10-Q/A 1 f10q0618a1_chinarecycling.htm AMENDMENT NO. 1 TO QUARTERLY REPORT

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q/A

(Amendment No. 1)

 

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

 

For the quarterly period ended June 30, 2018

 

OR

 

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

 

For the transition period from                      to                     

 

Commission File No. 000-12536

 

China Recycling Energy Corporation

(Exact Name of Registrant as Specified in Its Charter)

  

Nevada   90-0093373

(State or other jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification No.)

 

4/F, Tower C

Rong Cheng Yun Gu Building

Keji 3rd Road, Yanta District

Xi’an City, Shaanxi Province

China 710075

(Address of Principal Executive Offices, Zip Code)

 

Registrant’s Telephone Number, Including Area Code: + 86-29-8765-1097

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ☒ Yes   ☐ No

 

Indicate by check mark whether the registrant is large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” accelerated filer” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer ☐ Accelerated filer ☐
Non-accelerated filer ☐ Smaller reporting company ☒
Emerging growth company ☐  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

The number of shares outstanding of the registrant’s Common Stock, as of August 10, 2018 was 8,310,198.

 

 

 

 

 

 

EXPLANATORY NOTE

 

In response to a comment letter received from the Securities and Exchange Commission (the “SEC”), dated December 4, 2018, China Recycling Energy Corporation (the “Company,” “we,” “us” or “our”) is filing this Amendment No. 1 on Form 10-Q/A to our Quarterly Report on Form 10-Q for the period ended June 30, 2018, originally filed with the SEC on August 14, 2018 (the “Original Form 10-Q”) for the following purposes: reevaluate the leases for Erdos TCH as a result of a supplemental agreement effective on May 1, 2016, wherein Erdos TCH cancelled monthly minimum lease payments from Erdos, charged Erdos based on actual electricity sold at RMB 0.30 / Kwh, and concluded the lease payments that depend on a factor directly related to the future use of the leased property were contingent rentals and, accordingly, were excluded from minimum lease payments in their entirety. The Company therefore wrote off the net investment receivables of these leases on May 1, 2016.

 

This Form 10-Q/A should be read in conjunction with the Company’s periodic filings made with the SEC subsequent to the filing date of the Original Form 10-Q, including any amendments to those filings, as well as any Current Reports, filed on Form 8-K subsequent to the date of the Original Form 10-Q. In addition, in accordance with applicable rules and regulations promulgated by the SEC, the Company’s Chief Executive Officer and Chief Financial Officer are providing currently dated certifications in connection with this Form 10-Q/A. The certifications are filed as Exhibits 31.3, 31.4, 32.3 and 32.4. Because this Form 10-Q/A sets forth the Original Form 10-Q in its entirety, it includes both items that have been changed as a result of the amended disclosures and items that are unchanged from the Original Form 10-Q. Other than the revision of the disclosures as discussed above, this Form 10-Q/A speaks as of the original filing date of the Original Form 10-Q and has not been updated to reflect other events occurring subsequent to the original filing date. This includes forward-looking statements and all other sections of this Form 10-Q/A that were not directly impacted by this amendment, which should be read in their historical context.

 

 

 

INDEX

 

    Page No.
     
PART I - FINANCIAL INFORMATION  
     
Item 1. Consolidated Financial Statements 1
     
  Consolidated Balance Sheets as of June 30, 2018 (Unaudited) and December 31, 2017 1
     
  Consolidated Statements of Income and Comprehensive Income (Loss) (Unaudited) – Three and Six Months Ended June 30, 2018 and June 30, 2017 2
     
  Consolidated Statements of Cash Flows (Unaudited) – Three and Six Months Ended June 30, 2018 and June 30, 2017 3
     
  Notes to Consolidated Financial Statements (Unaudited) 4
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 32
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 47
     
Item 4. Controls and Procedures 47
     
PART II - OTHER INFORMATION  
     
Item 1. Legal Proceedings 49
     
Item 1A. Risk Factors 49
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 49
     
Item 3. Defaults Upon Senior Securities 49
     
Item 4. Mine Safety Disclosures 49
   
Item 5. Other Information 49
     
Item 6. Exhibits 49

 

i

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

CHINA RECYCLING ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS OF JUNE 30, 2018 (UNAUDITED) AND DECEMBER 31, 2017

 

   

JUNE 30, 

2018 

(Restated)

  

DECEMBER 31,
2017

(Restated)

 
            
ASSETS           
            
CURRENT ASSETS           
Cash and equivalents   $ 51,138,316     $ 49,830,243  
Notes receivable     906,810       979,462  
Accounts receivable     16,998,804       15,858,804  
Current portion of investment in sales-type leases, net     12,220,921       11,531,745  
Interest receivable on sales type leases     9,845,608       9,619,278  
Prepaid expenses     147,598       739,423  
Other receivables     1,338,442       1,169,660  
Total current assets     92,596,499       89,728,615  
                 
NON-CURRENT ASSETS                
Investment in sales-type leases, net     42,241,411       46,110,374  
Long term investment     488,249       514,896  
Long term deposit     16,566       16,775  
Property and equipment, net     9,766       11,957  
Construction in progress     95,616,923       95,165,973  
Total non-current assets     138,372,915       141,819,975  
TOTAL ASSETS   $ 230,969,414     $ 231,548,590  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY                
                 
CURRENT LIABILITIES                
Accounts payable   $ 3,581,825     $ 3,229,163  
Taxes payable     2,770,023       2,423,780  
Accrued liabilities and other payables     1,598,871       1,618,316  
Due to related parties     41,152       43,623  
Interest payable on entrusted loans     11,895,849       8,131,256  
Current portion of entrusted loan payable     50,176,828       50,825,375  
Total current liabilities     70,064,548       66,271,513  
                 
NONCURRENT LIABILITIES                
Income tax payable     6,998,625       6,998,625  
Deferred tax liability, net     1,500,680       2,157,414  
Refundable deposit from customers for systems leasing     1,073,059       1,086,591  
Total noncurrent liabilities     9,572,364       10,242,630  
Total liabilities     79,636,912       76,514,143  
                 
CONTINGENCIES AND COMMITMENTS                
                 
STOCKHOLDERS’ EQUITY                
Common stock, $0.001 par value; 20,000,000 shares authorized     8,310       8,310  
Additional paid in capital     111,796,813       111,796,813  
Statutory reserve     14,561,911       14,525,712  
Accumulated other comprehensive income     (1,119,916 )     860,553  
Retained earnings     26,738,579       28,321,696  
Total Company stockholders’ equity     151,985,697       155,513,084  
Noncontrolling interest     (653,195 )     (478,637 )
Total equity     151,332,502       155,034,447  
TOTAL LIABILITIES AND EQUITY   $ 230,969,414     $ 231,548,590  

 

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

 

1

 

  

CHINA RECYCLING ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

 

    SIX MONTHS ENDED
JUNE 30, 		    THREE MONTHS ENDED
JUNE 30 		 
    2018
(Restated) 		    2017
(Restated) 		    2018
(Restated) 		    2017
(Restated) 		 
                         
Revenue                        
Sales of systems   $    -     $ -     $ -     $ -  
Contingent rental income     2,804,268       3,309,272       1,381,437       1,538,240  
Total revenue     2,804,268       3,309,272       1,381,437       1,538,240  
Cost of sales                                
Cost of systems and contingent rental income     -       -       -       -  
Gross income     2,804,268       3,309,272       1,381,437       1,538,240  
Interest income on sales-type leases     2,264,481       3,327,583       657,866       1,648,608  
Total operating income     5,068,749       6,636,855       2,039,303       3,186,848  
Operating expenses                                
General and administrative     3,692,406       2,534,750       2,186,175       1,331,583  
Total operating expenses     3,692,406       2,534,750       2,186,175       1,331,583  
Income (loss) from operations     1,376,343       4,102,105       (146,872 )     1,855,265  
Non-operating income (expenses)                                
Interest income     77,220       70,877       40,016       34,844  
Interest expense     (2,918,465 )     (2,722,742 )     (1,493,837 )     (1,365,532 )
Other income (loss)     (1,281 )     7,798       460       3,275  
Total non-operating expenses, net     (2,842,526 )     (2,644,067 )     (1,453,361 )     (1,327,413 )
Income (loss) before income tax     (1,466,183 )     1,458,038       (1,600,233 )     527,852  
Income tax expense (benefit)     267,918       610,995       (71,627 )     293,750  
Income (loss) before noncontrolling interest     (1,734,101 )     847,043       (1,528,606 )     234,102  
                                 
Less: loss attributable to noncontrolling interest     (187,183 )     (178,255 )     (95,925 )     (89,832 )
                                 
Net income (loss) attributable to China Recycling Energy Corporation     (1,546,918 )     1,025,298       (1,432,681 )     323,934  
                                 
Other comprehensive items                                
Foreign currency translation gain (loss) attributable to China Recycling Energy Corporation     (1,980,469 )     3,484,452       (8,385,747 )     4,327,559  
Foreign currency translation loss attributable to noncontrolling interest     12,626       (5,686 )     34,548       (5,132 )
Comprehensive income (loss) attributable to China Recycling Energy Corporation   $ (3,527,387 )   $ 4,509,750     $ (9,818,428 )   $ 4,651,493  
Comprehensive loss attributable to noncontrolling interest   $ (174,557 )   $ (183,941 )   $ (61,377 )   $ (94,964 )
Basic and diluted weighted average shares outstanding     8,310,198       8,310,198     $ 8,310,198     $ 8,310,198  
Basic and diluted earnings / (loss) per share   $ (0.19 )   $ 0.12     $ (0.17 )   $ 0.04  

  

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

  

2

 

 

CHINA RECYCLING ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

    SIX MONTHS ENDED
JUNE 30, 		 
    2018
(Restated) 		   2017
(Restated) 		 
            
CASH FLOWS FROM OPERATING ACTIVITIES:           
Income (loss) including noncontrolling interest   $ (1,734,101 )   $ 847,043  
Adjustments to reconcile income (loss) including noncontrolling interest to net cash provided by (used in) operating activities:                
Changes in bad debt allowance     835,871       -  
Depreciation and amortization     2,117       760  
Stock option expense     -       4,647  
Investment loss     4,815       (87,331 )
Changes in deferred tax     (653,123 )     (53,656 )
Changes in assets and liabilities:                
Interest receivable on sales type leases     (358,904 )     (2,730,500 )
Collection of principal on sales type leases     1,716,968       370,139  
Prepaid expenses     604,127       578,292  
Other receivables     (190,118 )     (320,537 )
Accounts receivable     (1,386,881 )     (1,469,996 )
Notes receivable     62,686       (786,061 )
Construction in progress     (1,696,509 )     (1,575,823 )
Accounts payable     407,382       661,102  
Taxes payable     382,467       (51,783 )
Interest payable on entrusted loan     4,008,587       3,722,719  
Accrued liabilities and other payables     (253,103 )     (291,187 )
Net cash provided by (used in) operating activities     1,752,281       (1,182,172 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:                
Repayment of loans     -       (727,834 )
Net cash used in financing activities     -       (727,834 )
                 
