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.

The Company’s financial instruments include cash equivalents, trade receivables and payables, prepayments and other current assets, other payables and accruals. The carrying value of the Company’s short-term financial instruments approximates their fair value because of their short maturities.

The following table sets forth the financial instruments, measured at fair value, by level within the fair value hierarchy as of December 31, 2013:

	Fair value measurements at reporting date using
Items	As of December 31, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Warrant liability	$	33,262	$	-	$	33,262	$	-

The following table sets forth the financial instruments, measured at fair value, by level within the fair value hierarchy as of December 31, 2012:

	Fair value measurements at reporting date using
Items	As of December 31, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Warrant liability	$	354,000	$	-	$	354,000	$	-

Assets and liabilities measured at fair value on a recurring basis using significant observable inputs (Level 2) from January 1, 2011 to December 31, 2013 are summarized as follows:

	Warrant liability (Level 2)
Balance at January 1, 2011	$	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
Change in fair value included in earnings		124,000
Exercise of warrants		(385,000)
Balance at December 31, 2012		354,000
Change in fair value included in earnings		106,536
Exercise of warrants		(427,274)
Balance at December 31, 2013	$	33,262

There were no assets or liabilities measured at fair value on a non-recurring basis as of December 31, 2013 and 2012.

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, 2013			December 31, 2012
Series B Warrants
Market price of common stock:	$	-		$	4.390
Exercise price:		-			3.50
Remaining contractual life (years):		-			0.83
Dividend yield:		-			-
Expected volatility:		-			51.41	%
Risk-free interest rate:		-			0.13	%
Fair value – Series A and B Warrants	$	-		$	319,000

Underwriter Warrants
Market price of common stock:	$	5.720		$	4.390
Exercise price:		4.80			4.80
Remaining contractual life (years):		0.68			1.68
Dividend yield:		-			-
Expected volatility:		34.87	%		61.26	%
Risk-free interest rate:		0.10	%		0.21	%
Fair value – Underwriter Warrants	$	33,262		$	35,000
Fair value – Total	$	33,262		$	354,000

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

In 2012, 125,000 warrants were exercised on a cashless basis to purchase 48,402 shares of common stock. In accordance with ASC 470-50-40, “Debt – Modification and Extinguishments – Derecognition”, an aggregate gain of $73,291 was recognized. For details, please refer to the following table.

Exercise date:	February 7,
Market price of common stock:	$	6.44
Exercise warrants:		125,000
Exercise price:	$	3.50
Remaining contractual life (years):		1.73
Dividend yield:		-	%
Expected volatility:		39.43	%
Risk-free interest rate:		0.21	%
Fair values:	$	3.08
Gain on extinguishment of warrant liabilities	$	73,291

In 2013, 27,585 warrants were exercised at $3.50 each in cash and 227,915 warrants were exercised on a cashless basis to purchase 73,696 shares of common stock. In accordance with ASC 470-50-40, “Debt – Modification and Extinguishments – Derecognition”, an aggregate loss of $8,369 was recognized. As of December, 2013, 209 shares were not yet issued. For details, please refer to the following table.

Exercise date:	May 22,			September 27,			October 3,			October 11,			October 15,			October 29,			October 30,
Market price of common stock:	$	5.76		$	4.96		$	5.05		$	5.00		$	4.99		$	5.98		$	5.92
Exercise warrants:		28,348			58,000			35,000			96,652			12,500			15,000			10,000
Exercise price:	$	3.5		$	3.5		$	3.5		$	3.5		$	3.5		$	3.5		$	3.5
Remaining contractual life (years):		0.44			0.09			0.08			0.05			0.04			0.00			0.00
Dividend yield:		-	%		-	%		-	%		-	%		-	%		-	%		-	%
Expected volatility:		35.48	%		22.68	%		24.76	%		17.20	%		18.55	%		5.71	%		-	%
Risk-free interest rate:		0.07	%		0.02	%		0.13	%		0.25	%		0.34	%		0.03	%		-	%
Fair values:	$	2.2653		$	1.4572		$	1.5485		$	1.4956		$	1.4899		$	2.4788		$	2.4200
Gain (loss) on extinguishment of warrant liabilities	$	3,520		$	(7,124)		$	(2,135)		$	(4,432)		$	(217)		$	(378)		$	2,397