |       |
| Accounts receivable, net                                                                                                                               |       | 6                    |       | 6,707            |       | 4,968            |       |
| Prepayments and other  current assets                                                                                                                  |       |                 |       | 1,041            |       | 912              |       |
| Inventories, net                                                                                                                                       |       | 7                    |       | 2,600            |       | 2,012            |       |
| Taxation recoverable                                                                                                                                   |       |                 |       | —           |       | 12               |       |
| Total current assets                                                                                                                                   |       |                 |       | 17,882           |       | 17,623           |       |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Property, plant and  equipment, net                                                                                                                    |       | 8 & 21(iii) |       | 1,513            |       | 1,622            |       |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Investments in affiliates                                                                                                                              |       | 9                    |       | 7,679            |       | 5,046            |       |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Goodwill                                                                                                                                               |       | 12                   |       | 1,060            |       | 1,060            |       |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Deferred tax assets                                                                                                                                    |       | 4                    |       | 144              |       | 131              |       |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Total assets                                                                                                                                           |       |                 |       | 28,278           |       | 25,482           |       |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Liabilities and  shareholders’ equity                                                                                                             |       |                 |       |             |       |             |       |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Current liabilities:                                                                                                                                   |       |                 |       |             |       |             |       |
| Accounts payable                                                                                                                                       |       |                 |       | 5,838            |       | 3,112            |       |
| Other payables and accrued  expenses                                                                                                                   |       | 10                   |       | 2,844            |       | 3,892            |       |
| Taxation payable                                                                                                                                       |       |                 |       | 617              |       | 520              |       |
| Total current liabilities                                                                                                                              |       |                 |       | 9,299            |       | 7,524            |       |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Minority  interest                                                                                                                                     |       |                 |       | 1,986            |       | 1,545            |       |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Commitments and  contingencies                                                                                                                         |       | 19                   |       | —           |       | —           |       |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Shareholders’ equity:                                                                                                                             |       |                 |       |             |       |             |       |
| Ordinary share, par value  US$0.01 each, 20,000,000 (2007: 20,000,000)  shares authorized; 12,202,031 (2007: 12,024,901) shares issued and outstanding |       | 11                   |       | 122              |       | 120              |       |
| Additional paid-in capital                                                                                                                             |       |                 |       | 9,495            |       | 9,229            |       |
| Treasury stock, 381,692 (2007: 340,651) shares at cost                                                                                                 |       | 13                   |       | (281             | )          | (237             | )          |
| PRC statutory reserve                                                                                                                                  |       | 14                   |       | 200              |       | 165              |       |
| Accumulated other  comprehensive income                                                                                                                |       |                 |       | 478              |       | 271              |       |
| Retained earnings                                                                                                                                      |       |                 |       | 6,979            |       | 6,865            |       |
| Total shareholders’ equity                                                                                                                        |       |                 |       | 16,993           |       | 16,413           |       |
|                                                                                                                                                   |       |                 |       |             |       |             |       |
| Total liabilities and  shareholders’ equity                                                                                                       |       |                 |       | 28,278           |       | 25,482           |       |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**EURO TECH HOLDINGS COMPANY LIMITED**

 

**CONSOLIDATED STATEMENTS OF INCOME**

**FOR THE YEARS ENDED DECEMBER 31, 200****8,****200****7****AND 200****6**

** **
| ** **                                                                       | ** ** | **Note**         | ** ** | **200****8**     | ** ** | **200****7**     | ** ** | **200****6**     | ** ** |
|----------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                       | ** ** | ** **       | ** ** | **US$’000** | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
|                                                                             |       |             |       |             |       |             |       |             |       |
| Revenue                                                                          |       |             |       |             |       |             |       |             |       |
| Trading and manufacturing                                                        |       |             |       | 21,439           |       | 20,010           |       | 22,243           |       |
| Engineering                                                                      |       |             |       | 10,299           |       | 7,220            |       | 4,918            |       |
|                                                                             |       |             |       |             |       |             |       |             |       |
| Total revenue                                                                    |       | 21(i) & (ii) |       | 31,738           |       | 27,230           |       | 27,161           |       |
|                                                                             |       |             |       |             |       |             |       |             |       |
| Cost of revenue                                                                  |       |             |       |             |       |             |       |             |       |
| Trading and manufacturing                                                        |       |             |       | (16,618          | )          | (15,406          | )          | (17,321          | )          |
| Engineering                                                                      |       |             |       | (7,536           | )          | (4,992           | )          | (3,285           | )          |
|                                                                             |       |             |       |             |       |             |       |             |       |
| Total cost of revenue                                                            |       |             |       | (24,154          | )          | (20,398          | )          | (20,606          | )          |
| Gross profit                                                                     |       |             |       | 7,584            |       | 6,832            |       | 6,555            |       |
|                                                                             |       |             |       |             |       |             |       |             |       |
| Selling and administrative  expenses                                             |       |             |       | (7,213           | )          | (6,585           | )          | (5,961           | )          |
| Operating income                                                                 |       |             |       | 371              |       | 247              |       | 594              |       |
| Interest income                                                                  |       |             |       | 45               |       | 256              |       | 95               |       |
| Other income, net                                                                |       | 3                |       | 144              |       | 161              |       | 146              |       |
| Income before income taxes, minority interest and equity in profit of affiliates |       |             |       | 560              |       | 664              |       | 835              |       |
|                                                                             |       |             |       |             |       |             |       |             |       |
| Income taxes                                                                     |       | 4                |       | (321             | )          | (144             | )          | (156             | )          |
|                                                                             |       |             |       |             |       |             |       |             |       |
| Minority interest in profits of subsidiaries                                     |       |             |       | (363             | )          | (345             | )          | (318             | )          |
|                                                                             |       |             |       |             |       |             |       |             |       |
| Equity in profit of  affiliates                                                  |       |             |       | 273              |       | 247              |       | —           |       |
| Net  income for the year                                                         |       |             |       | 149              |       | 422              |       | 361              |       |
|                                                                             |       |             |       |             |       |             |       |             |       |
| Net income per ordinary  share                                                   |       |             |       |             |       |             |       |             |       |
| - Basic                                                                          |       |             |       | US$              | 0.01       |             | US$        | 0.04             |       | US$ | 0.04 |   |
|                                                                             |       |             |       |             |       |             |       |             |       |
| - Diluted                                                                        |       |             |       | US$              | 0.01       |             | US$        | 0.03             |       | US$ | 0.03 |   |
| Weighted average number of  ordinary shares outstanding                          |       |             |       |             |       |             |       |             |       |
| - Basic                                                                          |       | 5                |       | 11,824,153       |       | 11,105,556       |       | 8,047,911        |       |
|                                                                             |       |             |       |             |       |             |       |             |       |
| - Diluted                                                                        |       | 5                |       | 12,212,058       |       | 12,095,335       |       | 10,787,420       |       |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**EURO TECH HOLDINGS COMPANY LIMITED**

 

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**FOR THE YEARS ENDED DECEMBER 31, 200****8****, 200****7****AND 200****6**

 
| ** **                                                                                   | ** ** | **200****8**         | ** ** | **200****7**         | ** ** | **200****6**         | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                                   | ** ** | **US$’000**     | ** ** | **US$’000**     | ** ** | **US$’000**     | ** ** |
| Cash flows from operating  activities:                                                       |       |                 |       |                 |       |                 |       |
| Net income                                                                                   |       | 149                  |       | 422                  |       | 361                  |       |
| Adjustments to reconcile  net income to net cash provided by (used in) operating activities: |       |                 |       |                 |       |                 |       |
| Depreciation of property,  plant and equipment                                               |       | 218                  |       | 232                  |       | 216                  |       |
| Stock  based compensation expense                                                            |       | 217                  |       | 148                  |       | —               |       |
| Loss  (Gain) on disposal of property, plant and equipment                                    |       | 1                    |       | (19                  | )          | 1                    |       |
| Minority  interest in profits of subsidiaries                                                |       | 363                  |       | 345                  |       | 318                  |       |
| Equity in profit of  affiliates                                                              |       | (273                 | )          | (247                 | )          | —               |       |
| Deferred tax assets                                                                          |       | (10                  | )          | (96                  | )          | —               |       |
| Deferred  tax liabilities                                                                    |       | —               |       | —               |       | (4                   | )          |
| (Increase) decrease in  current assets:                                                      |       |                 |       |                 |       |                 |       |
| Accounts receivable, net                                                                     |       | (1,739               | )          | (54                  | )          | 553                  |       |
| Prepayments and other  current assets                                                        |       | (129                 | )          | (189                 | )          | (80                  | )          |
| Inventories, net                                                                             |       | (588                 | )          | 16                   |       | 704                  |       |
| Taxation recoverable                                                                         |       | 12                   |       | —               |       | 30                   |       |
| Increase (decrease) in  current liabilities:                                                 |       |                 |       |                 |       |                 |       |
| Accounts payable                                                                             |       | 2,726                |       | (1,080               | )          | (435                 | )          |
| Other payables and accrued  expenses                                                         |       | (400                 | )          | 896                  |       | (222                 | )          |
| Taxation payable                                                                             |       | 97                   |       | 75                   |       | 23                   |       |
| Net cash provided by  operating activities                                                   |       | 644                  |       | 449                  |       | 1,465                |       |
| Cash flows from investing  activities:                                                       |       |                 |       |                 |       |                 |       |
| Purchase of property,  plant and equipment                                                   |       | (99                  | )          | (250                 | )          | (106                 | )          |
| Proceeds  on disposal of property, plant and equipment                                       |       | —               |       | 43                   |       | —               |       |
| Dividend  received from affiliates                                                           |       | 294                  |       | —               |       | —               |       |
| Investments  in affiliates                                                                   |       | (3,302               | )          | (4,151               | )          | —               |       |
| Restricted  cash for issuance of bank guarantees                                             |       | (56                  | )          | 83                   |       | (111                 | )          |
| Dividend  paid to minority interest                                                          |       | —               |       | (140                 | )          | (135                 | )          |
| Net cash used in investing  activities                                                       |       | (3,163               | )          | (4,415               | )          | (352                 | )          |
| Cash flows from financing  activities:                                                       |       |                 |       |                 |       |                 |       |
| Issuance  of ordinary shares on exercise of options                                          |       | 51                   |       | 3,720                |       | 2,607                |       |
| Purchase  of treasury stock                                                                  |       | (44                  | )          | —               |       | —               |       |
| Cash  from issuance of registered capital in subsidiary to minority interest                 |       | —               |       | 200                  |       | —               |       |
| Net cash provided by financing activities                                                    |       | 7                    |       | 3,920                |       | 2,607                |       |
| Effect of exchange rate  changes on cash and cash equivalents                                |       | 271                  |       | 273                  |       | 78                   |       |
|                                                                                         |       |                 |       |                 |       |                 |       |
| Net (decrease)/increase in cash and cash equivalents                                         |       | (2,241               | )          | 227                  |       | 3,798                |       |
| Cash and cash equivalents,  beginning of year                                                |       | 9,387                |       | 9,160                |       | 5,362                |       |
| Cash and cash equivalents,  end of year                                                      |       | 7,146                |       | 9,387                |       | 9,160                |       |
|                                                                                         |       |                 |       |                 |       |                 |       |
| ** **                                                                                   | ** ** | **US$****’000** | ** ** | **US$****’000** | ** ** | **US$****’000** | ** ** |
| Supplementary information                                                                    |       |                 |       |                 |       |                 |       |
| Interest received                                                                            |       | 45                   |       | 256                  |       | 95                   |       |
| Interest paid                                                                                |       | —               |       | —               |       | —               |       |
| Income taxes paid                                                                            |       | 233                  |       | 166                  |       | 125                  |       |
| Shares  surrendered for exercise of stock options                                            |       | 73                   |       | 155                  |       | 168                  |       |

 

As at December 31, 2007 there was a final consideration ofUS$648,000 payable in relation to the acquisition of Zhejiang Tianlan Desulfurization and Dust—Removal Co., Ltd. included inother payables and accrued expenses.

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**EURO TECH HOLDINGS COMPANY LIMITED**

** **

**CONSOLIDATED STATEMENTS OFCHANGES IN SHAREHOLDERS’ EQUITY**

**FOR THE YEARS ENDED DECEMBER 31, 200****8****, 200****7****AND 200****6**

 
|                                                                 |       | **Number  of****Ordinary  share** |       | **Ordinary  share** |       | **Additional  paid-in  capital** |       | **Treasury  stock** |       | **Accumulated  other  comprehensive  income  (loss)** |       | **PRC  statutory  reserve** |       | **Retained  earnings** |       | **Total**        |       |
|----------------------------------------------------------------------|------------|-----------------------------------|------------|---------------------|------------|----------------------------------|------------|---------------------|------------|-------------------------------------------------------|------------|-----------------------------|------------|------------------------|------------|------------------|------------|
| ** **                                                           | ** ** | ** **                        | ** ** | **US$’000**    | ** ** | **US$’000**                 | ** ** | **US$’000**    | ** ** | **US$’000**                                      | ** ** | **US$’000**            | ** ** | **US$’000**       | ** ** | **US$’000** | ** ** |
|                                                                 |       |                              |       |                |       |                             |       |                |       |                                                  |       |                        |       |                   |       |             |       |
| Balance as of January 1, 2006                                   |       | 7,363,002                         |       | 74                  |       | 2,800                            |       | (237                | )          | (10                                                   | )          | 72                          |       | 6,193                  |       | 8,892            |       |
| Net income                                                           |       | —                            |       | —              |       | —                           |       | —              |       | —                                                |       | —                      |       | 361                    |       | 361              |       |
| Other  comprehensive income: Foreign exchange translation adjustment |       | —                            |       | —              |       | —                           |       | —              |       | 79                                                    |       | —                      |       | —                 |       | 79               |       |
| Total  comprehensive income                                          |       |                              |       |                |       |                             |       |                |       |                                                  |       |                        |       |                   |       | 440              |       |
| Shares  surrendered for exercise of stock options                    |       | (36,700                           | )          | —              |       | (168                             | )          | —              |       | —                                                |       | —                      |       | —                 |       | (168             | )          |
| Exercise  of stock options                                           |       | 2,048,890                         |       | 20                  |       | 2,706                            |       | —              |       | —                                                |       | —                      |       | —                 |       | 2,726            |       |
| Transfer of reserve                                                  |       | —                            |       | —              |       | —                           |       | —              |       | —                                                |       | 16                          |       | (32                    | )          | (16              | )          |
| Stock-based  compensation expense                                    |       | —                            |       | —              |       | 49                               |       | —              |       | —                                                |       | —                      |       | —                 |       | 49               |       |
| Balance  as of December 31, 2006                                |       | 9,375,192                         |       | 94                  |       | 5,387                            |       | (237                | )          | 69                                                    |       | 88                          |       | 6,522                  |       | 11,923           |       |
| Net income                                                           |       | —                            |       | —              |       | —                           |       | —              |       | —                                                |       | —                      |       | 422                    |       | 422              |       |
| Other  comprehensive income: Foreign exchange translation adjustment |       | —                            |       | —              |       | —                           |       | —              |       | 202                                                   |       | —                      |       | —                 |       | 202              |       |
| Total  comprehensive income                                          |       |                              |       |                |       |                             |       |                |       |                                                  |       |                        |       |                   |       | 624              |       |
| Shares  surrendered for exercise of stock options                    |       | (45,537                           | )          | (1                  | )          | (154                             | )          | —              |       | —                                                |       | —                      |       | —                 |       | (155             | )          |
| Exercise  of stock options                                           |       | 2,695,246                         |       | 27                  |       | 3,848                            |       | —              |       | —                                                |       | —                      |       | —                 |       | 3,875            |       |
| Transfer of reserve                                                  |       | —                            |       | —              |       | —                           |       | —              |       | —                                                |       | 77                          |       | (79                    | )          | (2               | )          |
| Stock-based  compensation expense                                    |       | —                            |       | —              |       | 148                              |       | —              |       | —                                                |       | —                      |       | —                 |       | 148              |       |
| Balance  as of December 31, 2007                                |       | 12,024,901                        |       | 120                 |       | 9,229                            |       | (237                | )          | 271                                                   |       | 165                         |       | 6,865                  |       | 16,413           |       |
| Net income                                                           |       | —                            |       | —              |       | —                           |       | —              |       | —                                                |       | —                      |       | 149                    |       | 149              |       |
| Other  comprehensive income: Foreign exchange translation adjustment |       | —                            |       | —              |       | —                           |       | —              |       | 207                                                   |       | —                      |       | —                 |       | 207              |       |
| Total  comprehensive income                                          |       |                              |       |                |       |                             |       |                |       |                                                  |       |                        |       |                   |       | 356              |       |
| Purchase  of treasury stock                                          |       | —                            |       | —              |       | —                           |       | (44                 | )          | —                                                |       | —                      |       | —                 |       | (44              | )          |
| Shares  surrendered for exercise of stock options                    |       | (31,240                           | )          | —              |       | (73                              | )          | —              |       | —                                                |       | —                      |       | —                 |       | (73              | )          |
| Exercise  of stock options                                           |       | 208,370                           |       | 2                   |       | 122                              |       | —              |       | —                                                |       | —                      |       | —                 |       | 124              |       |
| Transfer of reserve                                                  |       | —                            |       | —              |       | —                           |       | —              |       | —                                                |       | 35                          |       | (35                    | )          | —           |       |
| Stock-based  compensation expense                                    |       | —                            |       | —              |       | 217                              |       | —              |       | —                                                |       | —                      |       | —                 |       | 217              |       |
| Balance  as of December 31, 2008                                |       | 12,202,031                        |       | 122                 |       | 9,495                            |       | (281                | )          | 478                                                   |       | 200                         |       | 6,979                  |       | 16,993           |       |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTESTO THE CONSOLIDATED FINANCIAL STATEMENTS**

 

**1****             ****Organizationand principal activities**

 

Euro Tech Holdings CompanyLimited (the “Company”) was incorporated in the British Virgin Islands on September 30,1996.

 

Euro Tech (Far East) Limited(“Far East”) is the principal operating subsidiary of the Company.  It is principally engaged in the marketingand trading of water and waste water related process control, analytical andtesting instruments, disinfection equipment, supplies and related automationsystems in Hong Kong and in the People’s Republic of China (the “PRC”).

 

Details of the Company’s significantsubsidiaries and affiliates are summarized as follows:

 
| **Name**                                                       | ** ** | **Percentage  of equity  ownership** | ** ** | **Place of  incorporation** | ** ** | **Principal activities**                                                                                                                                                       |
|----------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                           |       |                                 |       |                        |       |                                                                                                                                                                           |
| Subsidiaries:                                                  |       |                                 |       |                        |       |                                                                                                                                                                           |
|                                                           |       |                                 |       |                        |       |                                                                                                                                                                           |
| Euro  Tech (Far East) Limited                                  |       | 100%                                 |       | Hong Kong                   |       | Marketing  and trading of water and waste water related process control, analytical and  testing instruments, disinfection equipment, supplies and related automation  systems |
|                                                           |       |                                 |       |                        |       |                                                                                                                                                                           |
| Euro  Tech (China) Limited                                     |       | 100%                                 |       | Hong Kong                   |       | Inactive                                                                                                                                                                       |
|                                                           |       |                                 |       |                        |       |                                                                                                                                                                           |
| ChinaH2O.com  Limited                                          |       | 100%                                 |       | Hong Kong                   |       | Internet  content provider and provision of marketing services for environmental  industry to the Company and its  subsidiaries                                                |
|                                                           |       |                                 |       |                        |       |                                                                                                                                                                           |
| Euro  Tech Trading (Shanghai) Limited                          |       | 100%                                 |       | The PRC                     |       | Marketing  and trading of water and waste water related process control, analytical and  testing instruments, disinfection equipment, supplies and related automation  systems |
|                                                           |       |                                 |       |                        |       |                                                                                                                                                                           |
| Shanghai  Euro Tech Limited                                    |       | 100%                                 |       | The PRC                     |       | Manufacturing  of analytical and testing equipment                                                                                                                             |
|                                                           |       |                                 |       |                        |       |                                                                                                                                                                           |
| Shanghai  Euro Tech Environmental  Engineering Company Limited |       | 100%                                 |       | The PRC                     |       | Undertaking water and waste-water  treatment engineering projects                                                                                                              |
|                                                           |       |                                 |       |                        |       |                                                                                                                                                                           |
| Chongqing Euro Tech Rizhi Technology Co., Ltd             |       | 100%                                 |       | The PRC                     |       | Marketing  and trading of water and waste water related process control, analytical and  testing instruments, disinfection equipment, supplies and related automation  systems |
|                                                           |       |                                 |       |                        |       |                                                                                                                                                                           |
| Rizhi  Euro Tech Instrument (Shaanxi) Co., Ltd            |       | 100%                                 |       | The PRC                     |       | Marketing  and trading of water and waste water related process control, analytical and                                                                                        |

 

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|                                                             |   |   |   |                       |   | testing instruments,  disinfection equipment, supplies and related automation systems                                                                                          |
|------------------------------------------------------------------|--------|--------|--------|----------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                             |   |   |   |                       |   |                                                                                                                                                                           |
| Guangzhou Euro Tech Environmental Equipment Co., Ltd             |   | 100%   |   | The PRC                    |   | Marketing  and trading of water and waste water related process control, analytical and  testing instruments, disinfection equipment, supplies and related automation  systems |
|                                                             |   |   |   |                       |   |                                                                                                                                                                           |
| Yixing  Pact Environmental Technology Co., Ltd              |   | 51%    |   | The PRC                    |   | Design,  manufacturing and operation of water and waste water treatment machinery and  equipment                                                                               |
|                                                             |   |   |   |                       |   |                                                                                                                                                                           |
| Pact  Asia Pacific Limited                                       |   | 51%    |   | The British Virgin Islands |   | Producing  and selling of environment protection equipment, undertaking environment  protection projects and providing relevant technology advice, training and  services      |
|                                                             |   |   |   |                       |   |                                                                                                                                                                           |
| Affiliates:                                                      |   |   |   |                       |   |                                                                                                                                                                           |
|                                                             |   |   |   |                       |   |                                                                                                                                                                           |
| Zhejiang Tianlan Desulfurization and Dust—Removal  Co. Ltd. |   | 20%*   |   | The PRC                    |   | Design, general contract, equipment  manufacturing, installation, testing and operation management of the  treatment of waste gases emitted                                    |
|                                                             |   |   |   |                       |   |                                                                                                                                                                           |
| Zhejaing Jia Huan Electronic Co. Ltd.                            |   | 20%**  |   | The  PRC                   |   | Design and manufacturing automatic control systems and electric voltage  control equipment for electrostatic precipitators (air  purification equipment)                       |

 

----

* In the year2007, the Company acquired 20% equity interest of this company.

 

** In the year2008, the Company acquired 20% equity interest of this company.

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**2****             ****Summaryof significant accounting policies**

 

**(a)****         ****Basis of Consolidation**

 

The consolidated financialstatements include the accounts of Euro Tech Holdings Company Limited and itssubsidiaries (the “Group”).  Thefinancial statements of variable interest entities (“VIEs”), as defined by the Financial Accounting Standards Board (“FASB”) InterpretationNo. 46 (R) (“FIN 46 (R)”), are included in the consolidated financialstatements, if applicable.  In January 2003,the FASB issued FASB Interpretation No. 46 (FIN 46), “Consolidation ofVariable Interest Entities” and amended it by issuing FIN 46 (R) in December 2003.  FIN 46 (R) addresses consolidation bybusiness enterprises of VIEs that either: (1) do not have sufficientequity investment at risk to permit the entity to finance its activitieswithout additional subordinated financial support, or (2) have equityinvestors that lack an essential characteristic of a controlling financialinterest.

 

The Group identified thatcertain retail shops established in the PRC qualified as variable interestentities as defined in FIN 46 (R).  Theretail shops are principally engaged in the retailing business of water andwaste water related process control, analytical and testing instruments,disinfection equipment, supplies and related automation systems.  The Company is the primary beneficiary ofthese retail shops and, accordingly, consolidated their financial statementseffective December 31, 2004.  TheCompany has a controlling financial interest in these retail shops and issubject to a majority of the risk of loss from the retailing activities, and isentitled to receive a majority of the retail shops’ residual returns.  Total assets and liabilities of theseconsolidated VIEs total US$107,386 and US$66,412, as of December 31, 2008 and US$150,602and US$289,127, as of December 31,2007, respectively.  The cumulative losses onconsolidating these VIEs in the Group’s consolidated statement of income in 2008 were US$41,443 (2007: profits ofUS$17,638 and 2006: losses of US$152,723), including taxes of US$3,126 (2007: US$11,118 and 2006: US$6,814).  The assets of the entities consist mainly ofcash and bank balances, trade and other receivables, inventories and property,plant and equipment.   The creditors ofthese entities do not have recourse to the general credit of the Group.  The Group will provide all the neededfinancing for the VIEs.

 

Investments in businessentities in which the Company does not have control, but has the ability toexercise significant influence over operating and financial policies (generally20-50 percent ownership), are accounted for using the equity method ofaccounting.  All material intercompanybalances and transactions have been eliminated on consolidation.

 

**(b)****         ****Subsidiaries**

 

A subsidiary is a company in which theCompany holds, directly or indirectly, more than 50% of its outstanding votingshare capital and over which it is able to exercise control.

 

**(c)****         ****Revenue Recognition**

 

The Group’s main source ofrevenue is the sale of water and waste water related process control,analytical and testing instruments, disinfection equipment, supplies andrelated automation systems. The Company recognizes revenue when the product isdelivered and the title is transferred. For certain products where installation is necessary, revenue isrecognized upon completion of installation. Revenue earned from customersupport services, which represents a minor percentage of total revenues, isrecognized when such services are provided.

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**2****             ****Summaryof significant accounting policies (Continued)**

 

**(c)****         ****Revenue Recognition (Continued)**

 

Revenues and profits in longterm fixed price contracts or the engineering income are recorded under thepercentage of completion methodin accordance with SOP 81-1, “Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts”.This approachrelies on estimates of total expected direct costs at completion, which arecompared to actual direct costs incurred to date to arrive at an estimate ofrevenue and profit earned to date. Recognized revenue and profit are subject to revisions as the contractprogresses to completion.  Revisions toprofit estimates are reflected in income in the period in which the facts thatgive rise to the revision become known. Forany contract where it is identified that a loss will be incurred, the full losswill be recognized immediately. 

 

**(d)****         ****Research and Development Costs**

 

Research and developmentcosts (“R&D” costs) are expensed as incurred.  The R&D costs amounted to approximatelyUS$89,000, US$47,000 and US$55,000 for theyears ended December 31, 2008, 2007 and 2006 respectivelyand were included in “Selling and Administrative” expenses****inthe Group’s consolidated statement of income.

 

**(e)****         ****Advertising and promotionalexpenses**

 

Advertising and promotionalexpenses (“A&P” expenses) are expensed as incurred.  The A&P expenses amounted to approximatelyUS$40,000, US$78,000 and US$76,000 for theyears December 31, 2008, 2007 and 2006 respectivelyand were included in “Selling and Administrative” expenses****inthe Group’s consolidated statement of income.

 

**(f)****          ****Taxation**

 

The Group accounts forincome and deferred tax under the provision of Statement of FinancialAccounting Standards (“SFAS”) No. 109: “Accounting for Income Taxes”,under which deferred taxes are recognized for all temporary differences betweenthe applicable tax balance sheets and the consolidated balance sheet.  Deferred tax assets and liabilities arerecognized for the estimated future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. SFAS No. 109 also requires the recognition of the future taxbenefits of net operating loss carry forwards. A valuation allowance is established when the deferred tax assets arenot expected to be realized within a reasonable period of time.

 

Effective January 1, 2007, the Company adoptedFIN No. 48, “Accounting for Uncertainty in Income Taxes.” In accordancewith FIN No. 48, the Company recognizes tax benefits that satisfy agreater than 50% probability threshold and provides for the estimated impact ofinterest and penalties for such tax benefits. The Company did not have such uncertain tax positions in 2007 and 2008.

 

Deferred tax assets andliabilities are measured using the enacted tax rates expected to be applicablefor taxable income in the years in which temporary differences are expected tobe recovered or settled.  The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inincome for the period that includes the enactment date.

 

Note 4 shows the applicabletax rates for individual subsidiary and variable interest entities, as well asthe major temporary differences so recorded.

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**2****             ****Summaryof significant accounting policies (Continued)**

 

**(g)****         ****Cash and Cash Equivalents**

 

Cash and cash equivalentsinclude cash on hand and demand depositswith banks.

 

**(h)****         ****Receivables and Other Assets**

 

Receivables and other assetsare recorded at their nominal values. Valuation allowances are provided for identified individual risks forthese line items.  If the loss of a certainpart of the receivables is probable, valuation allowances are provided to coverthe expected loss.  Receivables arewritten off against the allowance after all means of collection have beenexhausted and the potential for recovery is considered remote.

 

**(i)****          ****Inventories**

 

Inventories are stated atthe lower of cost, on the first-in, first-out method, or market value.  Costsinclude purchase and related costs incurred in bringing each product to itspresent location and condition.  Market value is calculated based on the estimated normalselling price, less further costs expected to be incurred for disposal.  Provision is made for obsolete, slow movingor defective items, where appropriate.

 

**(j)****          ****Property,Plant and Equipment**

 

Property, plant andequipment are stated at cost less accumulated depreciation. Gains or losses ondisposal are reflected in current operations. Major expenditures for betterments and renewals are capitalized.  All ordinary repair and maintenance costs areexpensed as incurred.  Depreciation ofproperty, plant and equipment is computed using the straight-line method overthe assets’ estimated useful lives as follows:

 
| Office premises                           |   | 47 to 51 years                                                 |
|-------------------------------------------|--------|----------------------------------------------------------------|
| Leasehold improvements                    |   | over terms of the leases or the useful lives whichever is less |
| Furniture, fixtures and  office equipment |   | 3 to 5 years                                                   |
| Motor vehicles                            |   | 4 years                                                        |
| Testing equipment                         |   | 3 years                                                        |

 

**(k)****        ****Impairment**

 

The Group has adopted SFAS No. 144:“Accounting for Impairment or Disposal of Long-Lived Assets” which requiresimpairment losses to be recorded for property, plant and equipment to be heldand used in operations when indicators of impairment are present.  Reviews are regularly performed to determinewhether the carrying value of assets is impaired.  The Group determines the existence of suchimpairment by measuring the expected future cash flows (undiscounted andwithout interest charges) and comparing such amount to the carrying amount ofthe assets.  An impairment loss, if oneexists, is then measured as the amount by which the carrying amount of theasset exceeds the discounted estimated future cash flows. Assets to be disposedof are reported at the lower of the carrying amount or fair value of suchassets less costs to sell.  Assetimpairment charges are recorded to reduce the carrying amount of the long-livedasset that will be sold or disposed of to their estimated fair values. Chargesfor the asset impairment reduce the carrying amount of the long-lived assets totheir estimated salvage value in connection with the decision to dispose ofsuch assets.  There were no impairmentlosses recorded during each of the three years ended December 31, 2008.

 

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**EUROTECH HOLDINGS COMPANY LIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**2****             ****Summaryof significant accounting policies (Continued)**

 

**(l)****          ****OperatingLeases**

 

Leases where substantiallyall the risks and rewards of ownership of the leased assets remain with thelessors are accounted for as operating leases. Rental payments under operating leases are charged to expense on thestraight-line basis over the period of the relevant leases.

 

**(m)****        ****Goodwill**

 

The Group has adopted SFASNo.142: “Goodwill and other intangible assets” which assess the possibleimpairment of goodwill existing at the date of adoption and perform asubsequent impairment test on an annual basis.

 

**(n)****         ****Foreign Currency Translation**

 

The Company maintains itsbooks and records in United States dollars. Its subsidiaries and affiliates maintain their books and records eitherin Hong Kong dollars or Chinese Renminbi (“functional currencies”).  Foreign currency transactions during the yearare translated into the respective functional currencies at the applicablerates of exchange at the dates of the transactions.  Monetary assets and liabilities denominatedin foreign currencies are translated into the respective functional currenciesusing the exchange rates prevailing at the balance sheet dates.  Gains or losses from foreign currencytransactions are recognized in the consolidated statements of income during theyear in which they occur.  Translationadjustments on subsidiaries’ equity are included as cumulative translationadjustments.

 

**(o)****         ****Derivative Instruments andHedging Activities**

 

SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities” (“SFAS 133”), as amended bySFAS No. 137, “Accounting for Derivative Instruments and HedgingActivities — Deferral of the Effective Date of FASB Statement No. 133 — anamendment of FASB Statement No. 133”, and SFAS No. 138, “Accountingfor Certain Derivative Instruments and Certain Hedging Activities — anamendment of FASB Statement No. 133”, as well as the interpretations ofthe Derivatives Implementation Group (“DIG”), are applied as amended by SFAS No. 149,“Amendment of Statement 133 on Derivative Instruments and Hedging Activities”.  SFAS No. 133 contains accounting andreporting standards for hedging accounting and for derivative financialinstruments, including certain derivative financial instruments embedded inother contracts.

 

SFAS No. 133 requiresthat all derivatives be recognized as either assets or liabilities in theconsolidated balance sheet and measured at fair value.  Depending on the documented designation of aderivative instrument, any change in fair value is recognized either in netincome or shareholders’ equity (as a component of accumulated othercomprehensive income).

 

Fair values of derivativeinstruments are classified as operating assets or liabilities.  Changes in fair value of derivativeinstruments affecting income are classified as other operating income orexpenses.  Please see note 17 for additional information regarding the Company’s use of derivativeinstruments.

 

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**EUROTECH HOLDINGS COMPANY LIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**2****             ****Summaryof significant accounting policies (Continued)**

 

**(p)****          ****ComprehensiveIncome**

 

The Group has adopted SFAS No. 130:  “Reporting Comprehensive Income,” whichrequires the Group to report all changes in equity during a period, except forthose resulting from investment by owners and distribution to owners, in thefinancial statements for the period in which they are recognized.  The Group has presented comprehensive income,which encompasses net income and foreign currency translation adjustments, inthe consolidated statement of changes in shareholders’ equity.

 

**(q)****         ****Ordinary Share**

 

Ordinary share refers to the$0.01 par value capital stock asdesignated in the Company’s Certificate of Incorporation.  Treasury stock is accounted for using thecost method.  When treasury stock isreissued, the value is computed and recorded using a weighted-average basis.

 

**(r)****         ****Net income per****Ordinary****Share**

 

Net income per ordinary share is computed in accordance with SFAS No. 128“Earnings Per Share”, by dividing the net income by the weighted average numberof shares of ordinary share outstanding during the period.  The Company reports both basic earnings pershare, which is based on the weighted average number of ordinary shares outstanding, and diluted earnings per share,which is based on the weighted average number of ordinary sharesoutstanding and all dilutive potential ordinary sharesoutstanding.  Outstanding stock optionsare the only dilutive potential shares of the Company.

 

**(s)****         ****Stock-based Compensation**

 

TheGroup adopted the provisions of Statement 123 (revised 2004) (Statement123(R)), Share-Based Payment, which revises Statement 123, Accounting forStock-Based Compensation using the modified prospectiveapplication transition methodStatement 123(R) requires the Group to recognize expense related to thefair value of our stock-based compensation awards, including employee stockoptions.

 

**(t)****           ****Use ofEstimates**

 

The preparation ofconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America (“GAAP”) requires managementto make estimates and assumptions that affect the amounts that are reported inthe consolidated financial statements and accompanying disclosures.  Although these estimates are based onmanagement’s best knowledge of current events and actions that the Company mayundertake in the future, actual results may be different from the estimates.

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**2****             ****Summaryof significant accounting policies (Continued)**

 

**(u)**          **Related Parties**

 

Entitiesare considered to be related to the Group if the parties, directly orindirectly, through one or more intermediaries, control, are controlled by, orare under common control with the Group. Related parties also include principal owners of the Group, itsmanagement, members of the immediate families of principal owners of the Groupand its management and other parties with which the Group may deal if one partycontrols or can significantly influence the management or operating policies ofthe other to an extent that one of the transacting parties might be preventedfrom fully pursuing its own separate interests. A party which can significantly influence the management or operatingpolicies of the transacting parties or if it has an ownership interest in oneof the transacting parties and can significantly influence the other to anextent that one or more of the transacting parties might be prevented fromfully pursuing its own separate interests is also a related party.

 

**(v)**          **Segment Information**

 

The Company’s segmentreporting is prepared in accordance with SFAS No. 131, “Disclosures aboutSegments of an Enterprise and Related Information”.  The management approach required by SFAS No. 131designates that the internal reporting structure that is used by management formaking operating decisions and assessing performance should be used as thesource for presenting the Company’s reportable segments.  The Company categorizes its operations intotwo business segments: Trading and Manufacturing, and Engineering.

 

**(w)**         **Recent Accounting Pronouncements**

 

In December 2007,the FASB issued SFAS No. 160, “Noncontrolling Interests inConsolidated Financial Statements—an amendment of ARB No. 51” (SFAS No. 160).SFAS No. 160 establishes accounting and reporting standards fornoncontrolling interests in subsidiaries. This statement requires the reportingof all noncontrolling interests as a separate component of stockholders’equity, the reporting of consolidated net income (loss) as the amountattributable to both the parent and the noncontrolling interests and theseparate disclosure of net income (loss) attributable to the parent and to thenoncontrolling interests. In addition, this statement provides accounting andreporting guidance related to changes in noncontrolling ownership interests.Other than the reporting requirements described above which requireretrospective application, the provisions of SFAS No. 160 are to beapplied prospectively in the first annual reporting period beginning on orafter December 15, 2008. The Company is currently evaluating the potentialimpact, if any, of the adoption of FAS No. 160 on the consolidatedfinancial statements.

 

In December 2007,the FASB issued SFAS No. 141 (revised 2007), “Business Combinations,”(FAS No. 141 (R)), which replaces FASB Statement No. 141. FAS No. 141(R) establishes principles and requirements for how an acquirer recognizesand measures in its financial statements the identifiable assets acquired, theliabilities assumed, any noncontrolling interest in the acquiree and thegoodwill acquired. The Statement also establishes disclosure requirements whichwill enable users to evaluate the nature and financial effects of the businesscombination. FAS No. 141 (R) is effective as of the beginning of anentity’s fiscal year that begins after December 15, 2008, which will bethe Company’s year beginning January 1, 2009. An entity is precluded fromimplementing Statement 141R early. The Company is 

 

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currently evaluating thepotential impact, if any, of the adoption of FAS No. 141 (R) on theconsolidated financial statements.

 

In March 2008, theFASB issued SFAS No. 161, “Disclosures about Derivative Instruments andHedging Activities - an amendment of FASB Statement No. 133” (SFAS No. 161).  SFASNo. 161 requires additional disclosures about the objectives of usingderivative instruments, the method by which the derivative instruments andrelated hedged items are accounted for under Statement No. 133 and itsrelated interpretations, and the effect of derivative instruments and relatedhedged items on financial position, financial performance, and cashflows.  SFAS No. 161 also requires disclosure of the fair valuesof derivative instruments and their gains and losses in a tabularformat.  SFAS No. 161 is effective for financial statementsissued for fiscal years and interim periods beginning after November 15,2008.  The Company has no derivative instruments or hedgingactivities and this pronouncement is only disclosure-related; accordingly, SFAS161 has no impact on the Company’s financial position, consolidated results ofoperations or cash flows.

 

In April 2008, theFASB issued Staff Position (FSP) No. FAS 142-3, “Determination of theUseful Life of Intangible Assets (FSP FAS No. 142-3)”.  FSP FAS No.142-3 amends the factors that should be considered in developing renewal orextension assumptions used to determine the useful life of a recognizedintangible asset under SFAS No. 142, Goodwill and Other IntangibleAssets.  It is effective for financial statements issued for fiscalyears beginning after December 15, 2008, and interim periods within thosefiscal years and should be applied prospectively to intangible assets acquiredafter the effective date.  Early adoption is not permitted. FSP FASNo. 142-3 also requires expanded disclosure related to the determination ofintangible asset useful lives for intangible assets and should be applied toall intangible assets recognized as of, and subsequent to the effectivedate.  The impact of FSP FAS No. 142-3 will depend on the size andnature of acquisitions on or after January 1, 2009.

 

InMay 2009, the FASB issued SFAS No. 165, “Subsequent Events” (SFAS No. 165).SFAS No. 165 provides general standards of accounting for and disclosure ofevents that occur after the balance sheet date but before financial statementsare issued or are available to be issued. SFAS No. 165 is applicable forinterim or annual periods after June 15, 2009. The application of SFAS No. 165is not expected to have a material effect on the Company’s consolidatedfinancial statements.

 

InJune 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of FinancialAssets - an amendment of FASB Statement No. 140” (SFAS No. 166). SFAS No. 166seeks to improve the relevance, representational faithfulness, andcomparability of the information that a reporting entity provides in itsfinancial statements about a transfer of financial assets; the effects of atransfer on its financial position, financial performance, and cash flows; anda transferor’s continuing involvement, if any, in transferred financial assets.SFAS No. 166 in applicable for annual periods after November 15, 2009 andinterim periods therein and thereafter. The Company is currently evaluating thepotential impact, if any, of the adoption of SFAS No. 166 on the consolidatedfinancial statements.

 

InJune 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No.46(R)” (SFAS No. 167). SFAS No. 167 seeks to improve financial reporting byenterprises involved with variable interest entities. SFAS No. 167 isapplicable for annual periods after November 15, 2009 and interim periodstherein and thereafter. The Company is currently evaluating the potentialimpact, if any, of the adoption of SFAS No. 167 on the consolidated financialstatements.

 

The Company does not believethat any other of the recently issued and adopted, but not yet effective,accounting standards would have a material effect on the accompanying financialstatements.

 

F-15

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**3****             ****Otherincome, net**

 
| ** **                                                 | ** ** | **200****8**     | ** ** | **200****7**     | ** ** | **200****6**     | ** ** |
|------------------------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **US$’000** | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
| Gain/(loss) on  disposal of property, plant and  equipment |       | (1               | )          | 19               |       | (1               | )          |
| Exchange gain, net                                         |       | 120              |       | 104              |       | 130              |       |
| Rental income                                              |       | 25               |       | 38               |       | 17               |       |
|                                                       |       | 144              |       | 161              |       | 146              |       |

 

**4****             ****Incometaxes**

 

The Company is exempt fromtaxation in the British Virgin Islands.

 

Euro Tech (Far East) Limited,Euro Tech (China) Limited and ChinaH2O.com Limited provided for Hong Kongprofits tax at a rate of 16.5% in year 2008 (2007 and 2006: 17.5%) on the basis of their income for financialreporting purposes, adjusting for income and expense items which are notassessable or deductible for profits tax purposes.

 

Euro Tech Trading (Shanghai)Limited, a subsidiary of the Company, provides for PRC Enterprise Income Tax ata rate of 18% (2007 and 2006:15%) (a rate currently levied by the Pudong localTax Bureau despite the rate National Tax Bureau of 25%), after offsettinglosses brought forward, if any, on the basis of its income for financialreporting purposes, adjusting for income and expense items which are notassessable or deductible for PRC Enterprise Income Tax purposes.

 

In accordance with therelevant income tax laws and regulations applicable to foreign investmententerprises in the PRC, Shanghai Euro Tech Limited (“SET”), a subsidiary of theCompany, is exempt from the PRC Enterprise Income Tax for two years startingfrom 2008, after offsetting losses brought forward, if any, followed by a 50%reduction for the next three years thereafter. As of December 31, 2008, SET had an assessable loss carriedforward of US$242,253 as agreed by the local tax authority to offset its profitfor the coming year (2007: US$225,300). Such loss will expire in 5years.

 

According to the relevantPRC tax rules and regulations,Shanghai Euro Tech Environmental Engineering Limited is exempt fromthe PRC Enterprise Income Tax of 18% (2007: 15%)for two years starting from 2007, followed by a50% reduction for the next three years thereafter.Chongqing Euro Tech Rizhi Technology Co., Ltd, Rizhi Euro Tech Instrument(Shaanxi) Co., Ltd and Guangzhou Euro Tech EnvironmentalEquipment Co., Ltd provide forPRC Enterprise Income Tax at a rate of 25%, afteroffsetting losses brought forward, if any, on the basis of its income forfinancial reporting purposes, adjusting for income and expense items which arenot assessable or deductible for PRC Enterprise Income Tax purposes.

 

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According to the relevantPRC tax rules and regulations, YixingPact Environmental Technology Co., Ltdis registered in Shanghai as Foreign Owned Enterprise that are entitled toEnterprise Income Tax rate of 25%(2007: 27%).Pact Asia Pacific Limited operates in the BritishVirgin Islands where thereare no taxes imposed on it. However, part of its profit is subject to Hong Kong profits tax at arate of 17.5% in year 2007 as the profit isearned in Hong Kong.

 

VIEs of the Group provide for PRC EnterpriseIncome Tax at a rate of 25% (2007: 33%), after offsetting losses broughtforward, if any, on the basis of its income for financial reporting purposes,adjusting for income and expense items which are not assessable or deductiblefor PRC Enterprise Income Tax purposes.

 

As of December 31,2008, certain VIEs had aggregated assessable losses carried forward ofUS$99,830 as agreed by the local tax authority(2007: US$118,161).

 

On March 16, 2007, the PRC NationalPeople’s Congress passed the China Corporate Income Tax Law (“Income Tax Law”),which became effective January 1, 2008 and applies a unified income taxrate for foreign invested enterprises and domestic enterprise. The Income TaxLaw is effective immediately for companies previously subject to highertaxation rates and provides a five-year transition period from its effectivedate for those enterprises which were established before the effective date ofthe new tax law and previously entitled to a preferential tax treatment.

 

On December 26, 2007, the State Counciland on February 20, 2008 the Ministry of Finance issued implementationguidelines (“Guidelines”) setting out how the transition of tax rates willoccur. The Guidelines state that those enterprises which enjoyed a preferentialtax rate of 15% are eligible for a graduated rate increase to 25% over the5-year period beginning from January 1, 2008. The applicable rates undersuch an agreements for such enterprises are 18%, 20%, 22%, 24% and 25% for2008, 2009, 2010, 2011, 2012 and thereafter, respectively. In addition, foreigninvestment manufacturing enterprises which have not fully utilized anypreferential tax treatments, such as tax holidays or reduced rates of taxation,will be able to continue to receive them during the transitional period. TheGroup has applied the new rate in relation to deferred tax balances.

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**4****             ****Incometaxes (Continued)**

 

Incomebefore income taxes:

 
| ** ** | ** ** | **200****8**     | ** ** | **200****7**     | ** ** | **200****6**     | ** ** |
|------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** ** | ** ** | **US$’000** | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
|       |       |             |       |             |       |             |       |
| Domestic   |       | —           |       | —           |       | —           |       |
| Foreign    |       | 560              |       | 664              |       | 835              |       |
|       |       | 560              |       | 664              |       | 835              |       |

 

Theprovision for income taxes consists of:

 
| ** **                | ** ** | **200****8**     | ** ** | **200****7**     | ** ** | **200****6**     | ** ** |
|---------------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                | ** ** | **US$’000** | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
| Current tax  expenses:    |       |             |       |             |       |             |       |
| Domestic                  |       | —           |       | —           |       | —           |       |
| Foreign                   |       | 331              |       | 240              |       | 163              |       |
| Total current  provision  |       | 331              |       | 240              |       | 163              |       |
|                      |       |             |       |             |       |             |       |
| Deferred tax  benefit:    |       |             |       |             |       |             |       |
| Domestic                  |       | —           |       | —           |       | —           |       |
| Foreign                   |       | (10              | )          | (96              | )          | (7               | )          |
| Total deferred  provision |       | (10              | )          | (96              | )          | (7               | )          |

 

The reconciliation of theweighted average statutory income tax rate to the effective income tax rate asstated in the consolidated statements of income is as follows:

 
| ** **                                   | ** ** | **200****8** | ** ** | **200****7** | ** ** | **200****6** | ** ** |
|----------------------------------------------|------------|--------------|------------|--------------|------------|--------------|------------|
|                                         |       |         |       |         |       |         |       |
| Weighted average statutory tax rate          |       | 39.8         | %          | 11.3         | %          | 14.3         | %          |
| Change in valuation allowances               |       | 17.8         | %          | 17.1         | %          | 5.5          | %          |
| Over-provision for income tax in prior years |       | —       | %          | —       | %          | (0.5         | )%         |
| Others                                       |       | (0.3         | )%         | (6.8         | )%         | (0.6         | )%         |
| Effective tax rate                           |       | 57.3         | %          | 21.6         | %          | 18.7         | %          |

 

The components of deferredtax assets are as follows:

 
| ** **                                                   | ** ** | **200****8**     | ** ** | **200****7**     | ** ** |
|--------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                   | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
|                                                         |       |             |       |             |       |
| Deferred  tax assets arising from tax losses                 |       | 147              |       | 137              |       |
| Deferred  tax liabilities arising from temporary differences |       | (3               | )          | (6               | )          |
| Less:  Valuation allowances                                  |       | —           |       | —           |       |
| Net  deferred tax assets                                     |       | 144              |       | 131              |       |

 

F-18

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**5****             ****Net income per ordinary share**

 

The calculation of the basic and diluted net incomeper ordinary share is based on the following data:

 
| ** **                                                                                   | ** ** | **200****8**     | ** ** | **200****7**     | ** ** | **200****6**     | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                   | ** ** | **US$’000** | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
| Number of shares                                                                             |       |             |       |             |       |             |       |
| Weighted  average number of ordinary shares for the purposes of basic net income per share   |       | 11,824,153       |       | 11,105,556       |       | 8,047,911        |       |
| Effect of dilutive potential ordinary shares:Stock options                                   |       | 387,905          |       | 989,779          |       | 2,739,509        |       |
| Weighted  average number of ordinary shares for the purposes of diluted net income per share |       | 12,212,058       |       | 12,095,335       |       | 10,787,420       |       |

 

**6****             ****Accountsreceivable**

** **
| ** **                         | ** ** | **200****8**     | ** ** | **200****7**     | ** ** |
|------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                         | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
|                               |       |             |       |             |       |
| Trade receivables                  |       | 6,792            |       | 5,063            |       |
| Less: Allowance for doubtful debts |       | (85              | )          | (95              | )          |
|                               |       | 6,707            |       | 4,968            |       |

 
| ** **                               | ** ** | **200****8**     | ** ** | **200****7**     | ** ** |
|------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                               | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
| Allowance for  doubtful debts            |       |             |       |             |       |
| Balance at beginning                     |       | 95               |       | 86               |       |
| Released/(charged) to costs and expenses |       | 8                |       | 28               |       |
| Write off                                |       | (18              | )          | (19              | )          |
| Balance at end                           |       | 85               |       | 95               |       |

 

Asof December 31, 2008, accounts receivables in the form of bills receivablethrough banks amounted to US$50,000 (2007: US$ 26,000).

 

**7****             ****Inventories,net**

** **
| ** **       | ** ** | **200****8**     | ** ** | **200****7**     | ** ** |
|------------------|------------|------------------|------------|------------------|------------|
| ** **       | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
|             |       |             |       |             |       |
| Raw materials    |       | 162              |       | 76               |       |
| Work in progress |       | 365              |       | 108              |       |
| Finished goods   |       | 2,073            |       | 1,828            |       |
|             |       | 2,600            |       | 2,012            |       |

 

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Managementcontinuously reviews obsolete and slow moving inventories and assesses theinventory valuation to determine if the provision is deemed appropriate. For the year ended December 31, 2008, and 2007, provision forobsolete and slow moving inventories amounted to US$68,758 and US$28,064, respectively, which werecharged to cost of revenue in Consolidated Statements of Income.

 

**8****             ****Property,plant and equipment**

 
| ** **                               | ** ** | **200****8**     | ** ** | **200****7**     | ** ** |
|------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                               | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
|                                     |       |             |       |             |       |
| Office premises                          |       | 2,257            |       | 2,257            |       |
| Leasehold improvements                   |       | 150              |       | 140              |       |
| Furniture, fixtures and office equipment |       | 857              |       | 776              |       |
| Motor vehicles                           |       | 162              |       | 173              |       |
| Testing equipment                        |       | 77               |       | 77               |       |
|                                     |       | 3,503            |       | 3,423            |       |
|                                     |       |             |       |             |       |
| Less: Accumulated depreciation           |       | (1,990           | )          | (1,801           | )          |
|                                     |       | 1,513            |       | 1,622            |       |

 
| ** **          | ** ** | **200****8**     | ** ** | **200****7**     | ** ** | **200****6**     | ** ** |
|---------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **          | ** ** | **US$’000** | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
| Depreciation charge |       | 218              |       | 232              |       | 216              |       |

 

F-20

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTESTO THE CONSOLIDATED ACCOUNTS**

 

**9****                                        ****Investmentsin affiliates****and acquisition ofsubsidiaries**

 

TheGroup granted the minority shareholder of Yixing Pact EnvironmentalTechnology Co., Ltd and Pact Asia Pacific Limited a three-year put optionrequiring the Group to acquire all remainingsecurities of these two companies at 5.2 timesof their average net income for the three prior fiscal years.

 

During the year ended December 31,2007, the Group acquired 20% equity interests in ZhejiangTianlan Desulfurization and Dust—Removal Co. Ltd, a company incorporated inthe PRC for a total consideration of US$4,648,000.  The Group believes that after this acquisition, ithas a strategic partner to work with in China for the environmentalprotection business.With this affiliate’s technology andtechnical support, it can nowprovide services and environmental solutions not only for water and wastewatertreatment but also for air pollution control for industrial clients in China.Investments in this affiliate areaccounted for using the equity method of accounting.

 

Asummary of the financial information of the affiliate, Zhejiang Tianlan Desulfurizationand Dust—Removal Co. Ltd, is set forth below:

 
| **Balance Sheet:**               | ** ** | **200****8**     | ** ** | **200****7**     | ** ** |
|----------------------------------|------------|------------------|------------|------------------|------------|
|                             |       | **US$’000** |       | **US$’000** |       |
| Current assets                   |       | 16,952           |       | 16,110           |       |
| Non-current assets               |       | 5,504            |       | 2,487            |       |
| Total assets                     |       | 22,456           |       | 18,597           |       |
| Current and total liabilities    |       | (9,831           | )          | (7,328           | )          |
| Total  shareholders’ equity |       | 12,625           |       | 11,269           |       |

 
| **Operating results:** | ** ** | **200****8**     | ** ** | **200****7**     | ** ** |
|------------------------|------------|------------------|------------|------------------|------------|
|                   |       | **US$’000** | ** ** | **US$’000** |       |
| Net sales              |       | 14,688           |       | 10,535           |       |
| Operating  profits     |       | 1,396            |       | 2,281            |       |
| Net profits            |       | 1,215            |       | 1,927            |       |

 

During the year ended December 31, 2008, the Groupacquired 20% equity interests in Zhejiang Jia Huan Electronic Co. Ltd., (“Jia Huan”), a company incorporated in the PRC, for approximately US$2,610,000. Jia Huan has been inthe environmental protection business since 1969 and is based in Jin Hua,Zhejiang. The Group believes that afterthis acquisition, it has a strategicpartner to help it make inroadsinto the rapidly growing air 

 

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pollution control market in China. Investments in this affiliate are accounted for using the equity method of accounting.

 

Asummary of the financial information of the affiliate, Zhejiang Jia HuanElectronic Co. Ltd, is set forth below:

 
| **Balance Sheet:**               | ** ** | **200****8**     | ** ** |
|----------------------------------|------------|------------------|------------|
|                             |       | **US$’000** |       |
| Current assets                   |       | 17,423           |       |
| Non-current assets               |       | 5,197            |       |
| Total assets                     |       | 22,620           |       |
| Current and total liabilities    |       | (11,559          | )          |
| Total  shareholders’ equity |       | 11,061           |       |

 
| **Operating results:** | ** ** | **200****8**     | ** ** |
|------------------------|------------|------------------|------------|
|                   |       | **US$’000** |       |
| Net sales              |       | 13,571           |       |
| Operating  profits     |       | 639              |       |
| Net profits            |       | 152              |       |

 

**10****                                 ****Otherpayables and accrued expenses**

 

Other payables and accruedexpenses mainly represent deposits received from customers and accruals foroperating expenses.

 

**11****                                 ****Ordinary share**

 

Duringthe year ended December 31, 2006,the Company issued 2,048,890 ordinary shares for stock options exercised andcancelled 36,700 shares surrendered for exercise of stock options.

 

Duringthe year ended December 31, 2007,the Company issued 2,695,246 ordinary shares for stock options exercised andcancelled 45,537 shares surrendered for exercise of stock options.

 

Duringthe year ended December 31, 2008,the Company issued 208,370 ordinary shares for stock options exercised andcancelled 31,240 shares surrendered for exercise of stock options.

 

**12****                                 ****Goodwill**

 

TheCompany accounted for the acquisition in accordance with SFAS No. 141 “BusinessCombinations”, which resulted in the recognition of goodwill. Goodwillrepresents the excess of acquisition cost over the estimated fair value of netassets acquired as of October 18, 2005 as described in Note 9.

 

Asof December 31, 2008, the Companycompleted the annual impairment test. (i.e. comparing the carrying amount ofthe net assets, including goodwill, with the fair value of the Company as of December 31, 2008) Based on theresult of the first step of the test, the Company believes that there was noimpairment of goodwill as of December 31, 2008.

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTESTO THE CONSOLIDATED ACCOUNTS**

 

**1****3****                                 ****Treasurystock**

 

The Company authorized astock buyback program in December 2000 pursuant to which up to 341,250 shares, but not to exceed US$281,250 in value, ofthe Company’s ordinary share could be purchased in the open market from time totime as market and business conditions warrant. The Company repurchased a total of 36,445 shares and 304,206 shares ofordinary share during 2000 and 2001 for considerations of approximatelyUS$16,000 and US$221,000, respectively.

 

The Company authorized astock buyback program in November 2008 pursuant towhich up to 300,000 shares, butnot to exceed US$420,000 in value, of the Company’s ordinary share could be purchased in theopen market from time to time as market and business conditions warrant.  The Company repurchased a total of 41,041 shares of ordinary shareduring 2008 for considerations ofapproximately US$44,000.

 

There was no reissuance oftreasury stock during each of the three years ended December 31, 2008.

 

**1****4****                                 ****PRCstatutory reserve**

 

Under the relevant PRC lawsand regulations, the PRC subsidiaries are required to appropriate certainpercentage of their respective net income to two statutory funds i.e. the statutory reserve fund and the statutorystaff welfare fund.  The PRC subsidiaries also appropriated certainamount of their net income to the expansion funds.

 

(i) Statutory reservefunds

 

Pursuant to applicable PRClaws and regulations, the PRC subsidiaries are required to allocate at least10% of the companies’ net income to thestatutory reserve funds until such funds reaches 50% of the companies’registered capital. The statutory reserve funds can be utilized upon theapproval by the relevant authorities, to offset accumulated losses or toincrease registered capital of the companies, provided that such funds bemaintained at a minimum of 25% of the companies’ registered capital.

 

(ii) Statutory welfarefunds

 

Pursuant to applicable PRClaws and regulations, the PRC subsidiaries are required to allocate certain amount of the companies’ net income to the staffwelfare funds determined by theCompany. The staff welfare funds can only be used to provide staff welfarefacilities and other collective benefits to the companies’ employees. This fundis non-distributable other than upon liquidation of the PRC subsidiaries.

 

(iii) Expansion funds

 

The expansion reserve shall only be used to make up losses,expand the PRC subsidiaries’ production operations, or increase the capital ofthe subsidiaries. The expansion fund can be utilized upon approval by relevantauthorities, to convert into registered capital and issue bonus capital toexisting investors, provided that such funds be maintained at a minimum of 25%of the companies’ registered capital.

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTESTO THE CONSOLIDATED ACCOUNTS**

 

**1****5****                                 ****Stockoptions**

 

(i)            ManagementOptions Plan

 

A total of 4,586,400 shares of ordinary share have been reserved forissuance under the Company’s management option plan (the “Management Options”).  The Management Options provide for the grantof options to its officers, directors and employees as the Company’s Chairmanof the Board of Directors and Chief Executive Officer may direct.

 

Duringthe year ended December 31, 2006, the Company granted 10,000 shares with the exercise price of US$1.6789 per share to itsofficers, directors and employees, which allowed them to purchase up to 10,000 shares of ordinary share.  The options expired in March 2007.  The Company further cancelled 21,840 options with an exercise price of US$1.6789. Duringthe same year, 1,015,740 options and 757,000 options under the Management Options with theexercise price of US$ 1.221 per share and US$1.6789 per share, respectively,wereexercised.

 

Duringthe year ended December 31, 2007, 90,090 options and 2,018,916 options under the Management Options with theexercise price of US$ 1.221 per share and US$1.6789 per share, respectively,wereexercised. All the remaining unexercised options expired in March 2007.

 

(ii)           2000 StockOption Plan

 

A total of 1,195,740 shares of ordinary share have been reserved forissuance under the Company’s 2000 Stock Option Plan (the “2000 Stock Options”).  The 2000 Stock Options provide for the grantof options to its officers, directors and employees as the Company’s Chairmanof the Board of Directors and Chief Executive Officer may direct. 

 

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During the year ended December 31,2006, 16,380 options with exercise price of US$0.5787 were cancelled. The Company further granted 40,000 options and 5,000 options underthe 2000 Stock Options with an exercise price of US$3.33 and US$2.02 per share, respectively, to its officers, directors and employees, whichallow them to purchase up to 45,000 shares ofordinary share. The options vested within a six-monthperiod and will expire in August 2010. During thesame year, 40,950 options and 214,200 options with exercise price of US$ 0.5787 and US$0.8191 per share, respectively,wereexercised**.**

 

During the year ended December 31,2007, 16,380 optionsand 6,300 options with exercise price of US$0.5787and US$0.6809, respectively, werecancelled.  During the same year, 46,410 optionsand 101,430 options with exercise price of US$ 0.5787 and US$0.8191 per share, respectively,wereexercised**.**

 

During the year ended December 31,2008, 32,000 options with an exerciseprice of US$2.56 per share weregranted to its employees. These options weresubsequently surrendered and cancelled duringthe vesting period. During the same year,24,570 options with exercise priceof US$ 0.5787 per sharewereexercised**.**

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTESTO THE CONSOLIDATED ACCOUNTS**

 

**1****5****                                 ****Stockoptions (Continued)**

 

(iii)          2002 Employees’Stock Option and Incentive Plan and 2002 Officers’ and Directors’ Stock Optionand Incentive Plan

 

A total of 294,000 shares and 840,000 shares ofordinary share have been reserved for issuance under the Company’s 2002Employees’ Stock Option and Incentive Plan (the “2002 Employee Stock Options”)and 2002 Officers’ and Directors’ Stock Option and Incentive Plan (the “2002D&O Stock Options”), respectively. Both 2002 Employee Stock Options and the 2002 D&O Stock Optionsprovide for the grant of options to its employees as the Company’s Chairman ofthe Board of Directors and Chief Executive Officer may direct.

 

Duringthe year ended December 31, 2006, 8,400 options with the exerciseprice of US$ 0.7618 were cancelled. During the same year,21,000 options with exercise priceof US$ 0.7618 per sharewereexercised.

 

Duringthe year ended December 31, 2007, 8,400 options with the exerciseprice of US$ 0.7618 were cancelled. During the same year,50,400 options and 388,000 options withexercise price of US$ 0.7618and US$0.5857 per share, respectively,wereexercised**.**

 

Duringthe year ended December 31, 2008, 16,800 options and 167,000 options with exercise price of US$ 0.7618 and US$0.5857 per share, respectively,wereexercised**.**

 

(iv)          2007 Officers’ and Directors’ Stock Option and Incentive Plan

 

A total of 880,000 shares of ordinary share have been reserved for issuanceunder the Company’s 2007 Officers’ andDirectors’ Stock Option and Incentive Plan (the “2007 D&O StockOptions”).  The 2007 D&O Stock Options provide for the grant of options to its directors and officers as the Company’s Chairman of the Board of Directorsand Chief Executive Officer may direct. During the year ended December 31, 2007, the Companygranted such options to its officers anddirectors under the 2007 D&O StockOptions, which allow them to purchase up to 133,000,66,500, 66,500,100,000 and133,000 shares of ordinary share at an exercise price of US$2.85, US$4.00, US$4.05, US$3.66 and US$2.66, respectively. The options vested for a period of asix-month period and will expire

 

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beforeend of November 2009. During the same year, nooptions had been exercised.

 

Duringthe year ended December 31, 2008, all the 499,000 options granted in 2007were cancelled. On January 24, 2008, 173,000 options with an exercise price of US$2.56 per share weregranted. These options were subsequentlysurrendered and cancelled on July 4, 2008.

 

The Company estimate thefair value of the options granted under the Black-Scholes pricing model.

 

Changes in outstandingoptions under various plans mentioned above were as follows:

 
| ** **                      | ** ** | **200****8**  | ** ** | **200****7**                              | ** ** | **200****6**  | ** ** |
|---------------------------------|------------|---------------|------------|-------------------------------------------|------------|---------------|------------|
| ** **                      | ** ** | **Number of** | ** ** | **Weighted  average  exercise** | ** ** | **Number of** | ** ** | **Weighted  average  exercise** | ** ** | **Number of** | ** ** | **Weighted  average  exercise** | ** ** |
| ** **                      | ** ** | **options**   | ** ** | ** price**                           | ** ** | **options**   | ** ** | **price** | ** ** | **options** | ** ** | ** price** | ** ** |
|                            |       |          |       | **US$**                                   |       |          |       | **US$** |   |   |   | **US$** |   |
| Outstanding,  beginning of year |       | 1,290,840     |       | 1.74                                      |       | 3,938,296     |       | 1.32 |   | 5,978,806 |   | 1.31 |   |
| Granted                         |       | 205,000       |       | 2.56                                      |       | 499,000       |       | 3.27 |   | 55,000 |   | 2.91 |   |
| Cancelled/Expired               |       | (704,000      | )          | (3.07                                     | )          | (451,210      | )          | (1.58 | ) | (46,620 | ) | (1.13 | ) |
| Exercised                       |       | (208,370      | )          | (0.60                                     | )          | (2,695,246    | )          | (1.44 | ) | (2,048,890 | ) | (1.33 | ) |
| Outstanding,  end of year       |       | 583,470       |       | 0.84                                      |       | 1,290,840     |       | 1.74 |   | 3,938,296 |   | 1.32 |   |
|                            |       |          |       |                                      |       |          |       |   |   |   |   |   |   |
| Exercisable,  end of year       |       | 583,470       |       | 0.84                                      |       | 791,840       |       | 0.78 |   | 3,923,296 |   | 1.32 |   |

 

As of December 31, 2008, the options outstanding and exercisable had exercise prices in therange of US$0.5787 to US$3.33 and a weightedaverage unexpired life of approximately 2.7 years.

 
| **As of  December 31, 2008**            | ** ** | **Shares** | ** ** | **Intrinsic  Value** | ** ** |
|-----------------------------------------|------------|------------|------------|----------------------|------------|
| ** **                              | ** ** | ** ** | ** ** | **US$’ 000**    | ** ** |
| Total outstanding  in-the-money options |       | 538,470    |       | 119,000              |       |
|                                    |       |       |       |                 |       |
| Total vested in-the-money  options      |       | 538,470    |       | 119,000              |       |

 

The total intrinsic value of share optionsexercised for the twelve months ended December 31, 2008 and 2007 wereapproximately $374,000 and $3,492,000, respectively. At of December 31, 2008,there was no unrecognized stock-based compensation expense related to unvestedstock options.

 

F-27

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTESTO THE CONSOLIDATED ACCOUNTS**

 

**1****5****                                 ****Stockoptions (Continued)**

 

OnJanuary 1, 2006, the Group adopted the provisions of Statement 123(revised 2004) (Statement 123(R)), Share-Based Payment, which revises Statement123, Accounting for Stock-Based Compensation, and supersedes APB Opinion 25,Accounting for Stock Issued to Employees. Statement 123(R) requires us torecognize expense related to the fair value of our stock-based compensationawards, including employee stock options.

 

The Black-Scholes option-pricing model isused to estimate the fair value of the options granted. This requires the inputof subjective assumptions, including the expected volatility of stock price,expected option term, expected risk-free rate over the expected option term andexpected dividend yield rate over the expected option term.  Because changes in subjective inputassumptions can materially affect the fair value estimate, in directors’opinion, the existing model may not necessarily provide a realizable measure ofthe fair value of the stock options. Expected volatility is based on historicalvolatility in the 180 days prior to the issue of the options. Expected option termand dividend yield rate are based on historical trends. Expected risk-free rateis based on US Treasury securities with similar maturities as the expectedterms of the options at the date of grant.

 

The following table summarizes theassumptions used during the years ended December 31, 2008 and 2007:

 
| **Assumptions**        | ** ** | **200****8** | ** ** | **200****7** | ** ** |
|------------------------|------------|--------------|------------|--------------|------------|
|                   |       |         |       |         |       |
| Expected  volatility   |       | 75.9-86.7%   |       | 75.9-86.7%   |       |
| Expected  dividends    |       | 0%           |       | 0%           |       |
| Expected  term (years) |       | 1.25         |       | 1.25         |       |
| Risk-free  rate        |       | 3.2-4.3%     |       | 3.2-4.3%     |       |

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTESTO THE CONSOLIDATED ACCOUNTS**

 

**1****6****                                 ****Pensionplan**

 

Prior to December 1,2000, the Group had only one defined contribution pension plan for all its HongKong employees.  Under this plan, allemployees were entitled to pension benefits equal to their own contributionsplus 50% to 100% of individual fund account balances contributed by the Group,depending on their years of service with the Group.  The Group was required to make specificcontributions at approximately 10% of the basic salaries of the employees to anindependent fund management company.

 

With the introduction of theMandatory Provident Fund Scheme, a defined contribution scheme managed by anindependent trustee on December 1, 2000, the Group and its employees whojoined the Group subsequently make monthly contributions to the scheme at 5% ofthe employee’s cash income as defined under the Mandatory Provident Fundlegislation.  Contributions of both theGroup and its employees are subject to a maximum of HK$1,000 per month andthereafter contributions are voluntary and are not subject to any limitation.  The Group and its employees made their firstcontributions in December 2000.

 

As stipulated by the rules andregulations in the PRC, the Group contributes to state-sponsored retirementplans for its employees in Mainland China. The Group contributes approximatelyranging from10% to 22% of the basic salaries of its employees, and has nofurther obligations for the actual payment of pension or post-retirementbenefits beyond the annual contributions. The state-sponsored retirement plans are responsible for the entirepension obligations payable to retired employees.

 

During the years ended December 31,2008, 2007 and 2006, the aggregatecontributions of the Group to the aforementioned pension plans and retirementbenefit schemes were approximately US$291,000, US$245,000 and US$202,000 respectively.

 

**1****7****                                 ****Riskfactor and Derivative Instruments**

 

Financial risk factors

 

The Group’s activitiesexpose it to a variety of financial risks: foreign exchange rate risk andcredit risk.

 

(i)            Credit risk

 

The Group has no significant concentration of credit risk.  The Group has policies in place to ensurethat sales of products are made to customers with an appropriate credithistory.  The Group has policies thatlimit the amount of credit exposure to any customers. Derivative counterpartiesand cash transactions are limited to high credit quality banks.

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTESTO THE CONSOLIDATED ACCOUNTS**

 

**1****7****                                 ****RiskFactor and Derivative Instruments (Continued)**

 

(ii)          Foreignexchange risk

 

The Group operates in HongKong, the PRC and trades with both local and overseas customers, and is exposedto foreign exchange risk arising from various currency exposures, primarilywith respect to purchases in, Hong Kong dollar, Renminbi andEuro.  Foreign exchange risk arises fromcommitted and unmatched future commercial transactions, such as confirmedimport purchase orders and sales orders, recognized assets and liabilities, andnet investment in the PRC operations. The Group uses derivative financialinstruments such as foreign exchange contracts to hedge certain foreigncurrency exposures.

 

The Group’s prevailing riskmanagement policy is to hedge the net committed transactions (mainly sales andimport purchases) in each major currency.

 

The Company’s policy generally permits the use of derivatives if theyare associated with underlying assets or liabilities, forecasted transactions,or legally binding rights or obligations. There were no such derivates duringthe years ended December 31, 2008 and 2007.

 

**18****                                 ****Relatedparty transactions**

 

Arelated party is an entity that can control or significantly influence themanagement or operating policies of another entity to the extent one of theentities may be prevented from pursuing its own interests.  A related party may also be any party theentity deals with that can exercise that control.  There were no transactions with relatedparties in the years 2008, 2007 and 2006.

 

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**EURO TECH HOLDINGS COMPANYLIMITED**

 

**NOTESTO THE CONSOLIDATED ACCOUNTS**

 

**19****                                 ****Commitmentsand contingencies**

 

(i)           Operatingleases

 

The Group has various operating leaseagreements for office and industrial premises. Rental expenses for the years ended December 31, 2008, 2007 and 2006 were approximately US$411,000, US$448,000, and US$404,000,respectively.  Future minimum rentalpayments as of December 31, 2008, underagreements classified as operating leases with non-cancellable terms amountedto US$177,000 of which US$154,000 are payable in the year 2009 and US$23,000 are payable each year from 2010 to 2012.

 

(ii)          Bankingfacilities

 

As at December 31, 2008, 2007 and 2006, the Group had various banking facilities available for overdraft,import and export credits and foreign exchange contracts from which the Groupcan access up to approximately US$2,564,000, US$4,167,000 and US$4,167,000respectively, of which approximatelyUS$234,000, US$138,000 and US$726,000 was utilized for issuance of bankguarantees.

 

**20****                                 ****Fairvalue of financial instruments**

 

The carrying values offinancial instruments, which consist of cash and cash equivalents, accountsreceivable and accounts payable, bills receivable, bills payable, otherpayables and balances with related companies approximate their fair values dueto the short-term nature of these instruments.

 

**2****1****                                 ****Segmentinformation**

 

(i)   TheGroup reports under two segments: Trading and manufacturing, and Engineering.

 

Operating incomerepresents total revenues less operating expenses, excluding other expense,interest and income taxes. The identifiable assets by segment are those used ineach segment’s operations. Intersegment amounts are not significant and areeliminated to arrive at consolidated totals.

 
| ** **                 | ** ** | **200****8**     | ** ** | **200****7**     | ** ** | **200****6**     | ** ** |
|----------------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                 | ** ** | **US$’000** | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
| Revenue                    |       |             |       |             |       |             |       |
| Trading and  manufacturing |       | 21,439           |       | 20,010           |       | 22,243           |       |
| Engineering                |       | 10,299           |       | 7,220            |       | 4,918            |       |
|                       |       | 31,738           |       | 27,230           |       | 27,161           |       |
| Operating income           |       |             |       |             |       |             |       |
| Trading and  manufacturing |       | (184             | )          | (76              | )          | (237             | )          |
| Engineering                |       | 555              |       | 323              |       | 831              |       |
|                       |       | 371              |       | 247              |       | 594              |       |

 

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| ** **                   | ** ** | **200****8**     | ** ** | **200****7**     | ** ** | **200****6**     | ** ** |
|------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                   | ** ** | **US$’000** | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
| Depreciation:                |       |             |       |             |       |             |       |
| Trading and  manufacturing   |       | 179              |       | 197              |       | 197              |       |
| Engineering                  |       | 39               |       | 35               |       | 19               |       |
|                         |       | 218              |       | 232              |       | 216              |       |
| Capital Expenditures,  Gross |       |             |       |             |       |             |       |
| Trading and  manufacturing   |       | 56               |       | 147              |       | 63               |       |
| Engineering                  |       | 43               |       | 103              |       | 43               |       |
|                         |       | 99               |       | 250              |       | 106              |       |

 
| ** **                 | ** ** | **200****8**     | ** ** | **200****7**     | ** ** |
|----------------------------|------------|------------------|------------|------------------|------------|
| ** **                 | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
| Assets                     |       |             |       |             |       |
| Trading and  manufacturing |       | 12,754           |       | 13,187           |       |
| Engineering                |       | 7,845            |       | 7,249            |       |
| Unallocated                |       | 7,679            |       | 5,046            |       |
|                       |       | 28,278           |       | 25,482           |       |
| Liabilities                |       |             |       |             |       |
| Trading and  manufacturing |       | 6,108            |       | 4,213            |       |
| Engineering                |       | 3,191            |       | 2,663            |       |
| Unallocated                |       | —           |       | 648              |       |
|                       |       | 9,299            |       | 7,524            |       |

 

(ii)                              Geographicalanalysis of revenue by customer location is as follows:

 
| ** ** | ** ** | **200****8**     | ** ** | **200****7**     | ** ** | **200****6**     | ** ** |
|------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** ** | ** ** | **US$’000** | ** ** | **US$’000** | ** ** | **US$’000** | ** ** |
| Revenue -  |       |             |       |             |       |             |       |
| The PRC    |       | 25,430           |       | 21,595           |       | 22,457           |       |
| Hong Kong  |       | 5,745            |       | 5,401            |       | 4,324            |       |
| Others     |       | 563              |       | 234              |       | 380              |       |
|       |       | 31,738           |       | 27,230           |       | 27,161           |       |

 

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**ZHEJIANGTIANLAN ENVIRONMENTAL PROTECTION TECHNOLOGY COMPANY****LIMITED**

 

**AUDITED CONSOLIDATED BALANCESHEETS**

 

**AS OF DECEMBER 31, 2009 AND 2008********AND**

 

**CONSOLIDATED STATEMENTS OFINCOME,**

 

**CASH FLOWS AND CHANGES INSHAREHOLDERS’ EQUITY**

 

**FOR THE YEARS ENDED DECEMBER 31,2009 AND 2008**

 

**TOGETHER WITH REPORT OFINDEPENDENT REGISTERED**

 

**PUBLIC ACCOUNTING FIRM**

 

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**Report of Independent Registered Public Accounting Firm**

 

To the Board of Directorsand Owners of

ZhejiangTianlan Environmental Protection Technology Company Limited

 

We have audited theaccompanying consolidated balance sheets of Zhejiang Tianlan EnvironmentalProtection Technology Company Limited as of December 31, 2009 and 2008 andthe related consolidated statements of income, shareholders’ equity and cashflows for the years ended December 31, 2009 and 2008. These financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

We conducted our audits inaccordance with standards of the Public Company Accounting Oversight Board(United States).  Those standards requirethat we plan and perform the audits to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  The Company is not required to have, nor werewe engaged to perform, an audit of its internal control over financialreporting.  Our audits includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An auditalso includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, as well as evaluating theoverall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Zhejiang TianlanEnvironmental Protection Technology Company Limited as of December 31,2009 and 2008 and the results of its operations and its cash flows for theyears ended December 31, 2009 and 2008, in conformity with accountingprinciples generally accepted in the United States of America.

 

 

/s/BDO Limited

BDO Limited

 

Hong Kong, June 28, 2010

 

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**ZHEJIANG TIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**CONSOLIDATED BALANCE SHEETS**

**AS OF DECEMBER 31, 2009 AND 2008**

 
| ** **                                                                                          | ** ** | **Note**   | ** ** | **200****9**         | ** ** | **2008**             | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                                          | ** ** | ** ** | ** ** | **RMB****’000** | ** ** | **RMB****’000** | ** ** |
|                                                                                                |       |       |       |                 |       |                 |       |
| Assets                                                                                              |       |       |       |                 |       |                 |       |
|                                                                                                |       |       |       |                 |       |                 |       |
| Current  assets:                                                                                    |       |       |       |                 |       |                 |       |
| Cash  and cash equivalents                                                                          |       |       |       | 13,031               |       | 9,906                |       |
| Accounts  receivable, net                                                                           |       | 6          |       | 73,412               |       | 77,697               |       |
| Amounts due from owners                                                                             |       | 15         |       | 308                  |       | 303                  |       |
| Prepayments  and other current assets                                                               |       |       |       | 15,787               |       | 19,107               |       |
| Inventories,  net                                                                                   |       | 7          |       | 1,720                |       | 2,058                |       |
| Income  taxes recoverable                                                                           |       |       |       | 969                  |       | 96                   |       |
|                                                                                                |       |       |       |                 |       |                 |       |
| Total  current assets                                                                               |       |       |       | 105,227              |       | 109,167              |       |
|                                                                                                |       |       |       |                 |       |                 |       |
| Property,  plant and equipment, net                                                                 |       | 8          |       | 45,293               |       | 35,882               |       |
| Deferred  tax assets                                                                                |       |       |       | 823                  |       | 219                  |       |
|                                                                                                |       |       |       |                 |       |                 |       |
| Total  assets                                                                                       |       |       |       | 151,343              |       | 145,268              |       |
|                                                                                                |       |       |       |                 |       |                 |       |
| Liabilities  and owners’ equity                                                                |       |       |       |                 |       |                 |       |
|                                                                                                |       |       |       |                 |       |                 |       |
| Current  liabilities:                                                                               |       |       |       |                 |       |                 |       |
| Short term borrowings                                                                               |       | 9          |       | 6,300                |       | 7,200                |       |
| Accounts  payable                                                                                   |       |       |       | 26,794               |       | 19,405               |       |
| Amounts due to owners’                                                                         |       | 15         |       | 720                  |       | 8,691                |       |
| Other  payables and accrued expenses                                                                |       | 10         |       | 19,064               |       | 16,631               |       |
| Other  taxes payable                                                                                |       | 5          |       | 3,544                |       | 1,169                |       |
|                                                                                                |       |       |       |                 |       |                 |       |
| Total  current liabilities                                                                          |       |       |       | 56,422               |       | 53,096               |       |
|                                                                                                |       |       |       |                 |       |                 |       |
| Commitments  and contingencies                                                                      |       | 16         |       | —               |       | —               |       |
|                                                                                                |       |       |       |                 |       |                 |       |
| Owners’ equity:                                                                                |       |       |       |                 |       |                 |       |
| Paid-in capital                                                                                     |       |       |       | 50,000               |       | 50,000               |       |
| Capital reserve                                                                                     |       | 12         |       | 11,374               |       | 11,274               |       |
| PRC  statutory reserves                                                                             |       | 11         |       | 7,675                |       | 6,152                |       |
| Retained  earnings                                                                                  |       |       |       | 21,771               |       | 23,435               |       |
|                                                                                                |       |       |       |                 |       |                 |       |
| Total  owners’ equity of Zhejiang Tianlan Environmental  Protection Technology Company Limited |       |       |       | 90,820               |       | 90,861               |       |
| Non-controlling  interest                                                                           |       |       |       | 4,101                |       | 1,311                |       |
|                                                                                                |       |       |       |                 |       |                 |       |
| Total  equity                                                                                       |       |       |       | 94,921               |       | 92,172               |       |
|                                                                                                |       |       |       |                 |       |                 |       |
| Total  liabilities and owners’ equity                                                          |       |       |       | 151,343              |       | 145,268              |       |

 

The accompanyingnotes are an integral part of these financial statements.

 

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**ZHEJIANG TIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**CONSOLIDATED STATEMENTS OF INCOME**

**FOR THE YEARS ENDED DECEMBER 31,2009****AND****2008**

 
| ** **                                                                                                     | ** ** | **Note**   | ** ** | **200****9**         | ** ** | **200****8**         | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                                                     | ** ** | ** ** | ** ** | **RMB****’000** | ** ** | **RMB****’000** | ** ** |
|                                                                                                           |       |       |       |                 |       |                 |       |
| Revenue                                                                                                        |       |       |       | 121,448              |       | 106,885              |       |
|                                                                                                           |       |       |       |                 |       |                 |       |
| Cost  of revenue                                                                                               |       |       |       | (96,891              | )          | (84,056              | )          |
|                                                                                                           |       |       |       |                 |       |                 |       |
| Gross  profit                                                                                                  |       |       |       | 24,557               |       | 22,829               |       |
|                                                                                                           |       |       |       |                 |       |                 |       |
| Selling  and administrative expenses                                                                           |       |       |       | (23,665              | )          | (14,288              | )          |
|                                                                                                           |       |       |       |                 |       |                 |       |
| Operating  income                                                                                              |       |       |       | 892                  |       | 8,541                |       |
| Interest  income                                                                                               |       |       |       | 70                   |       | 100                  |       |
| Interest  expenses                                                                                             |       |       |       | (1,410               | )          | (876                 | )          |
| Other  income, net                                                                                             |       | 3          |       | 4,106                |       | 2,328                |       |
|                                                                                                           |       |       |       |                 |       |                 |       |
| Income  before income taxes                                                                                    |       |       |       | 3,658                |       | 10,093               |       |
|                                                                                                           |       |       |       |                 |       |                 |       |
| Income  taxes                                                                                                  |       | 4          |       | (134                 | )          | (1,113               | )          |
|                                                                                                           |       |       |       |                 |       |                 |       |
| Net income                                                                                                     |       |       |       | 3,524                |       | 8,980                |       |
| Net  income attributable to non-controlling interest                                                           |       |       |       | (1,665               | )          | (962                 | )          |
|                                                                                                           |       |       |       |                 |       |                 |       |
| Net income attributable to Zhejiang Tianlan  Environmental Protection Technology Company Limited’s owners |       |       |       | 1,859                |       | 8,018                |       |

 

The accompanyingnotes are an integral part of these financial statements.

 

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**ZHEJIANGTIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**FOR THE YEARS ENDED DECEMBER 31,2009 AND 2008**

 
| ** **                                                                          | ** ** | **200****9**         | ** ** | **2008**             | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                          | ** ** | **RMB****’000** | ** ** | **RMB****’000** | ** ** |
| Cash flows from operating activities:                                               |       |                 |       |                 |       |
| Net income                                                                          |       | 3,524                |       | 8,980                |       |
| Adjustments to reconcile net income to net  cash provided by operating activities:  |       |                 |       |                 |       |
| Depreciation of property, plant and  equipment                                      |       | 1,430                |       | 1,152                |       |
| Loss on disposal of property, plant and  equipment                                  |       | 6                    |       | 19                   |       |
| Deferred tax  assets                                                                |       | (604                 | )          | (81                  | )          |
| (Increase)/decrease in current assets:                                              |       |                 |       |                 |       |
| Accounts receivable, net                                                            |       | 4,285                |       | (782                 | )          |
| Amounts due from  owners                                                            |       | (5                   | )          | (303                 | )          |
| Prepayments and other current assets                                                |       | 3,320                |       | 340                  |       |
| Inventories, net                                                                    |       | 338                  |       | (345                 | )          |
| Income taxes recoverable                                                            |       | (873                 | )          | (3,294               | )          |
| Increase/(decrease) in current liabilities:                                         |       |                 |       |                 |       |
| Accounts payable                                                                    |       | 7,389                |       | (1,458               | )          |
| Amounts due to owners                                                               |       | (7,971               | )          | 155                  |       |
| Other payables and accrued expenses                                                 |       | 2,433                |       | 193                  |       |
| Other taxes payable                                                                 |       | 2,375                |       | (41                  | )          |
|                                                                                |       |                 |       |                 |       |
| Net cash provided by operating activities                                           |       | 15,647               |       | 4,535                |       |
|                                                                                |       |                 |       |                 |       |
| Cash flows from investing activities:                                               |       |                 |       |                 |       |
| Purchase of property, plant and equipment                                           |       | (10,847              | )          | (19,000              | )          |
|                                                                                |       |                 |       |                 |       |
| Net cash used in investing activities                                               |       | (10,847              | )          | (19,000              | )          |
|                                                                                |       |                 |       |                 |       |
| Cash flows from financing activities:                                               |       |                 |       |                 |       |
| Repayment of  bank borrowings                                                       |       | (7,200               | )          | —               |       |
| Advance of bank  borrowings                                                         |       | 6,300                |       | 1,900                |       |
| Cash from  issuance of registered capital in subsidiary to non-controlling interest |       | 1,225                |       | —               |       |
| Capital  injection                                                                  |       | —               |       | 4,750                |       |
| Dividend paid to  owners                                                            |       | (2,000               | )          | (2,029               | )          |
|                                                                                |       |                 |       |                 |       |
| Net cash (used in)/provided by financing activities                                 |       | (1,675               | )          | 4,621                |       |
|                                                                                |       |                 |       |                 |       |
| Net increase/(decrease) in cash and cash equivalents                                |       | 3,125                |       | (9,844               | )          |
| Cash and cash equivalents, beginning of  year                                       |       | 9,906                |       | 19,750               |       |
|                                                                                |       |                 |       |                 |       |
| Cash and cash equivalents, end of year                                              |       | 13,031               |       | 9,906                |       |
|                                                                                |       |                 |       |                 |       |
| ** **                                                                          | ** ** | **RMB’000**     | ** ** | **RMB’000**     | ** ** |
| Supplementary information                                                           |       |                 |       |                 |       |
| Interest received                                                                   |       | 70                   |       | 100                  |       |
| Interest paid                                                                       |       | 1,207                |       | 664                  |       |
| Income taxes paid                                                                   |       | 1,614                |       | 4,487                |       |
|                                                                                |       |                 |       |                 |       |
| Non-cash  transactions                                                              |       |                 |       |                 |       |
| Accrued interest on amounts due to owners                                           |       | 203                  |       | 212                  |       |
| Capitalization of amounts due to owners                                             |       | —               |       | 264                  |       |

 

Theaccompanying notes are an integral part of these financial statements.

 

F-37

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Table of Contents

 

**ZHEJIANGTIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**CONSOLIDATED STATEMENTS OFCHANGES IN SHAREHOLDERS’ EQUITY**

**FOR THE YEARS ENDED DECEMBER 31,2009 AND 2008**

 
| ** **                                                                             | ** ** | **Paid-in  capital** | ** ** | **Capital  reserve** | ** ** | **PRC  statutory  reserves** | ** ** | **Retained******** earnings** | ** ** | **Non-  controlling********interest** | ** ** | **Total**            | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|------------------------------|------------|------------------------------------|------------|---------------------------------------|------------|----------------------|------------|
| ** **                                                                             | ** ** | **RMB****’000** | ** ** | **RMB****’000** | ** ** | **RMB****’000**         | ** ** | **RMB****’000**               | ** ** | **RMB****’000**                  | ** ** | **RMB****’000** | ** ** |
|                                                                                   |       |                 |       |                 |       |                         |       |                               |       |                                  |       |                 |       |
| Balance as of  January 1, 2008                                                    |       | 25,926               |       | 30,334               |       | 4,099                        |       | 27,470                             |       | 349                                   |       | 88,178               |       |
| Net income                                                                             |       | —               |       | —               |       | —                       |       | 8,018                              |       | 962                                   |       | 8,980                |       |
|                                                                                   |       |                 |       |                 |       |                         |       |                               |       |                                  |       |                 |       |
| Total comprehensive  income                                                            |       |                 |       |                 |       |                         |       |                               |       |                                  |       | 8,980                |       |
|                                                                                   |       |                 |       |                 |       |                         |       |                               |       |                                  |       |                 |       |
| Capital injection                                                                      |       | 5,014                |       | —               |       | —                       |       | —                             |       | —                                |       | 5,014                |       |
| Dividend declared                                                                      |       | —               |       | —               |       | —                       |       | (10,000                            | )          | —                                |       | (10,000              | )          |
| Capitalisation of reserve as paid-in  capital                                          |       | 19,060               |       | (19,060              | )          | —                       |       | —                             |       | —                                |       | —               |       |
| Transfer to reserve                                                                    |       | —               |       | —               |       | 2,053                        |       | (2,053                             | )          | —                                |       | —               |       |
|                                                                                   |       |                 |       |                 |       |                         |       |                               |       |                                  |       |                 |       |
| Balance as of  December 31, 2008                                                  |       | 50,000               |       | 11,274               |       | 6,152                        |       | 23,435                             |       | 1,311                                 |       | 92,172               |       |
| Net income                                                                             |       | —               |       | —               |       | —                       |       | 1,859                              |       | 1,665                                 |       | 3,524                |       |
|                                                                                   |       |                 |       |                 |       |                         |       |                               |       |                                  |       |                 |       |
| Total  comprehensive income                                                            |       |                 |       |                 |       |                         |       |                               |       |                                  |       | 3,524                |       |
|                                                                                   |       |                 |       |                 |       |                         |       |                               |       |                                  |       |                 |       |
| Acquisition of subsidiary at nil  consideration from an owner of the Company (note 15) |       | —               |       | 100                  |       | —                       |       | —                             |       | (100                                  | )          | —               |       |
| Contribution from non-controlling interest  of a subsidiary                            |       | —               |       | —               |       | —                       |       | —                             |       | 1,225                                 |       | 1,225                |       |
| Dividend declared                                                                      |       | —               |       | —               |       | —                       |       | (2,000                             | )          | —                                |       | (2,000               | )          |
| Transfer to reserve                                                                    |       | —               |       | —               |       | 1,523                        |       | (1,523                             | )          | —                                |       | —               |       |
|                                                                                   |       |                 |       |                 |       |                         |       |                               |       |                                  |       |                 |       |
| Balance as of  December 31, 2009                                                  |       | 50,000               |       | 11,374               |       | 7,675                        |       | 21,771                             |       | 4,101                                 |       | 94,921               |       |

 

Theaccompanying notes are an integral part of these financial statements.

 

F-38

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Table ofContents

 

**ZHEJIANGTIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**1****             ****Organization and principalactivities**

 

Zhejiang TianlanEnvironmental Protection Technology Company Limited (the“Company”), formerly known asZhejiang Tianlan Desulfurization & Dust-removal Company Limited, was incorporated inHangzhou City, Zhejiang Province, the People’sRepublic of China (“PRC”) on May 18, 2000 as a wholly domestic ownedenterprise with an operating period up to May 17, 2030.

 

The principal activities ofthe Company are engaged in flue gas desulphurization, dust removal, flue gasdenitration and purification of diversified industrial waster gas.

 

Details of the Company’s subsidiaries aresummarized as follows:

 
| ** **                                                                                                                                                      | ** ** | **Percentage of   equity   ownership** | ** ** | **Place of** | ** ** | ** **        |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|--------------|------------|-------------------|
| **Name**                                                                                                                                                        | ** ** | **2009**                               | ** ** | **2008**     | ** ** | **incorporation** | ** ** | **Principal activities** |
| Hangzhou  Tianlan Environmental Engineering and Design Company Limited(Formerly known as Hangzhou Tianlan  Equipments Installation Engineering Company Limited) |       | 100                                    | %*         | 90           | %          | PRC               |   | Provision  of maintenance services of environmental protection equipment |
|                                                                                                                                                            |       |                                   |       |         |       |              |   |   |
| Hangzhou  Huan Qing Information Technology Company Limited                                                                                                      |       | 88                                     | %**        | 88           | %          | PRC               |   | Provision  of consulting and training services for environmental industry |
|                                                                                                                                                            |       |                                   |       |         |       |              |   |   |
| Hangzhou  Tianlan Environmental Protection Equipments Company Limited                                                                                           |       | 51                                     | %          | 51           | %          | PRC               |   | Manufacturing  and installation services of environmental protection equipment |

 

----

* In the year 2009,the Company acquired the remaining 10% equity interest of this company.

 

** As at 31 December 2009,this company was in the process of deregistration.

 

**2****             ****Summary of significant accountingpolicies**

 

**(a)****          ****Basis of Consolidation**

 

The consolidatedfinancial statements include the accounts of ZhejiangTianlan Environmental Protection Technology Company Limited and its subsidiaries (the “Group”).  In preparing the consolidated financialstatements presented herewith, all significant intercompany balances andtransactions have been eliminated on consolidation.

 

F-39

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Tableof Contents

 

**ZHEJIANGTIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**2****             ****Summary of significant accountingpolicies - Continued**

 

**(b)****          ****Subsidiaries**

 

A subsidiary is acompany in which the Company holds, directly or indirectly, more than 50% ofits outstanding voting share capital and over which it is able to exercisecontrol.

 

**(c)****          ****Revenue Recognition**

 

The Group’s mainsource of revenue is the construction and installation services ofenvironmental protection equipment for flue gas desulphurization, dust removaland flue gas denitration. Revenues are recorded under the percentage ofcompletion methodinaccordance with FASB ASC Subtopic 605-35, Revenue Recognition —Construction-Type and Production-Type Contracts, (previously Statement of Position (“SOP”) 81-1,“Accounting for Performance of Construction-Type and Certain Production-TypeContracts”).Thisapproach is based on estimates of total efforts expended at completion, whichare compared to actual efforts incurred to date to arrive at an estimate ofrevenue and profit earned to date. Recognized revenue and profit are subject torevisions as the contract progresses to completion.  Revisions to profit estimates are reflectedin income in the period in which the facts that give rise to the revisionbecome known. For any contract where it is identified that aloss will be incurred, the full loss will be recognized immediately.

 

**(d)****          ****Research and Development Costs**

 

Researchand development costs (“R&D” costs) are expensed as incurred.  The R&D costs amounted to approximatelyRMB8,238,000 and RMB3,704,000 for the years ended December 31,2009 and 2008 respectively and were included in “Selling and Administrative”expenses****in the Group’s consolidated statementsof income.

 

**(e)****          ****Advertising and promotionalexpenses**

 

Advertisingand promotional expenses (“A&P” expenses) are expensed as incurred.  The A&P expenses amounted toapproximately RMB39,000 andRMB104,000 for theyears December 31, 2009 and 2008 respectively and were included in “Sellingand Administrative” expenses****in the Group’sconsolidated statement of income.

 

**(f)****           ****Taxation**

 

TheGroup accounts for income and deferred tax under the provision of FASB ASCSubtopic 740-10, Income Taxes, (previously Statementof Financial Accounting Standards (“SFAS”) No. 109: “Accounting for IncomeTaxes”), under which deferred taxes are recognized for all temporarydifferences between the applicable tax balance sheets and the consolidatedbalance sheet.  Deferred tax assets andliabilities are recognized for the estimated future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases.  ASC 740-10 also requires the recognition ofthe future tax benefits of net operating loss carry forwards.  A valuation allowance is established when thedeferred tax assets are not expected to be realized within a reasonable periodof time.

 

F-40

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Tableof Contents

 

**ZHEJIANGTIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**2****             ****Summary of significant accountingpolicies - Continued**

 

**(f)****           ****Taxation - Continued**

 

Inaccordance with ASC-740-10, the Company recognizes tax benefits that satisfy agreater than 50% probability threshold and provides for the estimated impact ofinterest and penalties for such tax benefits. The Company did not have such uncertain tax positions in 2008 and 2009.

 

Deferredtax assets and liabilities are measured using the enacted tax rates expected tobe applicable for taxable income in the years in which temporary differencesare expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in taxrates is recognized in income for the period that includes the enactment date.

 

Note4 shows the applicable tax rates for the Company and its subsidiaries, as wellas the major temporary differences so recorded.

 

**(g)****          ****Cash and Cash Equivalents**

 

Cashand cash equivalents include cash on hand and demanddeposits with banks.

 

**(h)****          ****Receivables and Other Assets**

 

Receivablesand other assets are recorded at their nominal values.  Doubtful debt allowances are provided foridentified individual risks for these line items.  If the loss of a certain part of thereceivables is probable, doubtful debt allowances are provided to cover theexpected loss. Receivablesare writtenoff against the allowance after all means of collection have been exhausted andthe potential for recovery is considered remote.

 

**(i)****           ****Inventories**

 

Inventoriesare stated at the lower of cost, on the first-in, first-out method, or market value. Costs include purchase and related costs incurred in bringing eachproduct to its present location and condition. Marketvalue is calculated based on the estimated normal selling price, less furthercosts expected to be incurred for disposal. Provision is made for obsolete, slow moving or defective items, where appropriate.

 

**(j)****           ****Property, Plant and Equipment**

 

Property,plant and equipment are stated at cost less accumulated depreciation. Gains orlosses on disposal are reflected in current operations.  Major expenditures for betterments andrenewals are capitalized.  All ordinaryrepair and maintenance costs are expensed as incurred.  Depreciation of property, plant and equipmentis computed using the straight-line method over the assets’ estimated usefullives as follows:

 
| Office  premises                          | 47-50  years                                                       |
|-------------------------------------------|--------------------------------------------------------------------|
| Leasehold improvements                    | over terms  of the leases or the useful lives whichever is shorter |
| Plant and machineries                     | 5 to 10 years                                                      |
| Furniture,  fixtures and office equipment | 5 years                                                            |
| Motor  vehicles                           | 5 years                                                            |

 

F-41

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Tableof Contents

 

**ZHEJIANGTIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**2****             ****Summary of significant accountingpolicies - Continued**

 

**(k)****          ****Impairment**

 

TheGroup has adopted FASB ASC Subtopic 360-10, Property, Plant, and Equipment, (previously SFAS No. 144: “Accounting for Impairmentor Disposal of Long-Lived Assets”) which requires impairment losses to berecorded for property, plant and equipment to be held and used in operationswhen indicators of impairment are present. Reviews are regularly performed to determine whether the carrying valueof assets is impaired.  The Groupdetermines the existence of such impairment by measuring the expected futurecash flows (undiscounted and without interest charges) and comparing suchamount to the carrying amount of the assets. An impairment loss, if one exists, is then measured as the amount bywhich the carrying amount of the asset exceeds the discounted estimated futurecash flows. Assets to be disposed of are reported at the lower of the carryingamount or fair value of such assets less costs to sell.  Asset impairment charges are recorded toreduce the carrying amount of the long-lived asset that will be sold ordisposed of to their estimated fair values. Charges for the asset impairmentreduce the carrying amount of the long-lived assets to their estimated salvagevalue in connection with the decision to dispose of such assets. There were noimpairment losses recorded during each of the two years ended December 31,2009 and 2008.

 

**(l)****           ****Operating Leases**

 

Leases wheresubstantially all the risks and rewards of ownership of the leased assetsremain with the lessors are accounted for as operating leases.  Rental payments under operating leases arecharged to expense on the straight-line basis over the period of the relevantleases.

 

**(m)****         ****Foreign Currency Translation**

 

The Group maintainsits books and records in Chinese Renminbi (“functional currency”). Foreign currency transactions during the year are translated into thefunctional currency at the applicable rates of exchange at the dates of thetransactions.  Monetary assets andliabilities denominated in foreign currency are translated into the functionalcurrency using the exchange rates prevailing at the balance sheet dates.  Gains or losses from foreign currencytransactions are recognized in the consolidated statements of income during theyear in which they occur.

 

**(n)****          ****Comprehensive Income**

 

TheGroup has adopted FASB ASC Subtopic 220-10, Comprehensive Income, (previously SFAS No. 130:  “Reporting Comprehensive Income,”) whichrequires the Group to report all changes in equity during a period, except forthose resulting from investment by owners and distribution to owners, in thefinancial statements for the period in which they are recognized.  The Group has presented comprehensive income,which encompasses net income, in the consolidated statement of changes inshareholders’ equity.

 

F-42

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Tableof Contents

 

**ZHEJIANGTIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**2****             ****Summary of significant accountingpolicies - Continued**

 

**(o)****          ****Paidin capital**

 

Paid in capitalrefers to the registered capital paid-up by the owners of the Company. Thepaid-in capital at both years ended December 31, 2009 and 2008 isRMB50,000,000.

 

**(p)****          ****Use of Estimates**

 

The preparation ofconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America (“GAAP”) requires managementto make estimates and assumptions that affect the amounts that are reported inthe consolidated financial statements and accompanying disclosures.  Although these estimates are based onmanagement’s best knowledge of current events and actions that the Group mayundertake in the future, actual results may be different from the estimates.

 

**(q)**           **Related Parties**

 

Entities areconsidered to be related to the Group if the parties, directly or indirectly,through one or more intermediaries, control, are controlled by, or are undercommon control with the Group.  Relatedparties also include principal owners of the Group, its management, members ofthe immediate families of principal owners of the Group and its management andother parties with which the Group may deal if one party controls or cansignificantly influence the management or operating policies of the other to anextent that one of the transacting parties might be prevented from fullypursuing its own separate interests.  Aparty which can significantly influence the management or operating policies ofthe transacting parties or if it has an ownership interest in one of thetransacting parties and can significantly influence the other to an extent thatone or more of the transacting parties might be prevented from fully pursuingits own separate interests is also a related party.

 

**(r)**           **Recent Accounting Pronouncements**

 

In May 2009, theFASB issued SFAS No. 165, Subsequent Events (now codified within ASC855-10, Subsequent Events (“ASC 855-10”)). ASC 855-10 provides general standards of accounting for and disclosureof events that occur after the balance sheet date but before financialstatements are issued or are available to be issued. ASC 855-10 is applicablefor interim or annual periods after June 15, 2009.  In January 2010, the FASB issuedAccounting Standards Update (“ASU”) No. 2010-09, “Subsequent Events”,which is codified as ASC 855, “Amendments to Certain Recognition and DisclosureRequirements”. This update amends the ASC855-10, to replace the term “publicentity” with the term “an SEC filer”, in order to avoid potential conflict withsome of the Securities and Exchange Commission’s (SEC) guidance. All of theamendments in this update are effective immediately. The application of ASC 855did not have a material effect on the Company’s consolidated financial statements.

 

F-43

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Tableof Contents

 

**ZHEJIANGTIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATED FINANCIALSTATEMENTS**

 

**2****             ****Summary of significant accountingpolicies - Continued**

 

**(r)**           **Recent Accounting Pronouncements- Continued**

 

In June 2009,the FASB issued SFAS No. 168, “The FASB Accounting Standards Codificationand the Hierarchy of Generally Accepted Accounting Principles”, (now codifiedwithin ASC 105, Generally Accepted Accounting Principles). ASC 105 establishesthe Codification as the single source of authoritative GAAP recognized by theFASB to be applied by nongovernmental entities. All guidance contained in theCodification carries an equal level of authority. Following this statement,FASB will not issue new standards in the form of statements, FASB StaffPositions, or Emerging Issues Task Force Abstracts. Instead, it will issueAccounting Standards Updates, which will serve only to: (1) update theCodification; (2) provide background information about the guidance; and(3) provide the bases for conclusions on the change(s) in theCodification. ASC 105 was effective for financial statements issued for interimand annual periods ending after September 15, 2009. The Codificationsupersedes all existing non-SEC accounting and reporting standards. Theadoption of ASC 105 did not have an impact on the Company’s consolidatedresults of operations or financial position.

 

In August 2009,FASB issued ASU 2009-5 Fair Value Measurements and Disclosures (Topic 820)Measuring Liabilities at Fair Value (“ASU 2009-5”). ASU 2009-5 providesamendments to Subtopic 820-10, Fair Value Measurements and Disclosures-Overall,for the fair value measurement of liabilities. ASU 2009-5 clarifies that incircumstances in which a quoted price in an active market for the identicalliability is not available, a reporting entity is required to measure fairvalue. ASU 2009-5 was effective for the Company for interim and annual periodsending after September 30, 2009. The adoption of ASU 2009-5 did not have amaterial impact on the Company’s consolidated results of operations orfinancial position.

 

InDecember 2009, FASB issued ASU 2009-17 Consolidations (Topic 810)Improvements to Financial Reporting by Enterprises Involved with VariableInterest Entities (“ASU 2009-17”). ASU 2009-17 amends the FASB ASC for theissuance of FASB Statement No. 167, Amendments to FASB InterpretationNo. 46(R) . The amendments in ASU 2009-17 replace thequantitative-based risks and rewards calculation for determining whichenterprise, if any, has a controlling financial interest in a variable interestentity with an approach focused on identifying which enterprise has the powerto direct the activities of a variable interest entity that most significantlyimpact the entity’s economic performance and (1) the obligation to absorblosses of the entity or (2) the right to receive benefits from the entity.ASU 2009-17 also requires additional disclosures about an enterprise’sinvolvement in variable interest entities. ASU 2009-17 is effective as of thebeginning of each reporting entity’s first annual reporting period that beginsafter November 15, 2009. The Company does not expect the adoption of ASU2009-17 to have a material impact on its consolidated results of operations orfinancial position.

 

In January 2010,FASB issued ASU 2010-01, Entity, which is codified as ASC505, “Accounting forDistributions to Shareholders with Components of Stock and Cash (A Consensus ofthe FASB Emerging Issues Task Force)”. The amendments in this Update clarifythat the stock portion of a distribution to shareholders that allow them toelect to receive cash or shares with a potential limitation on the total amountof cash that all shareholders can elect to receive in the aggregate isconsidered a share issuance thus eliminating the diversity in practice. Theamendments in this Update are effective for interim and annual periods endingon or after December 15, 2009, and should be applied on a retrospectivebasis. The application of ASC 505 did not have a material effect on the Company’sconsolidated financial statements.

 

F-44

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Tableof Contents

 

**ZHEJIANGTIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**2****             ****Summary of significant accountingpolicies - Continued**

 

**(r)**           **Recent Accounting Pronouncements- Continued**

 

In January 2010,FASB issued ASU 2010-02 Accounting and Reporting for Decreases in Ownership ofa Subsidiary- a Scope Clarification (“ASU 2010-2”). ASU 2010-2 addressesimplementation issues related to the changes in ownership provisions in theConsolidation—Overall Subtopic (Subtopic 810-10) of the FASB AccountingStandards Codification , originally issued as FASB Statement No. 160,Noncontrolling Interests in Consolidated Financial Statements. Subtopic 810-10establishes the accounting and reporting guidance for noncontrolling interestsand changes in ownership interests of a subsidiary. An entity is required todeconsolidate a subsidiary when the entity ceases to have a controllingfinancial interest in the subsidiary. Upon deconsolidation of a subsidiary, anentity recognizes a gain or loss on the transaction and measures any retainedinvestment in the subsidiary at fair value. The gain or loss includes any gainor loss associated with the difference between the fair value of the retainedinvestment in the subsidiary and its carrying amount at the date the subsidiaryis deconsolidated. In contrast, an entity is required to account for a decreasein ownership interest of a subsidiary that does not result in a change ofcontrol of the subsidiary as an equity transaction. ASU 2010-2 is effective forthe Company starting January 1, 2010. The Company does not expect theadoption of ASU 2010-2 to have a material impact on the Company’s consolidatedresults of operations or financial position.

 

In January 2010,FASB issued ASU 2010-6 Improving Disclosures about Fair Measurements (“ASU2010-6”). ASU 2010-6 provides amendments to subtopic 820-10 that requireseparate disclosure of significant transfers in and out of Level 1 and Level 2fair value measurements and the presentation of separate information regardingpurchases, sales, issuances and settlements for Level 3 fair valuemeasurements. Additionally, ASU 2010-6 provides amendments to subtopic 820-10that clarify existing disclosures about the level of disaggregation and inputsand valuation techniques. ASU 2010-6 is effective for financial statementsissued for interim and annual periods ending after December 15, 2010. TheCompany does not expect the adoption of ASU 2010-06 to have a material impacton its consolidated results of operations or financial position.

 

**3****             ****Other income, net**

 
| ** **                   | ** ** | **200****9**         | ** ** | **200****8**     | ** ** |
|------------------------------|------------|----------------------|------------|------------------|------------|
|                         |       | **RMB****’000** | ** ** | **RMB’000** |       |
|                         |       |                 |       |             |       |
| Subsidy income (note i)      |       | 3,087                |       | 1,753            |       |
| Sales of scrapped  materials |       | 352                  |       | 530              |       |
| Others                       |       | 667                  |       | 45               |       |
|                         |       | 4,106                |       | 2,328            |       |

 

----

(i)    TheGroup recognises subsidy income for R&D projects when granted byinstitutions and are not probably to be returned or reimbursed.

 

F-45

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Tableof Contents

 

**ZHEJIANGTIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**4****             ****Income taxes**

 

According to relevantPRC tax laws and regulations, entities incorporated in the PRC are subject toEnterprise Income Tax (“EIT”) at a statutory rate of 25% or reduced national EITrates for certain High and New Technology Enterprises (“HNTE”) on PRC taxableincome. Zhejiang TianlanEnvironmental Protection Technology Company Limitedand Hangzhou Tianlan Environmental Protection Equipments Company Limited arequalified for a reduced statutory rate of 10% on national EIT as a HNTE andaccordingly, the applicable tax rate was 15%. Hangzhou Tianlan EnvironmentalEngineering and Design Company Limited and Huangzhou Huan Qing InformationTechnology Company Limited areentitled to Enterprise Income Tax rate of 25%.

 

The provision for income taxes consists of:

 
| ** **               | ** ** | **200****9**         | ** ** | **200****8**         | ** ** |
|--------------------------|------------|----------------------|------------|----------------------|------------|
|                     |       | **RMB****’000** | ** ** | **RMB****’000** |       |
| Current PRC EIT          |       | 739                  |       | 1,194                |       |
| Income Taxes             |       | 739                  |       | 1,194                |       |
|                     |       |                 |       |                 |       |
| Deferred tax benefit     |       | (605                 | )          | (81                  | )          |
| Total deferred provision |       | (605                 | )          | (81                  | )          |

 

The principalreconciling items from income tax computed at the statutory rates and at theeffective income tax rates are as follows:

 
| ** **                                                    | ** ** | **200****9**     | ** ** | **200****8**         | ** ** |
|---------------------------------------------------------------|------------|------------------|------------|----------------------|------------|
| ** **                                                    | ** ** | **RMB’000** | ** ** | **RMB****’000** | ** ** |
|                                                          |       |             |       |                 |       |
| Income before income taxes                                    |       | 3,658            |       | 10,093               |       |
|                                                          |       |             |       |                 |       |
| Computed tax at respective company’s statutory tax  rate |       | 541              |       | 1,410                |       |
| Change in valuation allowances                                |       | 19               |       | 96                   |       |
| (Over)/under-provision for income tax in prior years          |       | (162             | )          | 16                   |       |
| Tax effect on revenue not subject to tax                      |       | (676             | )          | (415                 | )          |
| Tax effect on expenses not deductible for tax  purposes       |       | 412              |       | 6                    |       |
|                                                          |       |             |       |                 |       |
| Total provision for income tax at effective tax rate          |       | 134              |       | 1,113                |       |

 

F-46

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Tableof Contents

 

**ZHEJIANGTIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**4****             ****Income taxes - Continued**

 

Thecomponents of deferred tax assets are as follows:

 
| ** **                                                                           | ** ** | **200****9**     | ** ** | **200****8**         | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------|------------|----------------------|------------|
| ** **                                                                           | ** ** | **RMB’000** | ** ** | **RMB****’000** | ** ** |
|                                                                                 |       |             |       |                 |       |
| Deferred  tax assets arising from tax losses                                         |       | 115              |       | 96                   |       |
| Deferred  tax assets arising from temporary differences allowance for doubtful debts |       | 823              |       | 219                  |       |
| Less:  Valuation allowances                                                          |       | (115             | )          | (96                  | )          |
| Net  deferred tax assets                                                             |       | 823              |       | 219                  |       |

 

**5****             ****Other taxes payable**

 

Other taxes payable comprises mainly Valued-AddedTax (“VAT”) and Business Tax (“BT”). The Group is subject to output VAT leviedat the rate of 17% of the revenue from sales of equipment.  The input VAT paid on purchases of materialsand other direct inputs can be used to offset the output VAT levied onoperating revenue to determine the net VAT payable or recoverable.  BT is charged at a rate of 5% on the revenuefrom installation services.

 

**6****             ****Accounts receivable**

** **
| ** **                         | ** ** | **2009**         | ** ** | **2008**         | ** ** |
|------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                         | ** ** | **RMB’000** | ** ** | **RMB’000** | ** ** |
|                               |       |             |       |             |       |
| Trade receivables                  |       | 78,902           |       | 78,716           |       |
| Less: Allowance for doubtful debts |       | (5,490           | )          | (1,019           | )          |
|                               |       | 73,412           |       | 77,697           |       |

 
| ** **                     | ** ** | **2009**         | ** ** | **200****8**     | ** ** |
|--------------------------------|------------|------------------|------------|------------------|------------|
| ** **                     | ** ** | **RMB’000** | ** ** | **RMB’000** | ** ** |
| Allowance for doubtful debts   |       |             |       |             |       |
| Balance at beginning           |       | 1,019            |       | —           |       |
| Charged to statement of income |       | 4,471            |       | 1,019            |       |
| Balance at year end            |       | 5,490            |       | 1,019            |       |

 

As of December 31, 2009, accounts receivable in the form ofretention receivables and bills receivable under letter of credit through banksamounted to approximately RMB10,453,000 (2008: RMB6,213,000) and RMB7,395,000 (2008: RMB6,195,000) respectively.

 

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** **

**ZHEJIANG TIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**7****             ****Inventories, net**

** **
| ** **    | ** ** | **2009**         | ** ** | **2008**         | ** ** |
|---------------|------------|------------------|------------|------------------|------------|
| ** **    | ** ** | **RMB’000** | ** ** | **RMB’000** | ** ** |
|          |       |             |       |             |       |
| Raw materials |       | 1,720            |       | 2,058            |       |

 

**8****             ****Property, plant and equipment**

 
| ** **                                  | ** ** | **2009**         | ** ** | **2008**         | ** ** |
|---------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                  | ** ** | **RMB’000** | ** ** | **RMB’000** | ** ** |
|                                        |       |             |       |             |       |
| Office  premises and leasehold improvements |       | 43,260           |       | 10,791           |       |
| Construction  in progress                   |       | —           |       | 22,713           |       |
| Furniture,  fixtures and office equipment   |       | 2,868            |       | 1,786            |       |
| Motor  vehicles                             |       | 2,417            |       | 2,417            |       |
| Plant and machineries                       |       | 899              |       | 899              |       |
|                                        |       | 49,444           |       | 38,606           |       |
|                                        |       |             |       |             |       |
| Less:  Accumulated depreciation             |       | (4,151           | )          | (2,724           | )          |
|                                        |       | 45,293           |       | 35,882           |       |

 
| ** **           | ** ** | **2009**         | ** ** | **2008**         | ** ** |
|----------------------|------------|------------------|------------|------------------|------------|
| ** **           | ** ** | **RMB’000** | ** ** | **RMB’000** | ** ** |
| Depreciation  charge |       | 1,430            |       | 1,152            |       |

 

**9****             ****Shortterm borrowings**

 

The short term loans as of December 31, 2009 bear interest at fixedrates 5.31% (2008: 7.56%) per annum with maturity date on or before September 22,2010 (2008: September 24, 2009) and are secured by the Company’s office premises and leasehold improvements. Interest paid during the year ended December 31, 2009 was RMB367,000(2008: RMB314,000)

 

**10****          ****Other payables and accruedexpenses**

 

Other payables andaccrued expenses mainly represent deposits received from customers and accrualsfor operating expenses.

 

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Table ofContents

 

**ZHEJIANG TIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

**11****          ****PRC statutory reserves**

 

Under the relevantPRC laws and regulations, the Group are required to appropriate certainpercentage of their respective net incometo two statutoryfunds, namely, the statutory reserve fund and the statutory staff welfare fund. The Group also appropriatedcertain amount of their net income to the expansion funds.

 

(i) Statutoryreserve funds

 

Pursuant toapplicable PRC laws and regulations, the Group are required to allocate atleast 10% of the companies’ net incometo the statutory reserve funds until such funds reaches 50% of the companies’registered capital. The statutory reserve funds can be utilized upon theapproval by the relevant authorities, to offset accumulated losses or toincrease registered capital of the companies, provided that such funds bemaintained at a minimum of 25% of the companies’ registered capital.

 

(ii) Statutorywelfare funds

 

Pursuant toapplicable PRC laws and regulations, the Group are required to allocate certain amount of the companies’ net income to the staff welfare funds determined by theCompany. The staffwelfare funds can only be used to provide staff welfare facilities and othercollective benefits to the companies’ employees. This fund is non-distributableother than upon liquidation of the Group.

 

**12****          ****Capital reserve**

 

Theamount represents the capital contributions from owners.

 

**13****          ****Pension plan**

 

Asstipulated by the rules and regulations in the PRC, the Group contributesto state-sponsored retirement plans for its employees in Mainland China.  The Group contributes approximately ranging from10% to 22% of the basic salaries of its employees, andhas no further obligations for the actual payment of pension or post-retirementbenefits beyond the annual contributions. The state-sponsored retirement plans are responsible for the entirepension obligations payable to retired employees.

 

Duringthe years ended December 31, 2009 and 2008, the aggregate contributions ofthe Group to the aforementioned pension plans and retirement benefit schemeswere approximately RMB1,177,000and RMB910,000respectively.

 

**14****          ****Risk factor****s**

 

TheGroup’s activities expose itself mainly to credit risk.

 

TheGroup has no significant concentration of credit risk.  The Group has policies in place to ensurethat sales of products are made to customers with an appropriate credithistory.  The Group has policies thatlimit the amount of credit exposure to any customers. 

 

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Table ofContents

 

**ZHEJIANG TIANLAN****ENVIRONMENTALPROTECTION TECHNOLOGY****COMPANYLIMITED**

 

**NOTES TO THE CONSOLDIATEDFINANCIAL STATEMENTS**

 

**15****          ****Related party**

 

Amountsdue from/(to) owners

 

The owners, from timeto time, receive income and pays expenses on behalf of the Group. The amountsdue to owners are unsecured, bear interest at 10% per annum and do not haveclearly defined terms of repayment.  There wereno other transactionswith related parties in the years 2009 and 2008 other than disclosed inelsewhere in the financial statements.

 

Acquisition of subsidiary at nil consideration from an owner of theCompany

 

During the year, the Company received 10% equity interest in Hangzhou Tianlan Environmental Engineeringand Design Company Limited from an owner of the Company at nilconsideration.

 

**16****          ****Commitments and contingencies**

 

Operating leases

 

Rental expenses forthe years ended December 31, 2009 and 2008 were approximately RMB410,000 andRMB573,000 respectively.  As of December 31,2009, the Group has no future minimum lease payments under non-cancellableoperating leases are payable in the year 2010.  As of December 31, 2008, the future minimumrental payments under non-cancellable operating leases amounted to RMB71,000are payable in the year 2009.

 

**17****          ****Fair value of financialinstruments**

 

The carrying valuesof financial instruments, which consist of cash and cash equivalents, accountsreceivable and accounts payable, bills receivable, bills payable, otherpayables and balances with related companies approximate their fair values dueto the short-term nature of these instruments.

 

**18           Subsequent events**

 

TheGroup evaluated all events or transactions that occurred after December 31,2009 up through June 28, 2010, the date the Group issued these consolidatedfinancial statements. During this period, the Group did not have any materialrecognisable subsequent events.

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