EFFECT OF EXCHANGE RATE CHANGE ON CASH AND EQUIVALENTS     (444,208 )     1,133,676  
                 
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS     1,308,073       (776,330 )
CASH AND EQUIVALENTS, BEGINNING OF PERIOD     49,830,243       47,752,353  
                 
CASH AND EQUIVALENTS, END OF PERIOD   $ 51,138,316     $ 46,976,023  
                 
Supplemental cash flow data:                
Income tax paid   $ 956,858     $ 1,128,756  
Interest paid   $ -     $ 14,363  

 

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

 

3

 

 

CHINA RECYCLING ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2018 (UNAUDITED) AND DECEMBER 31, 2017

 

1. ORGANIZATION AND DESCRIPTION OF BUSINESS

 

China Recycling Energy Corporation (the “Company” or “CREG”) was incorporated on May 8, 1980 as Boulder Brewing Company under the laws of the State of Colorado. On September 6, 2001, the Company changed its state of incorporation to the Nevada. In 2004, the Company changed its name from Boulder Brewing Company to China Digital Wireless, Inc. and on March 8, 2007, again changed its name from China Digital Wireless, Inc. to its current name, China Recycling Energy Corporation. The Company, through its subsidiaries, provides energy saving solutions and services, including selling and leasing energy saving systems and equipment to customers, project investment, investment management, economic information consulting, technical services, financial leasing, purchase of financial leasing assets, disposal and repair of financial leasing assets, consulting and ensuring of financial leasing transactions in the Peoples Republic of China (“PRC”).

 

Erdos TCH – Joint Venture

 

On April 14, 2009, the Company formed a joint venture (the “JV”) with Erdos Metallurgy Co., Ltd. (“Erdos”) to recycle waste heat from Erdos’ metal refining plants to generate power and steam to be sold back to Erdos. The name of the JV was Inner Mongolia Erdos TCH Energy Saving Development Co., Ltd. (“Erdos TCH”) with a term of 20 years. Total investment for the project was estimated at $79 million (RMB 500 million) with an initial investment of $17.55 million (RMB 120 million). Erdos contributed 7% of the total investment of the project, and Xi’an TCH Energy Technology Co., Ltd. (“Xi’an TCH”) contributed 93%. According to the parties’ agreement on profit distribution, Xi’an TCH and Erdos will receive 80% and 20%, respectively, of the profit from the JV until Xi’an TCH receives the complete return of its investment. Xi’an TCH and Erdos will then receive 60% and 40%, respectively, of the profit from the JV. On June 15, 2013, Xi’an TCH and Erdos entered into a share transfer agreement, pursuant to which Erdos sold its 7% ownership interest in the JV to Xi’an TCH for $1.29 million (RMB 8 million), plus certain accumulated profits as described below. Xi’an TCH paid the $1.29 million in July 2013 and, as a result, became the sole stockholder of the JV. In addition, Xi’an TCH paid Erdos accumulated profits from inception up to June 30, 2013 in accordance with a supplementary agreement entered on August 6, 2013. In August 2013, Xi’an TCH paid 20% of the accumulated profit (calculated under PRC GAAP) of $226,000 to Erdos. Erdos TCH currently has two power generation systems in Phase I with a total of 18 MW power capacity, and three power generation systems in Phase II with a total of 27 MW power capacity. On April 28, 2016, Erdos TCH and Erdos entered into a supplemental agreement, effective on May 1, 2016, whereby Erdos TCH cancelled monthly minimum lease payments from Erdos, and charges Erdos based on actual electricity sold at RMB 0.30 / KWH. The selling price of each KWH is determined annually based on prevailing market conditions. The Company evaluated the modified terms for payments based on actual electricity sold as minimum lease payments as defined in ASC 840-10-25-4, since lease payments that depend on a factor directly related to the future use of the leased property are contingent rentals and, accordingly, are excluded from minimum lease payments in their entirety. The Company wrote off the net investment receivables of these leases at the lease modification date.

 

4

 

 

Pucheng Biomass Power Generation Projects

 

On June 29, 2010, Xi’an TCH entered into a Biomass Power Generation (“BMPG”) Project Lease Agreement with Pucheng XinHengYuan Biomass Power Generation Co., Ltd. (“Pucheng”), a limited liability company incorporated in China. Under this lease agreement, Xi’an TCH leased a set of 12 MW BMPG systems to Pucheng at a minimum of $279,400 (RMB 1,900,000) per month for 15 years (“Pucheng Phase I”).

 

On September 11, 2013, Xi’an TCH entered into a BMPG Asset Transfer Agreement (the “Pucheng Transfer Agreement”) with Pucheng. The Pucheng Transfer Agreement provided for the sale by Pucheng to Xi’an TCH of a set of 12 MW BMPG systems with completion of system transformation for RMB 100 million ($16.48 million) in the form of 8,766,547 shares of common stock of the Company at $1.87 per share. These shares were issued to Pucheng on October 29, 2013. Also on September 11, 2013, Xi’an TCH entered into a BMPG Project Lease Agreement with Pucheng (the “Pucheng Lease”). Under the Pucheng Lease, Xi’an TCH leases this same set of 12 MW BMPG system to Pucheng, and combined this lease with the lease for the 12 MW BMPG station of Pucheng Phase I project, under a single lease to Pucheng for RMB 3.8 million ($0.63 million) per month (the “Pucheng Phase II Project”). The term for the combined lease is from September 2013 to June 2025. The lease agreement for the 12 MW station from Pucheng Phase I project terminated upon the effective date of the Pucheng Lease. The ownership of two 12 MW BMPG systems will transfer to Pucheng at no additional charge when the Pucheng Lease expires. 

 

Shenqiu Yuneng Biomass Power Generation Projects

 

On May 25, 2011, Xi’an TCH entered into a Letter of Intent with Shenqiu YuNeng Thermal Power Co., Ltd. (“Shenqiu”) to reconstruct and transform a Thermal Power Generation System owned by Shenqiu into a 75T/H BMPG System for $3.57 million (RMB 22.5 million). The project commenced in June 2011 and was completed in the third quarter of 2011. On September 28, 2011, Xi’an TCH entered into a BMPG Asset Transfer Agreement with Shenqiu (the “Shenqiu Transfer Agreement”). Pursuant to the Shenqiu Transfer Agreement, Shenqiu sold Xi’an TCH a set of 12 MW BMPG systems (after Xi’an TCH converted the system for BMPG purposes). As consideration for the BMPG systems, Xi’an TCH agreed to pay Shenqiu $10,937,500 (RMB 70 million) in cash in three installments within six months upon the transfer of ownership of the systems. By the end of 2012, all the consideration was paid. On September 28, 2011, Xi’an TCH and Shenqiu also entered into a BMPG Project Lease Agreement (the “2011 Shenqiu Lease”). Under the 2011 Shenqiu Lease, Xi’an TCH agreed to lease a set of 12 MW BMPG systems to Shenqiu at a monthly rental rate of $286,000 (RMB 1,800,000) for 11 years. Upon expiration of the 2011 Shenqiu Lease, ownership of this system will transfer from Xi’an TCH to Shenqiu at no additional cost. In connection with the 2011 Shenqiu Lease, Shenqiu paid one month’s rent as a security deposit to Xi’an TCH, in addition to providing personal guarantees.

5

 

 

On October 8, 2012, Xi’an TCH entered into a Letter of Intent for technical reformation of Shenqiu Project Phase II with Shenqiu for technical reformation to enlarge the capacity of the Shenqiu Project Phase I (the “Shenqiu Phase II Project”). The technical reformation involved the construction of another 12 MW BMPG system. After the reformation, the generation capacity of the power plant increased to 24 MW. The project commenced on October 25, 2012 and was completed during the first quarter of 2013. The total cost of the project was $11.1 million (RMB 68 million). On March 30, 2013, Xi’an TCH and Shenqiu entered into a BMPG Project Lease Agreement (the “2013 Shenqiu Lease”). Under the 2013 Shenqiu Lease, Xi’an TCH agreed to lease the second set of 12 MW BMPG systems to Shenqiu for $239,000 (RMB 1.5 million) per month for 9.5 years. When the 2013 Shenqiu Lease expires, ownership of this system will transfer from Xi’an TCH to Shenqiu at no additional cost.

 

The Fund Management Company

 

On June 25, 2013, Xi’an TCH and HongyuanHuifu Venture Capital Co. Ltd. (“HongyuanHuifu”) jointly established Beijing Hongyuan Recycling Energy Investment Management Company Ltd. (the “Fund Management Company”) with registered capital of RMB 10 million ($1.45 million). Xi’an TCH made an initial capital contribution of RMB 4 million ($650,000) and has a 40% ownership interest in the Fund Management Company. With respect to the Fund Management Company, voting rights and dividend rights are allocated 80% and 20% between HongyuanHuifu and Xi’an TCH, respectively.

 

The Fund Management Company is the general partner of Beijing Hongyuan Recycling Energy Investment Center, LLP (the “HYREF Fund”), a limited liability partnership established on July 18, 2013 in Beijing. The Fund Management Company made an initial capital contribution of RMB 5 million ($830,000) to the HYREF Fund. An initial total of RMB 460 million ($77 million) was fully subscribed by all partners for the HYREF Fund. The HYREF Fund has three limited partners: (1) China Orient Asset Management Co., Ltd., which made an initial capital contribution of RMB 280 million ($46.67 million) to the HYREF Fund and is a preferred limited partner; (2) HongyuanHuifu, which made an initial capital contribution of RMB 100 million ($16.67 million) to the HYREF Fund and is an ordinary limited partner; and (3) the Company’s wholly-owned subsidiary, Xi’an TCH, which made an initial capital contribution of RMB 75 million ($12.5 million) to the HYREF Fund and is a secondary limited partner. In addition, Xi’an TCH and HongyuanHuifu formed Beijing Hongyuan Recycling Energy Investment Management Company Ltd. to manage this Fund and also subscribed in the amount of RMB 5 million ($830,000) from the Fund. The term of the HYREF Fund’s partnership is six years from the date of its establishment, expiring July 18, 2019. The term is four years from the date of contribution for the preferred limited partner, and four years from the date of contribution for the ordinary limited partner. The total size of the HYREF Fund is RMB 460 million ($76.66 million). The HYREF Fund was formed for the purpose of investing in Xi’an Zhonghong New Energy Technology Co., Ltd., a 90% owned subsidiary of Xi’an TCH, for the construction of two coke dry quenching (“CDQ”) WHPG stations with Jiangsu Tianyu Energy and Chemical Group Co., Ltd. (“Tianyu”) and one CDQ WHPG station with Boxing County Chengli Gas Supply Co., Ltd. (“Chengli”).

 

Chengli Waste Heat Power Generation Projects

 

On July 19, 2013, Xi’an TCH formed a new company, “Xi’an Zhonghong New Energy Technology Co., Ltd.” (“Zhonghong”), with registered capital of RMB 30 million ($4.85 million). Xi’an TCH paid RMB 27 million ($4.37 million) and owns 90% of Zhonghong. Zhonghong is engaged to provide energy saving solution and services, including constructing, selling and leasing energy saving systems and equipment to customers.

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On July 24, 2013, Zhonghong entered into a Cooperative Agreement of CDQ and CDQ WHPG Project with Boxing County Chengli Gas Supply Co., Ltd. (“Chengli”). The parties entered into a supplement agreement on July 26, 2013. Pursuant to these agreements, Zhonghong will design, build and maintain a 25 MW CDQ system and a CDQ WHPG system to supply power to Chengli, and Chengli will pay energy saving fees (the “Chengli Project”). Chengli will contract the operation of the system to a third-party contractor that is mutually agreed to by Zhonghong. In addition, Chengli will provide the land for the CDQ system and CDQ WHPG system at no cost to Zhonghong. The term of the Agreements is for 20 years. The watt hours generated by the Chengli Project will be charged at RMB 0.42 ($0.068) per kilowatt hour (excluding tax). The operating time shall be based upon an average 8,000 hours annually. If the operating time is less than 8,000 hours per year due to a reason attributable to Chengli, then time charged shall be 8,000 hours a year, and if it is less than 8,000 hours due to a reason attributable to Zhonghong, then it shall be charged at actual operating hours. The construction of the Chengli Project was completed in the second quarter of 2015 and the project successfully completed commissioning tests in the first quarter of 2017. The Chengli Project is now operational, however, due to the environmental protection intensifies, the local environmental authorities required the project owner constructing CDQ sewage treatment supporting works, which must be completed and passed through acceptance inspection before the project is allowed to put into operation. So far, the project owner has completed the bidding of the sewage treatment supporting works and started construction on or about July 20, 2018. We anticipate that construction will require three months to complete. The Company expects the Boxing project will be put into operation in the fourth quarter of 2018. When operations begin, Chengli shall ensure its coking production line works properly and that working hours for the CDQ system are at least 8,000 hours per year, and Zhonghong shall ensure that working hours for the CDQ WHPG system are at least 7,200 hours per year.  

 

On July 22, 2013, Zhonghong entered into an Engineering, Procurement and Construction (“EPC”) General Contractor Agreement for the Boxing County Chengli Gas Supply Co., Ltd. CDQ Power Generation Project (the “Chengli Project”) with Xi’an Huaxin New Energy Co., Ltd. (“Huaxin”). Zhonghong, as the owner of the Chengli Project, contracted EPC services for a CDQ system and a 25 MW CDQ WHPG system for Chengli to Huaxin. Huaxin shall provide construction, equipment procurement, transportation, installation and adjustment, test run, construction engineering management and other necessary services to complete the Huaxin Project and ensure the CDQ system and CDQ WHPG system for Chengli meet the inspection and acceptance requirements and work normally. The Chengli Project is a turn-key project in which Huaxin is responsible for monitoring the quality, safety, duration and cost of the Chengli Project. The total contract price is RMB 200 million ($33.34 million), which includes all the materials, equipment, labor, transportation, electricity, water, waste disposal, machinery and safety costs.

 

Tianyu Waste Heat Power Generation Project

 

On July 19, 2013, Zhonghong entered into a Cooperative Agreement (the “Tianyu Agreement”) for Energy Management of CDQ and CDQ WHPG Project with Jiangsu Tianyu Energy and Chemical Group Co., Ltd. (“Tianyu”). Pursuant to the Tianyu Agreement, Zhonghong will design, build, operate and maintain two sets of 25 MW CDQ systems and CDQ WHPG systems for two subsidiaries of Tianyu – Xuzhou Tian’an Chemical Co., Ltd. (“Xuzhou Tian’an”) and Xuzhou Huayu Coking Co., Ltd. (“Xuzhou Huayu”) – to be located at Xuzhou Tian’an and Xuzhou Huayu’s respective locations (the “Tianyu Project”). Upon completion of the Tianyu Project, Zhonghong will charge Tianyu an energy saving fee of RMB 0.534 ($0.087) per kilowatt hour (excluding tax). The operating time will be based upon an average 8,000 hours annually for each of Xuzhou Tian’an and Xuzhou Huayu. If the operating time is less than 8,000 hours per year due to a reason attributable to Tianyu, then time charged will be 8,000 hours a year. Because of the control of the overcapacity and pollution of the iron and steel and related industries, the government has imposed production limitations for the energy-intensive enterprises with heavy pollution, including Xuzhou Tian’an. Xuzhou Tian’an has slowed the construction process for its dry quenching production line which caused the delay of our project. The term of the Tianyu Agreement is 20 years. The construction of the Xuzhou Tian’an Project is anticipated to be completed by the fourth quarter of 2018. Xuzhou Tian’an will provide the land for the CDQ and CDQ WHPG systems for free. Xuzhou Tian’an has also guaranteed that it will purchase all the power generated by the CDQ WHPG systems. The Xuzhou Huayu Project is currently on hold due to a conflict between Xuzhou Huayu Coking Co., Ltd. and local residents on certain pollution-related issues. The local government has acted in its capacity to coordinate the resolution of this issue. The local residents were requested to move from the hygienic buffer zone of the project location with compensatory payments from the government. Xuzhou Huayu was required to stop production and implement technical innovations to mitigate pollution discharge including sewage treatment, dust collection, noise control, and recycling of coal gas. Currently, some local residents have moved. Xuzhou Huayu has completed the implementation of the technical innovations of sewage treatment, dust collection, and noise control, and the Company is waiting for local governmental agencies to approve these technical innovations. Due to the strict administration of environmental protection policies and recent increase of environmental protections for the coking industry in Xuzhou, all local coking, as well as steel iron enterprises, are facing a similar situation of suspended production while rectifying technologies and procedures. The Company expects to receive governmental acceptance and approval and to resume construction in the fourth quarter of 2018.

 

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On July 22, 2013, Zhonghong entered into an EPC General Contractor Agreement for the Tianyu Project with Xi’an Huaxin New Energy Co., Ltd. (“Huaxin”). Zhonghong, as the owner of the Tianyu Project, contracted EPC services for two CDQ systems and two 25 MW CDQ WHPG systems for Tianyu to Huaxin. Huaxin shall provide construction, equipment procurement, transportation, installation and adjustment, test run, construction engineering management and other necessary services to complete the Tianyu Project and ensure the CDQ and CDQ WHPG systems for Tianyu meet the inspection and acceptance requirements and work normally. The Tianyu Project is a turn-key project in which Huaxin is responsible for monitoring the quality, safety, duration and cost of the project. The total contract price is RMB 400 million ($66.68 million), which includes all the materials, equipment, labor, transportation, electricity, water, waste disposal, machinery and safety costs.

 

Zhongtai Waste Heat Power Generation Energy Management Cooperative Agreement

 

On December 6, 2013, Xi’an TCH entered into a CDQ and WHPG Energy Management Cooperative Agreement (the “Zhongtai Agreement”) with Xuzhou Zhongtai Energy Technology Co., Ltd. (“Zhongtai”), a limited liability company incorporated in Jiangsu Province, China.

 

Pursuant to the Zhongtai Agreement, Xi’an TCH will design, build and maintain a 150 ton per hour CDQ system and a 25 MW CDQ WHPG system and sell the power to Zhongtai, and Xi’an TCH will also build a furnace to generate steam from the waste heat of the smoke pipeline and sell the steam to Zhongtai. 

  

The construction period of the Project is expected to be 18 months from the date when conditions are ready for construction to begin. Zhongtai will start to pay an energy saving service fee from the date when the WHPG station passes the required 72-hour test run. The payment term is 20 years. For the first 10 years, Zhongtai shall pay an energy saving fee at RMB 0.534 ($0.089) per kilowatt hour (KWH) (including value added tax) for the power generated from the system. For the second 10 years, Zhongtai shall pay an energy saving fee at RMB 0.402 ($0.067) per KWH (including value added tax). During the term of the contract the energy saving fee shall be adjusted at the same percentage as the change of local grid electricity price. Zhongtai shall also pay an energy saving fee for the steam supplied by Xi’an TCH at RMB 100 ($16.67) per ton (including value added tax). Zhongtai and its parent company will provide guarantees to ensure Zhongtai will fulfill its obligations under the Agreement. Upon the completion of the term, Xi’an TCH will transfer the systems to Zhongtai at RMB 1 ($0.16). Zhongtai shall provide waste heat to the systems for no less than 8,000 hours per year and waste gas volume no less than 150,000 Normal Meter Cubed (Nm3) per hour with a temperature no less than 950°C. If these requirements are not met, the term of the Agreement will be extended accordingly. If Zhongtai wants to terminate the Zhongtai Agreement early, it shall provide Xi’an TCH a 60 day notice and pay the termination fee and compensation for the damages to Xi’an TCH according to the following formula: (1) if it is less than five years into the term when Zhongtai requests termination, Zhongtai shall pay: Xi’an TCH’s total investment amount plus Xi’an TCH’s annual investment return times five years minus the years in which the system has already operated; or 2) if it is more than five years into the term when Zhongtai requests the termination, Zhongtai shall pay: Xi’an TCH’s total investment amount minus total amortization cost (the amortization period is 10 years).

 

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In March 2016, Xi’an TCH entered into a Transfer Agreement of CDQ and a CDQ WHPG system with Zhongtai and Xi’an Huaxin (the “Transfer Agreement”). Under the Transfer Agreement, Xi’an TCH agreed to transfer to Zhongtai all of the assets associated with the CDQ Waste Heat Power Generation Project (the “Project”), which is under construction pursuant to the Zhongtai Agreement. Additionally, Xi’an TCH agreed to transfer to Zhongtai the Engineering, Procurement and Construction (“EPC”) Contract for the CDQ Waste Heat Power Generation Project which Xi’an TCH had entered into with Xi’an Huaxin in connection with the Project. Xi’an Huaxin will continue to construct and complete the Project and Xi’an TCH agreed to transfer all its rights and obligation under the EPC Contract to Zhongtai. As consideration for the transfer of the Project, Zhongtai agreed to pay to Xi’an TCH an aggregate transfer price of RMB 167,360,000 ($25.77 million) including payments of: (i) RMB 152,360,000 ($23.46 million) for the construction of the Project; and (ii) RMB 15,000,000 ($2.31 million) as payment for partial loan interest accrued during the construction period. Those amounts have been, or will be, paid by Zhongtai to Xi’an TCH according to the following schedule: (a) RMB 50,000,000 ($7.70 million) was to be paid within 20 business days after the Transfer Agreement was signed; (b) RMB 30,000,000 ($4.32 million) was to be paid within 20 business days after the Project is completed, but no later than July 30, 2016; and (c) RMB 87,360,000 ($13.45 million) was to be paid no later than July 30, 2017. Xuzhou Taifa Special Steel Technology Co., Ltd. (“Xuzhou Taifa”) guaranteed the payments from Zhongtai to Xi’an TCH. The ownership of the Project was conditionally transferred to Zhongtai following the initial payment of RMB 50,000,000 ($7.70 million) by Zhongtai to Xi’an TCH and the full ownership of the Project will be officially transferred to Zhongtai after it completes all payments pursuant to the Transfer Agreement. As of June 30, 2018, Xi’an TCH had received the first payment of $7.70 million and the second payment of $4.32 million. The Company recorded a $2.82 million loss from this transaction in 2016. As of the date of this report, the Company has not yet received the remaining payment of RMB 87,360,000 ($13.45 million). However, the Company received a repayment commitment letter from Zhongtai on February 23, 2018, in which Zhongtai committed to pay the remaining payment of RMB 87,360,000 ($13.45 million) no later than the end of July 2018; in July 2018, Zhongtai and the Company reached a further oral agreement to extend the repayment term of RMB 87,360,000 ($13.45 million) by another two to three months.

 

Formation of Zhongxun

 

On March 24, 2014, Xi’an TCH incorporated a subsidiary, Zhongxun Energy Investment (Beijing) Co., Ltd (“Zhongxun”) with registered capital of $5,695,502 (RMB 35,000,000), which must be contributed before October 1, 2028. Zhongxun is 100% owned by Xi’an TCH and will be mainly engaged in project investment, investment management, economic information consulting, and technical services. Zhongxun has not yet commenced operations as of the date of this report.

 

Formation of Yinghua

 

On February 11, 2015, the Company incorporated a subsidiary, Shanghai Yinghua Financial Leasing Co., Ltd (“Yinghua”) with registered capital of $30,000,000, to be paid within 10 years from the date the business license is issued. Yinghua is 100% owned by the Company and will be mainly engaged in financial leasing, purchase of financial leasing assets, disposal and repair of financial leasing assets, consulting and ensuring of financial leasing transactions, and related factoring business. Yinghua has not yet commenced operations as of the date of this report.

  

Summary of Sales-Type Lease at June 30, 2018

 

As of June 30, 2018, Xi’an TCH leases the following systems: (i) BMPG systems to Pucheng Phase I and II (15 and 11-year terms, respectively); (ii) BMPG systems to Shenqiu Phase I (11-year term); and (iii) Shenqiu Phase II (9.5-year term). In addition, as of June 30, 2018, Erdos TCH leased power and steam generating systems for recycling waste heat from metal refining to Erdos (five systems) for a term of 20 years.

 

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2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The financial statements included herein were prepared by the Company, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The information furnished herein reflects all adjustments (consisting of normal recurring accruals and adjustments) that are, in the opinion of management, necessary to fairly present the operating results for the respective periods. Certain information and footnote disclosures normally present in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) were omitted pursuant to such rules and regulations.

  

Basis of Consolidation

 

The consolidated financial statements (“CFS”) include the accounts of CREG and its subsidiaries, Shanghai Yinghua Financial Leasing Co., Ltd. (“Yinghua”) and Sifang Holdings, Sifang Holdings’ wholly owned subsidiaries, Huahong New Energy Technology Co., Ltd. (“Huahong”) and Shanghai TCH Energy Tech Co., Ltd. (“Shanghai TCH”), Shanghai TCH’s wholly-owned subsidiary, Xi’an TCH Energy Tech Co., Ltd. (“Xi’an TCH”) and Xi’an TCH’s subsidiaries, Erdos TCH Energy Saving Development Co., Ltd (“Erdos TCH”), 100% owned by Xi’an TCH (See note 1), Zhonghong, 90% owned by Xi’an TCH, and Zhongxun, 100% owned by Xi’an TCH. Substantially all the Company’s revenues are derived from the operations of Shanghai TCH and its subsidiaries, which represent substantially all the Company’s consolidated assets and liabilities as of June 30, 2018 and December 31, 2017, respectively. All significant inter-company accounts and transactions were eliminated in consolidation.

 

Use of Estimates

 

In preparing these CFS in accordance with US GAAP, management makes estimates and assumptions that affect the reported amounts of assets and liabilities in the balance sheets as well as revenues and expenses during the period reported. Actual results may differ from these estimates.

 

Revenue Recognition

 

Sales-type Leasing and Related Revenue Recognition

 

The Company constructs and leases waste energy recycling power generating projects to its customers. The Company typically transfers ownership of the waste energy recycling power generating projects to its customers at the end of the lease. The investment in these projects is recorded as investment in sales-type leases in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 840, “Leases,” and its various amendments and interpretations. The Company finances construction of waste energy recycling power generating projects. The sales and cost of sales are recognized at the inception of the lease. The investment in sales-type leases consists of the sum of the minimum lease payments receivable less unearned interest income and estimated executory cost. Minimum lease payments are part of the lease agreement between the Company (as the lessor) and the customer (as the lessee). The discount rate implicit in the lease is used to calculate the present value of minimum lease payments. The minimum lease payments consist of the gross lease payments net of executory costs and contingent rentals, if any. Unearned interest is amortized to income over the lease term to produce a constant periodic rate of return on net investment in the lease. While revenue is recognized at the inception of the lease, the cash flow from the sales-type lease occurs over the course of the lease, which results in interest income and reduction of receivables. Revenue is recognized net of sales tax. 

 

Contingent Rental Income

 

The Company records income from actual electricity usage in addition to minimum lease payments of each project as contingent rental income in the period contingent rental income is earned. Contingent rent is not part of minimum lease payments.   

 

Cash and Equivalents

 

Cash and equivalents include cash on hand, demand deposits placed with banks or other financial institutions and all highly liquid investments with an original maturity of three months or less as of the purchase date of such investments.

 

Accounts Receivable

 

As of June 30, 2018, the Company had accounts receivable of $16,998,804 (from the sales of CDQ and a CDQ WHPG system to Zhongtai, and accounts receivable of Erdos TCH for electricity sold). As of December 31, 2017, the Company had accounts receivable of $15,858,804 (from the sales of CDQ and a CDQ WHPG system to Zhongtai, and accounts receivable of Erdos TCH for electricity sold).

 

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Interest Receivable on Sales Type Leases

 

As of June 30, 2018, the interest receivable on sales type leases was $9,845,608, mainly from recognized but not yet collected interest income for the Pucheng and Shenqiu systems. As of December 31, 2017, the interest receivable on sales type leases was $9,619,278. As of April 1, 2018, the Company stopped accruing interest receivable on the Pucheng lease as the Pucheng leasee was at least one year overdue in its payments.

 

The Company maintains reserves for potential credit losses on receivables. Management reviews the composition of receivables and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. As of June 30, 2018, the Company had bad debt allowance for net investment receivable of $2,586,479 for the Pucheng and Shenqiu systems.

 

Concentration of Credit Risk

 

Cash includes cash on hand and demand deposits in accounts maintained within China. Balances at financial institutions within China are not covered by insurance. The Company has not experienced any losses in such accounts.

 

Certain other financial instruments, which subject the Company to concentration of credit risk, consist of accounts and other receivables. The Company does not require collateral or other security to support these receivables. The Company conducts periodic reviews of its customers’ financial condition and customer payment practices to minimize collection risk on accounts receivable.

 

The operations of the Company are located in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC.

 

Property and Equipment

 

Property and equipment are stated at cost, net of accumulated depreciation. Expenditures for maintenance and repairs are expensed as incurred; additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation of property and equipment is provided using the straight-line method over the estimated lives as follows:

 

Building     20 years  
Vehicles     2 - 5 years  
Office and Other Equipment     2 - 5 years  
Software     2 - 3 years  

   

Impairment of Long-lived Assets

 

In accordance with FASB ASC Topic 360, “Property, Plant, and Equipment,” the Company reviews its long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be fully recoverable. If the total expected undiscounted future net cash flows is less than the carrying amount of the asset, a loss is recognized for the difference between the fair value and carrying amount of the asset. The Company did not record any asset impairment loss for the six and three months ended June 30, 2018 and 2017.

 

Notes Payable – Banker’s Acceptances

 

The Company endorses banker’s acceptances that are issued from a bank to vendors as payment for its obligations. Most of the banker’s acceptances have maturity dates of less than six months following their issuance.

 

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Cost of Sales

 

Cost of sales consists primarily of the direct material of the power generating system and expenses incurred directly for project construction for sales-type leasing and sales tax and additions for contingent rental income.

 

Income Taxes

 

Income taxes are accounted for using an asset and liability method. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates, applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

 

The Company follows ASC Topic 740, which prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC Topic 740 also provides guidance on recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures.

 

Under the provisions of ASC Topic 740, when tax returns are filed, it is likely that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

 

CREG is subject to U.S. corporate income taxes on its taxable income at a rate of up to 21% for taxable years beginning after December 31, 2017 and U.S. corporate income tax on its taxable income of up to 35% for prior tax years. On December 22, 2017, the Tax Cut and Jobs Act (“Tax Act”) was signed into law. The Tax Act introduced a broad range of tax reform measures that significantly changed the federal income tax laws. The provisions of the Tax Act that may have significant impact on the Company include the permanent reduction of the corporate income tax rate from 35% to 21% effective for tax years including or commencing on January 1, 2018, one-time transition tax on post-1986 foreign unremitted earnings, provision for Global Intangible Low Tax Income (“GILTI”), deduction for Foreign Derived Intangible Income (“FDII”), repeal of corporate alternative minimum tax, limitation of various business deductions, and modification of the maximum deduction of net operating loss with no carryback but indefinite carryforward provision. Many provisions in the Tax Act are generally effective in tax years beginning after December 31, 2017. Taxpayers may elect to pay the one-time transition tax over eight years, or in a single lump-sum payment. 

 

To the extent that portions of its U.S. taxable income, such as Subpart F income or GILTI, are determined to be from sources outside of the U.S., subject to certain limitations, the Company may be able to claim foreign tax credits to offset its U.S. income tax liabilities. Any remaining liabilities are accrued in the Company’s consolidated statements of comprehensive income and estimated tax payments are made when required by U.S. law.

 

Noncontrolling Interests

 

The Company follows FASB ASC Topic 810, “Consolidation,” which established new standards governing the accounting for and reporting of noncontrolling interests (“NCIs”) in partially owned consolidated subsidiaries and the loss of control of subsidiaries. Certain provisions of this standard indicate, among other things, that NCIs (previously referred to as minority interests) be treated as a separate component of equity, not as a liability (as was previously the case), that increases and decreases in the parent’s ownership interest that leave control intact be treated as equity transactions rather than as step acquisitions or dilution gains or losses, and that losses of a partially-owned consolidated subsidiary be allocated to NCIs even when such allocation might result in a deficit balance. 

 

The net income (loss) attributed to NCIs was separately designated in the accompanying statements of income and comprehensive income (loss). Losses attributable to NCIs in a subsidiary may exceed an NCI’s interests in the subsidiary’s equity. The excess attributable to NCIs is attributed to those interests. NCIs shall continue to be attributed their share of losses even if that attribution results in a deficit NCI balance.

 

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Statement of Cash Flows

 

In accordance with FASB ASC Topic 230, “Statement of Cash Flows,” cash flows from the Company’s operations are calculated based upon the local currencies. As a result, amounts related to assets and liabilities reported on the statement of cash flows may not necessarily agree with changes in the corresponding balances on the balance sheet.

 

Fair Value of Financial Instruments

 

For certain of the Company’s financial instruments, including cash and equivalents, restricted cash, accounts receivable, other receivables, accounts payable, accrued liabilities and short-term debts, the carrying amounts approximate their fair values due to their short maturities. Receivables on sales-type leases are based on interest rates implicit in the lease.

 

FASB ASC Topic 820, “Fair Value Measurements and Disclosures,” requires disclosure of the fair value (“FV”) of financial instruments held by the Company. FASB ASC Topic 825, “Financial Instruments,” defines FV, and establishes a three-level valuation hierarchy for disclosures of FV measurement that enhances disclosure requirements for FV measures. The carrying amounts reported in the consolidated balance sheets for receivables and current liabilities each qualify as financial instruments and are a reasonable estimate of their FV because of the short period of time between the origination of such instruments and their expected realization and their current market rate of interest. The three levels of valuation hierarchy are defined as follows:

 

  ● Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
     
  ● Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
     
  ● Level 3 inputs to the valuation methodology are unobservable and significant to FV measurement.

 

The Company analyzes all financial instruments with features of both liabilities and equity under ASC 480, “Distinguishing Liabilities from Equity,” and ASC 815, “Derivatives and Hedging.”

 

As of June 30, 2018 and December 31, 2017, the Company did not have any long-term debt obligations.

 

As of June 30, 2018 and December 31, 2017, the Company did not identify any assets or liabilities that are required to be presented on the balance sheet at FV.

 

Stock-Based Compensation

 

The Company accounts for its stock-based compensation in accordance with FASB ASC Topic 718 “Compensation—Stock Compensation,” and FASB ASC Topic 505, “Equity.” The Company recognizes in its statement of operations FV at the grant date for stock options and other equity-based compensation issued to employees and non-employees.

 

Basic and Diluted Earnings per Share

 

The Company presents net income (loss) per share (“EPS”) in accordance with FASB ASC Topic 260, “Earning Per Share.” Accordingly, basic income (loss) per share is computed by dividing income (loss) available to common stockholders by the weighted average number of shares outstanding, without consideration for common stock equivalents. Diluted EPS is computed by dividing the net income by the weighted-average number of common shares outstanding as well as common share equivalents outstanding for the period determined using the treasury-stock method for stock options and warrants and the if-converted method for convertible notes. The Company made an accounting policy election to use the if-converted method for convertible securities that are eligible to receive common stock dividends, if declared. Diluted EPS reflect the potential dilution that could occur based on the exercise of stock options or warrants or conversion of convertible securities using the if-converted method.

 

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Foreign Currency Translation and Comprehensive Income (Loss)

 

The Company’s functional currency is the Renminbi (“RMB”). For financial reporting purposes, RMB were translated into United States Dollars (“USD” or “$”) as the reporting currency. Assets and liabilities are translated at the exchange rate in effect at the balance sheet date. Revenues and expenses are translated at the average rate of exchange prevailing during the reporting period. Translation adjustments arising from the use of different exchange rates from period to period are included as a component of stockholders’ equity as “Accumulated other comprehensive income.” Gains and losses resulting from foreign currency transactions are included in income. There was no significant fluctuation in the exchange rate for the conversion of RMB to USD after the balance sheet date.    

 

The Company follows FASB ASC Topic 220, “Comprehensive Income.” Comprehensive income is comprised of net income and all changes to the statements of stockholders’ equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders.

  

Segment Reporting

 

FASB ASC Topic 280, “Segment Reporting,” requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. FASB ASC Topic 280 has no effect on the Company’s CFS as substantially all of the Company’s operations are conducted in one industry segment. All of the Company’s assets are located in the PRC.

 

New Accounting Pronouncements

  

In February 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842). The guidance in ASU 2016-02 supersedes the lease recognition requirements in ASC Topic 840, Leases (FAS 13). ASU 2016-02 requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases, along with additional qualitative and quantitative disclosures. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the effect this standard will have on its CFS.

   

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The standard should be applied prospectively on or after the effective date. The Company will evaluate the impact of adopting this standard prospectively upon any transactions of acquisitions or disposals of assets or businesses. 

 

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its FV, not to exceed the carrying amount of goodwill. The guidance should be adopted on a prospective basis for the annual or any interim goodwill impairment tests beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact of adopting this standard on its CFS.

 

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In June 2018, the FASB issued ASU 2018-07, “Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting,” which simplifies the accounting for share-based payments granted to nonemployees for goods and services and aligns most of the guidance on such payments to nonemployees with the requirements for share-based payments granted to employees. ASU 2018-07 becomes effective for the Company on January 1, 2019. Early adoption is permitted. The adoption of this accounting pronouncement is not expected to have an impact on the Company’s CFS.

 

Other recent accounting pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the SEC did not or are not believed by management to have a material impact on the Company’s present or future CFS. 

  

3. NOTES RECEIVABLE – BANK ACCEPTANCE

 

As of June 30, 2018 and December 31, 2017, the Company had outstanding notes receivable on-hand of $906,810 and $979,462, respectively, representing the commercial notes (also called bank acceptances) that were issued by customers to Erdos TCH and were honored by the applicable bank. Erdos TCH may hold a bank acceptance until the maturity for the full payment, have the bank acceptance cashed out from the bank at a discount at an earlier date, or transfer the bank acceptance to its vendors in lieu of payment. As of June 30, 2018, Erdos TCH had a $0.26 million bank acceptance that was transferred to one of its suppliers but had not matured. If the honoring bank refuses to redeem the bank acceptance, which only occurs in rare circumstances, then Erdos TCH would be obligated to redeem these bank acceptance. 

 

4. INVESTMENT IN SALES-TYPE LEASES, NET

 

Under sales-type leases, Xi’an TCH leases the following systems: (i) BMPG systems to Pucheng Phase I and II (15 and 11 year terms, respectively); (ii) BMPG systems to Shenqiu Phase I (11-year term); and (iii) BMPG systems to Shenqiu Phase II (9.5-year term). In addition, as of June 30, 2018, Erdos TCH leased power and steam generating systems from waste heat from metal refining to Erdos (five systems) for a term of twenty years. The components of the net investment in sales-type leases as of June 30, 2018 and December 31, 2017 are as follows:

 

    2018
(Restated) 		  

2017

(Restated)

 
Total future minimum lease payments receivable   $ 94,187,347     $ 99,155,214  
Less: executory cost     (6,042,207 )     (6,360,901 )
Less: unearned interest     (21,854,351 )     (23,730,094 )
Less: realized interest income but not yet received     (9,241,978 )     (9,619,278 )
Less: allowance for net investment receivable     (2,586,479 )     (1,802,822 )
Investment in sales-type leases, net     54,462,332       57,642,119  
Current portion     12,220,921       11,531,745  
Noncurrent portion   $ 42,241,411     $ 46,110,374  

 

As of June 30, 2018, the future minimum rentals to be received on non-cancelable sales-type leases by years are as follows:

 

2019   $ 33,385,727  
2020     12,876,704  
2021     12,876,704  
2022     12,876,704  
2023     8,387,994  
Thereafter     13,783,514  
Total   $ 94,187,347  

 

15

 

 

5. PREPAID EXPENSES

 

Prepaid expenses mainly consisted of prepayment for office rental and decorations, taxes, and consulting fees for the Company’s HYREF fund completed in July 2013. Before the HYREF Fund released the money to Zhonghong, Xi’an TCH paid 2% of the funds raised for Zhonghong, i.e. RMB 8.2 million ($1.2 million) to the Fund Management Company as a consulting fee and it shall pay such 2% on the amount of funds actually contributed as an annual management fee on every 365-day anniversary thereafter until Zhonghong fully repays the loan, and the HYREF Fund no longer has an ownership interest in Zhonghong. The Company had $0.10 million and $0.71 million prepaid consulting expense as of June 30, 2018 and December 31, 2017, respectively. The Company had $33,602 and $34,026 prepaid tax as of June 30, 2018 and December 31, 2017, respectively. 

 

6. OTHER RECEIVABLES

 

As of June 30, 2018, other receivables mainly consisted of (i) advances to third parties of $7,557, bearing no interest, payable upon demand. As of December 31, 2017, other receivables mainly consisted of an advance to a third party of $7,652, bearing no interest, payable upon demand.

 

7. LONG TERM INVESTMENT

 

On June 25, 2013, Xi’an TCH with HongyuanHuifu Venture Capital Co. Ltd (“HongyuanHuifu”) jointly established Beijing Hongyuan Recycling Energy Investment Management Company Ltd. (the “Fund Management Company”) with registered capital of RMB 10 million ($1.6 million), to manage a fund that will be used for financing CDQ WHPG projects. Xi’an TCH made an initial capital contribution of RMB 4 million ($0.65 million) and has a 40% ownership interest in the Fund Management Company. Voting rights and dividend rights are allocated between HongyuanHuifu and Xi’an TCH at 80% and 20%, respectively. The Company accounted for this investment using the equity method. The Company recorded $(4,815) and $(671) equity based investment loss during six and three months ended June 30, 2018, respectively. The Company recorded $87,331 and $47,580 equity based investment income during six and three months ended June 30, 2017, respectively.

 

On July 18, 2013, the HYREF Fund was established as a limited liability partnership in Beijing. Pursuant to the Partnership Agreement, the HYREF Fund has a general partner, the Fund Management Company, which made an initial capital contribution of RMB 5 million ($0.83 million) to the HYREF Fund. The HYREF Fund has three limited partners: (1) China Orient Asset Management Co., Ltd., which made an initial capital contribution of RMB 280 million ($46.67 million) and is a preferred limited partner, (2) HongyuanHuifu, which made an initial capital contribution of RMB 100 million ($16.67 million) and is an ordinary limited partner and (3) the Company’s wholly-owned subsidiary, Xian TCH, which made an initial capital contribution of RMB 75 million ($10.81 million) and is a secondary limited partner. The term of the HYREF Fund’s partnership is six years from the date of its establishment, July 18, 2013. The current term for (x) the preferred limited partner is four years from the date of its contribution and (y) the ordinary limited partner is four years from the date of its contribution. Unless otherwise approved by the general partner (the Fund Management Company), upon the expiration of their respective terms, each partner shall exit from the partnership automatically. The total size of the HYREF Fund is RMB 460 million ($75.0 million), and the purpose of the HYREF Fund is to invest in Zhonghong for constructing 3 new CDQ WHPG projects. Xi’an TCH owns 16.3% of the HYREF Fund. The Company accounted for this investment using the cost method. The Company netted off the investment of RMB 75 million ($10.81 million) by Xi’an TCH with the entrusted loan payable of the HYREF Fund.

 

8. CONSTRUCTION IN PROGRESS

 

Construction in progress was for constructing power generation systems. As of June 30, 2018 and December 31, 2017, the Company’s construction in progress included:

 

   2018   2017 
Xuzhou Huayu  $24,665,136   $24,976,178 
Xuzhou Tian’an   38,979,814    37,814,637 
Boxing County Chengli   31,971,973    32,375,158 
Total  $95,616,923   $95,165,973 

 

As of June 30, 2018, the Company was committed to pay an additional (1) $12.09 million for the Xuzhou Huayu project, (2) $4.19 million for the Xuzhou Tian’an project, and (3) $4.66 million for Boxing County Chengli project. The Boxing County Chengli project has finished construction, but is waiting for government approval before beginning operations. 

 

16

 

 

9. TAXES PAYABLE

 

Taxes payable consisted of the following as of June 30, 2018 and December 31, 2017:

 

   2018   2017 
Income - current  $1,057,136   $1,097,768 
VAT   1,480,255    1,145,363 
Other   232,632    180,649 
Total - current   2,770,023    2,423,780 
Income - noncurrent  $6,998,625   $6,998,625 

 

Income tax payable was approximately $8.06 million at June 30, 2018, of which, $1.06 million current and $7.00 million noncurrent was from recording the estimated one-time transition tax on post-1986 foreign unremitted earnings under the Tax Cut and Jobs Act signed on December 22, 2017. An election is available for the U.S. shareholder of a foreign company to pay the tax liability in installments over a period of eight years with 8% of net tax liability in the first five years, 15% in the sixth year, 20% in the seventh year, and 25% in the eighth year. The Company will consider making such an election.

 

10. ACCRUED LIABILITIES AND OTHER PAYABLES

 

Accrued liabilities and other payables consisted of the following as of June 30, 2018 and December 31, 2017:

 

   2018   2017 
Employee training, labor union expenditure and social insurance payable  $841,388   $852,316 
Consulting, auditing, and legal expenses   482,581    480,057 
Accrued payroll and welfare   258,710    261,793 
Other   16,192    24,150 
Total  $1,598,871   $1,618,316 

   

11. DEFERRED TAX LIABILITY, NET

 

Deferred tax asset resulted from accrued employee social insurance that can be deducted for tax purposes in the future, and the difference between tax and accounting basis of cost of fixed assets which was capitalized for tax purposes and expensed as part of cost of systems in accordance with US GAAP. Deferred tax liability arose from the difference between tax and accounting basis of net investment in sales-type leases.

 

As of June 30, 2018 and December 31, 2017, deferred tax liability consisted of the following:

 

    2018
(Restated) 		   2017
(Restated) 		 
Deferred tax asset — current (accrual of employee social insurance)   $ 187,255     $ 189,617  
Deferred tax liability — current (net investment in sales-type leases)     (1,597,776 )     (1,520,538 )
Deferred tax liability, net of current deferred tax asset   $ (1,410,521 )   $ (1,330,921 )
                 
Deferred tax asset — noncurrent (depreciation of fixed assets)   $ 9,590,713     $ 10,250,395  
Deferred tax asset — noncurrent (asset impairment loss)     879,480       450,706  
Deferred tax liability — noncurrent (net investment in sales-type leases)     (10,560,354 )     (11,527,594 )
Deferred tax liability, net of noncurrent deferred tax asset   $ (90,159 )   $ (826,493 )
Total Deferred tax liability, noncurrent per ASU 2015-17   $ (1,500,680 )   $ (2,157,414 )

 

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12. LOANS PAYABLE

 

Entrusted Loan Payable

 

The HYREF Fund (Beijing Hongyuan Recycling Energy Investment Center, LLP) established in July 2013 with total fund size of RMB 460 million ($75.0 million) invests in Xi’an Zhonghong for Zhonghong’s three new CDQ WHPG projects. The HYREF Fund invested RMB 3 million ($0.5 million) as an equity investment and RMB 457 million ($74.5 million) as a debt investment in Xi’an Zhonghong; in return for such investments, the HYREF Fund will receive interest from Zhonghong for the HYREF Fund’s debt investment. The RMB 457 million ($74.5 million) was released to Zhonghong through an entrusted bank, which is also the supervising bank for the use of the loan. The loan was deposited in a bank account at the Supervising Bank (the Industrial Bank Xi’an Branch) and is jointly supervised by Zhonghong and the Fund Management Company. Project spending shall be verified by the Fund Management Company to confirm that it is in accordance with the project schedule before the funds are released. All the operating accounts of Zhonghong have been opened with the branches of the Supervising Bank and the Supervising Bank has the right to monitor all bank accounts opened by Zhonghong. The entrusted bank will charge 0.1% of loan amount as service fee and will not take any lending risk. The loan was collateralized by the accounts receivable and the fixed assets of Shenqiu Phase I and II power generation systems, the accounts receivable and fixed assets of Zhonghong’s three CDQ WHPG systems, and a 27 million RMB capital contribution made by Xi’an TCH. Repayment of the loan (principal and interest) was also jointly and severally guaranteed by Xi’an TCH and the Chairman and CEO of the Company. In the fourth quarter of 2015, three power stations of Erdos TCH were pledged to Industrial Bank as an additional guarantee for the loan lent to Zhonghong’s three CDQ WHPG systems. In 2016, two additional power stations of Erdos TCH and Pucheng Phase I and II systems were pledged to Industrial Bank as an additional guarantee along with Xi’an TCH’s equity in Zhonghong. 

 

The loan agreement provides that Zhonghong shall also maintain a certain capital level in its account with the Supervising Bank to make sure it has sufficient funds to make interest payments when they are due:

 

  ● During the first three years from the first release of the loan, the balance in its account shall be no less than RMB 7.14 million ($1.19 million) on the 20th day of the second month of each quarter and no less than RMB 14.28 million ($2.38 million) on the 14th day of the last month of each quarter;

 

  ● During the fourth year from the first release of the loan, the balance in its account shall be no less than RMB 1.92 million ($0.32 million) on the 20th day of the second month of each quarter and no less than RMB 3.85 million ($0.64 million) on the 14th day of the last month of each quarter; and
     
  ● During the fifth year from the first release of the loan, the balance in its account shall be no less than RMB 96,300 ($16,050) on the 20th day of the second month of each quarter and no less than RMB 192,500 ($32,080) on the 14th day of the last month of each quarter.

 

The term of this loan is for 60 months from July 31, 2013 to July 30, 2018. On August 6, 2016, Zhonghong was to repay principal of RMB 280 million ($42.22 million); on August 6, 2017, Zhonghong was initially supposed to repay principal of RMB 100 million ($16.27 million) and on July 30, 2018, Zhonghong was initially supposed to repay the remainder of RMB 77 million ($12.52 million). The interest rate is 12.5%. During the term, Zhonghong shall maintain a minimal funding level and capital level in its designated account with the Supervising Bank to make sure it has sufficient funds to make principal payments when they are due. Notwithstanding the requirements, the HYREF Fund and Supervising Bank verbally notified Zhonghong from the beginning that it was unlikely that they would enforce these requirements for the purpose of the efficient utilization of working capital. As of June 30, 2018, the entrusted loan payable had an outstanding balance of $61.51 million, of which, $11.33 million was from the investment of Xi’an TCH; accordingly, the Company netted the loan payable of $11.33 million with the long-term investment to the HYREF Fund made by Xi’an TCH. For the six months ended June 30, 2018, the Company recorded interest expense of $2.31 million on this loan and capitalized $1.70 million interest to construction in progress. The Company had fully paid RMB 50 million ($7.54 million) of the RMB 280 million ($42.22 million), and on August 5, 2016, the Company entered into a supplemental agreement with the lender to extend the due date of the remaining RMB 230 million ($34.68 million) of the original RMB 280 million ($45.54 million) to August 6, 2017. During the year ended December 31, 2017, the Company negotiated with the lender again for further extending the remaining loan balance of RMB 230 million ($34.68 million), RMB 100 million ($16.27 million), and RMB 77 million ($12.52 million) (which included investment from Xi’an TCH of RMB 75 million and was netted off with the entrusted loan payable of the HYREF Fund in the balance sheet). The lender has tentatively agreed to extend the remaining loan balance for another two years until August 2019 with an adjusted annual interest rate of 9%, subject to the final approval from its headquarters. The related extension documents are currently going through the lender’s internal approval procedure. 

 

18

 

 

Due to the slow progress of the construction of the three CDQ WHPG projects, the Company applied for a lower interest rate from the lender in January 2017, and the lender tentatively agreed to lower the interest rate to 9% in December 2017 subject to the approval from its headquarters. The Company plans to repay the interest once the lender’s internal approval procedure, which is still pending, is officially completed. As of June 30, 2018, the interest payable for this loan was $11.9 million.

 

As of June 30, 2018, the future minimum repayment of all the loans including the entrusted loan to be made by years is as follows:

 

2019  $50,176,828 
Total  $50,176,828 

  

13. REFUNDABLE DEPOSIT FROM CUSTOMERS FOR SYSTEMS LEASING

 

As of June 30, 2018 and December 31, 2017, the balance of refundable deposit from customers for systems leasing for Pucheng and Shengqiu was $1,073,059 and $1,086,591, respectively.

 

14. RELATED PARTY TRANSACTIONS

 

As of June 30, 2018 and December 31, 2017, the Company had $41,152 and $43,623 in advances from the Company’s management, which bear no interest, are unsecured, and are payable upon demand.  

  

15. NONCONTROLLING INTEREST

 

On July 15, 2013, Xi’an TCH and HYREF Fund jointly established Xi’an Zhonghong New Energy Technology (“Zhonghong”) with registered capital of RMB 30 million ($4.88 million), to manage new projects. Xi’an TCH paid RMB 27 million ($4.37 million) as its contribution of the registered capital to Zhonghong. Xi’an TCH owns 90% of Zhonghong while HYREF Fund owns 10% of Zhonghong as a non-controlling interest of Zhonghong.

 

In addition, the HYREF Fund was 16.3% owned by Xi’an TCH and 1.1% owned by the Fund Management Company, and the Fund Management Company was 40% owned by Xi’an TCH as described in Note 7, which resulted in an additional indirect ownership of Xi’an TCH in Zhonghong of 1.7%; accordingly, the ultimate non-controlling interest (HYREF Fund) in Zhonghong became 8.3%. During the six and three months ended June 30, 2018, the Company had losses of $187,183 and $95,925 that were attributable to the noncontrolling interest, respectively. During the six and three months ended June 30, 2017, the Company had losses of $178,255 and $89,832 that were attributable to the noncontrolling interest, respectively.

 

16. INCOME TAX

 

The Company’s Chinese subsidiaries are governed by the Income Tax Law of the PRC concerning privately-run enterprises, which are generally subject to tax at 25% on income reported in the statutory financial statements after appropriate tax adjustments. Under the Chinese tax law, the tax treatment of finance and sales-type leases is similar to US GAAP. However, the local tax bureau continues to treat CREG sales-type leases as operating leases. Accordingly, the Company recorded deferred income taxes. 

 

The Company’s subsidiaries generate all of their income from their PRC operations. All of the Company’s Chinese subsidiaries’ effective income tax rate for 2018 and 2017 was 25%. Yinghua, Shanghai TCH, Xi’an TCH, Huahong, Zhonghong and Erdos TCH file separate income tax returns.

 

19

 

 

There is no income tax for companies domiciled in the Cayman Islands. Accordingly, the Company’s CFS do not present any income tax provisions related to Cayman Islands tax jurisdiction, where Sifang Holding is domiciled.  

 

The US parent company, China Recycling Energy Corporation, is taxed in the US and, as of June 30, 2018, had net operating loss (“NOL”) carry forwards for income taxes of $14.56 million, which may be available to reduce future years’ taxable income as NOLs can be carried forward up to 20 years from the year the loss is incurred. Our management believes the realization of benefits from these losses may be uncertain due to the US parent company’s continuing operating losses. Accordingly, a 100% deferred tax asset valuation allowance was provided.

 

The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the six and three months ended June 30, 2018 and 2017, respectively:

 

    Six Months    Three Months  
    2018
(Restated) 		   2017
(Restated) 		   2018
(Restated) 		   2017
(Restated) 		 
U.S. statutory rates     (21.0 )%     34.0 %     (21.0 )%     34.0 %
Tax rate difference – current provision     (3.3 )%     (9.0 )%     (3.7 )%     (10.8 )%
Other     7.8 %     (1.5 )%     7.9 %     (2.5 )%
Permanent differences     10.3 %     0.1 %     9.5 %     0.3 %
Valuation allowance on PRC NOL     21.0 %     18.2 %     1.1 %     29.5 %
Valuation allowance on US NOL     3.5 %     0.1 %     1.7 %     0.1 %
Tax (benefit) per financial statements     18.3 %     41.9 %     (4.5 )%     55.7 %

 

The provision for income taxes expense for the six and three months ended June 30, 2018 and 2017 consisted of the following:

 

    Six Months    Three Months  
    2018
(Restated) 		   2017
(Restated) 		   2018
(Restated) 		   2017
(Restated) 		 
Income tax expense – current   $ 921,041     $ 664,651     $ 463,046     $ 325,428  
Income tax expense – deferred     (653,123 )     (53,656 )     (534,673 )     31,678  
Total income tax expense   $ 267,918     $ 610,995     $ (71,627 )   $ 293,750  

 

On December 22, 2017, the Tax Cut and Jobs Act (“Tax Act”) was signed into law in the United States. The Tax Act introduced a broad range of tax reform measures that significantly change the federal income tax laws. The provisions of the Tax Act that may have significant impact on the Company include the permanent reduction of the corporate income tax rate from 35% to 21% effective for tax years including or commencing on January 1, 2018, a one-time transition tax on post-1986 foreign unremitted earnings, the provision for Global Intangible Low Tax Income (“GILTI”), the deduction for Foreign Derived Intangible Income (“FDII”), the repeal of corporate alternative minimum tax, the limitation of various business deductions, and the modification of the maximum deduction of net operating loss with no carryback but indefinite carryforward provision. Many provisions in the Tax Act are generally effective in tax years beginning after December 31, 2017.

 

In 2017 the Company reflected the provisional income tax effects of the Tax Act under Accounting Standards Codification Topic 740, Income Taxes, and had approximately $7.61 million tax expense from recording the estimated one-time transition tax on post-1986 foreign unremitted earnings.

 

The Company continues to examine the impact of certain provisions of the Tax Act that will become applicable in calendar year 2018 related to Base Erosion and Anti Abuse Tax (“BEAT”), GILTI, deduction for FDII, and other provisions that could affect its effective tax rate in the future. The Company records the income tax effects of GILTI and other provisions of the Tax Act as incurred beginning in calendar year 2018. For the six and three months ended June 30, 2018, there was no such income tax effects. Also, because there may be additional state income tax implications, the Company will continue to monitor changes in state and local tax laws to determine if state and local taxing authorities intend to conform or deviate from changes to U.S. federal tax legislation as a result of the Tax Act. The prospects of supplemental legislation or regulatory processes to address questions that arise because of the Tax Act, or evolving technical interpretations of the tax law, may cause the final impact from the Tax Act to differ from the provisionally recorded amounts. The Company expects to complete its analysis within the measurement period allowed by Staff Accounting Bulletin (“SAB”) No.118 no later than the fourth quarter of calendar year 2018.

 

China maintains a “closed” capital account, meaning companies, banks, and individuals cannot move money in or out of the country except in accordance with strict rules. The People’s Bank of China (PBOC) and State Administration of Foreign Exchange (SAFE) regulate the flow of foreign exchange in and out of the country. For inward or outward foreign currency transactions, the Company needs to make a timely declaration to the bank with sufficient supporting documents to declare the nature of the business transaction. 

 

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17. STOCK-BASED COMPENSATION PLAN

 

Options to Employees

 

On June 19, 2015, the stockholders of the Company approved the China Recycling Energy Corporation Omnibus Equity Plan (the “Plan”) at its annual meeting. The total shares of common stock authorized for issuance during the term of the Plan is 12,462,605 (prior to the 10:1 Reverse Stock Split). The Plan was effective immediately upon the adoption by our Board of Directors on April 24, 2015, subject to stockholder approval, and will terminate on the earliest to occur of (i) the 10th anniversary of the Plan’s effective date, or (ii) the date on which all shares available for issuance under the Plan shall have been issued as fully-vested shares. The stockholders approved the Plan at its annual meeting on June 19, 2015.

 

On April 27, 2017, the Board approved the grant to the Company’s CFO of an option to purchase 5,000 shares of the Company’s common stock at $1.61 per share, with a term of 10 years. The option vested immediately upon the grant.

 

The FV of the stock option granted is estimated on the date of the grant using the Black-Scholes option pricing model (“BSOPM”). The BSOPM has assumptions for risk free interest rates, dividends, stock volatility and expected life of an option grant. The risk-free interest rate is based upon market yields for United States Treasury debt securities at a maturity near the term remaining on the option. Dividend rates are based on the Company’s dividend history. The stock volatility factor is based on the historical volatility of the Company’s stock price. The expected life of an option grant is based on management’s estimate as no options have been exercised in the Plan to date. The FV of the option granted to employees is recognized as compensation expense over the vesting period of the stock option award. The FV of the options was calculated using the following assumptions, estimated life of ten years, volatility of 124%, risk free interest rate of 2.30%, and dividend yield of 0%. The FV of the 5,000 stock options was $7,647 at the grant date. 

  

Options to Independent Directors

 

On March 31, 2015, the Board appointed Mr. Cangsang Huang as a member of the Company’s Board of Directors to fill a vacancy. In connection with the appointment, the Board authorized the Company to provide Mr. Huang with (i) compensation of $2,000 per month and (ii) the grant of an option to purchase 40,000 shares of the Company’s Common Stock, par value $0.001, at an exercise price of $1.02 per share (prior to the 10:1 Reverse Stock Split effective May 25, 2016), which was equal to the closing price per share of the Company’s Common Stock on March 31, 2015. Such options were only valid and exercisable upon stockholder approval. The options to Mr. Huang were not voted upon at the Company’s annual stockholder’s meeting on June 19, 2015 and were cancelled automatically. However, the Company’s Plan adopted by the Board on April 24, 2015 for providing equity awards to employees, directors and consultants was approved at the annual stockholder’s meeting; accordingly, the Compensation Committee of the Board of Directors approved a grant of 40,000 options (prior to the 10:1 Reverse Stock Split) to Mr. Huang at an exercise price of $1.02 per share under the Plan, which vested immediately on the date of grant, which was on October 10, 2015. The options may be exercised within five years of the date of the grant. The FV of the options was calculated using the following assumptions, estimated life of five years, volatility of 82%, risk free interest rate of 1.37%, and dividend yield of 0%. The FV of the 40,000 stock options was $26,528 at the grant date.

 

21

 

 

The Company recorded $0 compensation expense for stock options to employees during six and three months ended June 30, 2018 and 2017.

 

The following table summarizes option activity with respect to employees and independent directors, the number of options reflects the 10:1 Reverse Stock Split effective May 25, 2016:

 

  

Number of

Shares

  

Average

Exercise Price
per Share

  

Weighted

Average

Remaining

Contractual

Term in Years

 
             
Outstanding at January 1, 2016   4,000   $10.2    4.77 
Exercisable at January 1, 2016   4,000    10.2    4.77 
Granted   -    -    - 
Exercised   -    -    - 
Forfeited   -    -    - 
Outstanding at December 31, 2016   4,000    10.2    3.77 
Exercisable at December 31, 2016   4,000    10.2    3.77 
Granted   5,000    1.6    10 
Exercised   -    -    - 
Forfeited   -    -    - 
Outstanding at December 31, 2017   9,000    5.4    6.41 
Exercisable at December 31, 2017   9,000    5.4    6.41 
Granted   -    -    - 
Exercised   -    -    - 
Forfeited   -    -    - 
Outstanding at June 30, 2018   9,000   $5.4    6.16 
Exercisable at June 30, 2018   9,000   $5.4    6.16 

 

18. STATUTORY RESERVES

 

Pursuant to the corporate law of the PRC effective January 1, 2006, the Company is only required to maintain one statutory reserve by appropriating from its after-tax profit before declaration or payment of dividends. The statutory reserve represents restricted retained earnings.

 

Surplus Reserve Fund

 

The Company’s Chinese subsidiaries are required to transfer 10% of their net income, as determined under PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital. 

 

The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital.

 

The maximum statutory reserve amount has not been reached for any subsidiary. 

 

Common Welfare Fund

 

The common welfare fund is a voluntary fund to which the Company can transfer 5% to 10% of its net income. This fund can only be utilized on capital items for the collective benefit of the Company’s employees, such as construction of dormitories, cafeteria facilities, and other staff welfare facilities. This fund is non-distributable other than upon liquidation. The Company does not participate in this fund.

 

22

 

 

19. CONTINGENCIES

 

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

 

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

 

The Company sells electricity to its customers and receives commercial notes (bank acceptance) from them in lieu of payments for accounts receivable. The Company discounts the commercial notes with the bank or endorses the commercial notes to vendors for payment of their own obligations or to get cash from third parties. Most of the commercial notes have a maturity of less than six (6) months. As of June 30, 2018, the Company had outstanding notes receivable of $906,810 and endorsed notes receivable to vendors but not yet matured of $0.56 million; at December 31, 2017, the Company had outstanding notes receivable of $979,462 and endorsed notes receivable to vendors of $1.41 million. 

 

20. COMMITMENTS

 

Lease Commitment

 

On November 20, 2017, Xi’an TCH entered a lease agreement for its office use for a lease term from December 1, 2017 through November 30, 2020. The monthly rent is RMB 36,536 ($5,600) with quarterly payment in advance. At June 30, 2018, the future annual rental payment is approximately $67,200, $67,200 and $28,000 for next three years up to expiration of the lese.

 

For the six and three months ended June 30, 2018, the rental expense of Xi’an TCH was $33,600 and $16,800, respectively. For the six and three months ended June 30, 2017, the rental expense of Xi’an TCH was $118,413 and $59,348, respectively.

 

Construction Commitment

 

Refer to Note 1 for additional details related to lease commitments with Chengli, and Tianyu (and its subsidiaries Xuzhou Tian’an and Xuzhou Huayu), Note 8 for commitments on construction in progress.

 

21. SUBSEQUENT EVENTS

 

Security Purchase Agreement

 

On July 11, 2018, the Company entered into a Securities Purchase Agreement with Iliad Research and Trading, L.P., a Utah limited partnership (the “Purchaser”), pursuant to which the Company sold and issued to the Purchaser a Convertible Promissory Note (the “Note”) of $1,070,000. The Purchaser purchased the Note with an original issue discount of $50,000, and the Company agreed to pay to the Purchaser $20,000 for fees and costs incurred by Purchaser in connection with the consummation of the Purchase Agreement. The Note was sold to the Purchaser pursuant to an exemption from registration under Regulation D, promulgated under the Securities Act of 1933, as amended.

 

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The Note bears interest at 8% per annum. All outstanding principal and accrued interest on the Note will become due and payable on July 11, 2020, subject to a potential one-year extension period during which interest would not accrue. The Company’s obligations under the Note may be prepaid at any time, provided that in such circumstance the Company would pay a 125% premium on any amounts outstanding under the Note. Amounts outstanding under the Note may be converted at any time, at the Lender’s option, into shares of the Company’s common stock at a conversion price of $3.00 per share, subject to certain adjustments. During the term of the Note, the Company shall not, without the prior written consent of the Purchaser, enter into or effect certain fundamental business transactions. The Purchaser has the option to redeem the Note at any time after the six month anniversary of the date when the purchase price is delivered to the Company (“Purchase Price Date”) in the amounts of up to 50% of the amount outstanding during the nine month period after Purchase Price Date or any percentage of the amount outstanding under the Note at any time after the nine month anniversary of Purchase Price Date, with such redemption amounts paid in cash or shares of the Company’s common stock, or a combination thereof, at the Company’s election.

 

Acquisition of 18% of Xinhuan 

 

On September 30, 2018, Shanghai TCH entered into an Equity Purchase Agreement with Mr. Jihua Wang (“Seller”), pursuant to which Xi’an TCH shall acquire 20% of the outstanding equity interests (the “Acquired Interests”) of Xi’an Xinhuan Energy Co., Ltd. (“Xinhuan”).

 

Pursuant to the Purchase Agreement, Shanghai TCH shall purchase the Acquired Interests for RMB 320 million ($46.72 million) (the “Purchase Price”), which shall be paid as follows: (i) in cash RMB 60 million ($8.76 million); (ii) in the form of 2.6 million shares of the Company’s common stock using a value of $1.90 per share; and (iii) in the form of 17,376,950 shares of the Company’s preferred stock using a value of $1.90 per share. The preferred shares shall have no voting rights but shall have preferential dividend rights to participate in and receive a 15% premium on a per share basis for any dividends declared and paid by the Company on its common stock. The holder of the preferred shares shall have the right to convert the preferred shares into shares of the Company’s common stock on a 1:1 basis after the six month anniversary of the issuance of the preferred shares, but the Holder may only exercise such conversion right to the extent that, after giving effect to the issuance of common stock after such conversion, the Holder would beneficially own less than 20% of the Company’s issued and outstanding common stock.

 

The payment of the Purchase Price in the form of the 2.6 million shares of common stock and 17,376,950 shares of the Company’s preferred stock (the “Share Payment”) is contingent on the Company receiving shareholder approval at a special shareholders meeting for the Share Payment, and to create the new class of preferred shares and increase the number of authorized shares of common stock. The shares of common and preferred stock subject to the Share Payment shall be sold and issued pursuant to the exemption from registration provided by Regulation S promulgated under the Securities Act of 1933, as amended. In the event that the Share Payment and other matters are not approved at a special meeting of the Company’s shareholders, the parties to the Purchase Agreement shall negotiate another form of payment for the remaining portion of the Purchase Price.

 

The parties to the Purchase Agreement agreed to complete the transactions contemplated thereby within 60 days of the date of the Purchase Agreement or upon the approval of the shareholders of the Company, whichever comes later, and Seller agreed to various restrictions on, and covenants in relation to, its activities pending the completion of the sale of the Acquired Interests.

 

On November 21, 2018, Shanghai TCH and Mr. Jihua Wang entered into an Agreement of Supplementary and Amendment (the “Amendment Agreement”) to that Equity Purchase Agreement, dated September 30, 2018, by and between Shanghai TCH and Mr. Jihua Wang (the “Original Agreement”).

 

Pursuant to the Amendment Agreement, Shanghai TCH agreed to (a) purchase an 18% equity interest in Xi’an Xinhuan Energy Co., Ltd. (“Xinhuan”) instead of the 20% equity interest contemplated by the Original Agreement; (b) pay RMB 288 ($42.05 million)million for such equity interests (the “Purchase Price) instead of the RMB 320 million contemplated by the Original Agreement; (c) pay RMB 228 million of the Purchase Price in shares of the Company’s capital stock (the “Share Payment”) instead of the RMB 260 million contemplated by the Original Agreement; (d) complete the Share Payment using a per share value of $1.70 for both common and preferred shares instead of the $1.90 contemplated by the Original Agreement; and (e) issue to Mr. Wang 16,837,340 preferred shares as a portion of the Share Payment instead of the 17,376,950 preferred shares contemplated by the Original Agreement.

 

On March 29, 2019, Shanghai TCH Energy Technology Co., Ltd (“Shanghai TCH”), a wholly owned subsidiary of China Recycling Energy Corporation (the “Company”) entered into a Termination Agreement (the “Termination Agreement”) of Equity Purchase Agreement and Supplementary Amendment Agreement with Mr. Jihua Wang. Shanghai TCH originally entered into an Equity Purchase Agreement dated on September 30, 2018 and Supplementary Amendment Agreement of Equity Purchase Agreement dated on November 21, 2018 with Mr. Wang (the “Original Agreements”) to purchase an 18% equity interest in Xi’an Xinhuan Energy Co., Ltd. from Mr. Wang, as disclosed in the Form 8-Ks filed on October 2, 2018 and November 26, 2018.

 

Pursuant to the Termination Agreement, the parties agree to cancel and terminate the Original Agreement upon the effective date of the Termination Agreement. Parties agree not to pursue any breach of contract liability against each other under Original Agreements.

 

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Security Purchase Agreements

 

On October 29, 2018, China Recycling Energy Corporation entered into Securities Purchase Agreements with certain purchasers, pursuant to which the Company will offer to the Purchasers, in a registered direct offering, of 1,985,082 shares (the “Shares”) of the Company’s common stock.  The Shares will be sold to the Purchasers at $1.375 per share, for gross proceeds to the Company of approximately $2.75 million, before deducting fees to the placement agent and other estimated offering expenses payable by the Company.  

 

In a concurrent private placement, the Company is also issuing to the each of the Purchasers a warrant to purchase one (1) share of the Company’s Common Stock for each Share purchased under the Purchase Agreement, pursuant to that certain Common Stock Purchase Warrant, by and between the Company and each Purchaser, for $0.125 per Warrant and gross proceeds to the Company of approximately $250,000, before deducting fees to the placement agent and other estimated offering expenses payable by the Company.  The Warrants will be exercisable on the date of issuance at an exercise price of $1.3725 per share and will expire on the five and a half year anniversary of the date of issuance.

 

H.C. Wainwright & Co., LLC is acting as the Company’s exclusive placement agent in connection with the offerings under the Purchase Agreement and will receive a fee equal to 7.0% of the gross proceeds received by the Company from the offerings, up to $75,000 for certain expenses and warrants to purchase our Common Stock in an amount equal to 7% of our Shares sold to the Purchasers in the offerings, or 138,956 shares of Common Stock, on substantially the same terms as the Warrants, with an initial exercise price of $1.875 per share and expiration date of October 29, 2023 (the “Placement Agent Warrants”).

 

Repayment of HYREF loan

 

On December 29, 2018, Xi’an Zhonghong, Xi’an TCH, Beijing Hongyuan Recycling Energy Investment Center, LLP (the “HYREF”), Guohua Ku, the Chairman and CEO of the Company, and Chonggong Bai entered into a CDQ WHPG Station Fixed Assets Transfer Agreement, pursuant to which Xi’an Zhonghong will transfer a CDQ WHPG station as the repayment of loan at RMB 188,639,400 ($27.54 million) to HYREF. Xi’an Zhonghong, Xi’an TCH, Guohua Ku and Chonggong Bai also agreed to buy back the CDQ WHPG Station when conditions under the Buy Back Agreement are met.

 

On December 29, 2018, Xi’an TCH, Xi’an Zhonghong, HYREF, Guohua Ku, Chonggong Bai and Xi’an Hanneng Enterprises Management Consulting Co. Ltd. (“Xi’an Hanneng”) entered into a Buy Back Agreement.

 

Pursuant to the Buy Back Agreement, Xi’an TCH, Xi’an Zhonghong, Guohua Ku and Chonggong Bai (the “Buyers”) jointly and severally agreed to buy back all outstanding capital equity of Xi’an Hanneng which was transferred to HYREF by Chonggong Bai, and a CDQ WHPG station in Boxing County which was transferred to HYREF by Xi’an Zhonghong. The buy-back price for the Xi’an Hanneng’s equity will be the higher of (i) the market price of the equity shares at the time of buy-back; or (ii) the original transfer price of the equity shares plus bank interest. HYREF may request that the Buyers buy back the equity shares of Xi’an Hanneng and/or the CDQ WHPG station if one of the following conditions is met: (i) HYREF holds the equity shares of Xi’an Hanneng until December 31, 2021; (ii) Xi’an Huaxin New Energy Co., