NOTE 3

FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS

ASC Topic 820, Fair Value Measurement and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This topic also establishes a fair value hierarchy which requires classification based on observable and unobservable inputs when measuring fair value. The fair value hierarchy distinguishes between assumptions based on market data (observable inputs) and an entity’s own assumptions (unobservable inputs). The hierarchy consists of three levels:

	·	Level one — Quoted market prices in active markets for identical assets or liabilities;
	·	Level two — Inputs other than level one inputs that are either directly or indirectly observable; and
	·	Level three — Unobservable inputs developed using estimates and assumptions, which are developed by the reporting entity and reflect those assumptions that a market participant would use.

Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter.

Changes in assets and liabilities measured at fair value on a recurring basis are summarized as follows:

	Warrant liability (Level 3)			Warrant liability (Level 2)

Balance at December 31, 2009	$	-		$	-
Reclassification due to adoption of ASC 815-40-15-5 through 815-40-15-8 as of January 1, 2010		2,306,688			-
Issue of warrants to public offering underwriter		291,378			-
Change in fair value included in earnings		11,877,341			-
Exercise of warrants		(199,924	)
Transfer from Level 3 to Level 2 due to changes in the observability of significant in puts upon public trading of the Company’s stock on the NASDAQ Capital Market from September 4, 2009		(14,275,483	)		14,275,483
Balance at January 1, 2010				$	14,275,483
Change in fair value included in earnings					1,448,819
Exercise of warrants					(7,041,861	)
Balance at December 31, 2010					8,682,441
Change in fair value included in earnings					(3,062,575	)
Exercise of warrants					(5,004,866	)
Balance at December 31, 2011				$	615,000

Before September 4, 2009, the Company’s common stock had not been publicly traded. The Company has determined the fair value of its common stock as of January 1, 2009 based on retrospective valuations prepared consistent with the methods outlined in the American Institute of Certified Public Accountants Practice Aids, “ Valuation of Privately-Held Company Equity Securities Issued as Compensation ” and based on a discounted future cash flow approach that used the Company’s estimates of revenue, driven by assumed market growth rates, and estimated costs as well as appropriate discount rates.

As the Company’s stock only begun public trading on September 4, 2009, historical volatility information is limited and considered not representative of the expected volatility. In accordance with ASC 718-10-30-2, the Company identified five similar public entities for which share and option price information was available, and considered the historical volatilities of those public entities’ share prices in calculating the expected volatility appropriate to the Company (i.e. the calculated value).

The risk-free rate of return reflects the interest rate for United States Treasury Note with similar time-to-maturity to that of the warrants.

There were no assets or liabilities measured at fair value on a non-recurring basis as of December 31, 2011 and 2010.

The carrying values of cash and cash equivalents, trade receivables and payables, and short-term bank loans and debts approximate their fair values due to the short maturities of these instruments.

Derivative Instruments – Warrants

The Company’s warrants have been classified as derivatives in accordance with the guidance provided in FASB ASC 815-40-15-7I, because they are denominated in U.S. dollars, which is different from the Company’s functional currency (Renminbi).

For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the consolidated statements of income.

The Company accounted for the exercise of these warrants as extinguishment of debts in accordance with ASC 815-10-40-1, “Derivatives and Hedges – Derecognition” and ASC 470-50-40, “Debt – Modification and Extinguishments – Derecognition”.

For stock-based derivative financial instruments, the Company uses the Black-Scholes option pricing model using the following assumptions to value the derivative instruments at inception and on subsequent valuation dates:

	December 31, 2011			December 31, 2010
Series A and B Warrants
Market price of common stock:	$	4.76		$	11.24
Exercise price:		3.50			3.50
Remaining contractual life (years):		1.83			2.83
Dividend yield:		-			-
Expected volatility:		39.58	%		46.37	%
Risk-free interest rate:		0.22	%		0.92	%
Fair value – Series A and B Warrants	$	586,000		$	7,961,362

Underwriter Warrants
Market price of common stock:	$	4.76		$	11.24
Exercise price:		4.80			4.80
Remaining contractual life (years):		2.68			3.68
Dividend yield:		-			-
Expected volatility:		36.39	%		43.94	%
Risk-free interest rate:		0.32	%		1.32	%
Fair value – Underwriter Warrants	$	29,000		$	721,079

Fair value – Total	$	615,000		$	8,682,441

In 2009, 35,900 warrants were exercised at $3.50 each in cash.

In 2010, 921,800 warrants were exercised at $3.50 each in cash and 41,880 warrants were exercised on a cashless basis to purchase 23,728 shares of common stock. The Company accounted for the exercise of these warrants as extinguishment of debts in accordance with ASC 815-10-40-1, “Derivatives and Hedges – Derecognition.” In accordance with ASC 470-50-40, “Debt – Modification and Extinguishments – Derecognition,” an aggregate gain of $186,897 was recognized in 2010, for details please refer to the following table.

Exercise date:	January 14			March 12			October 27			November 26			December 30
Market price of common stock:	$	10.26		$	9.4		$	10.92		$	11.96		$	11.26
Exercise warrants:		700,000			6,000			35,880			211,500			10,300
Exercise price:		3.50		$	3.50			4.80			3.50			3.50
Remaining contractual life (years):		3.79			3.63			3.85			2.93			2.83
Dividend yield:		-			-			-			-			-
Expected volatility:		41.12	%		41.70	%		42.23	%		46.49	%		46.30	%
Risk-free interest rate:		1.87	%		1.77	%		0.91	%		0.75	%		0.97	%
Fair values:	$	6.9482		$	6.2975		$	6.7131		$	8.5925		$	7.9760
Gain on extinguishment of warrant liabilities	$	131,744		$	3,625		$	21,281		$	28,022		$	2,225

In 2011, 542,300 warrants were exercised at $3.50 each in cash and 187,164 warrants were exercised on a cashless basis to purchase 108,855 shares of common stock. In accordance with ASC 470-50-40, “Debt – Modification and Extinguishments – Derecognition”, an aggregate gain of $88,777 was recognized. For details, please refer to the following table.

Exercise date:	January 14,			March 3,			March 14,			March 17,			April 7,			December 21,
Market price of common stock:	$	10.64		$	10.98		$	10.19		$	9.79		$	8.39			5.00
Exercise warrants:		549,300			20,000			28,814			74,000			44,850			12,500
Exercise price:	$	3.50		$	3.50		$	4.80		$	3.50		$	4.80			3.50
Remaining contractual life (years):		2.79			2.66			3.47			2.62			3.41			1.86
Dividend yield:		-			-			-			-			-			1.19	%
Expected volatility:		46.34	%		48.00	%		44.05	%		48.54	%		44.05	%		39.58	%
Risk-free interest rate:		0.90	%		1.09	%		1.27	%		0.86	%		1.46	%		0.22	%
Fair values:	$	7.2301		$	7.7083		$	6.0599		$	6.5324		$	4.4485			1.7342
Gain (loss) on extinguishment of warrant liabilities	$	48,210		$	8,153		$	5,722		$	(1,361	)	$	26,531			1,522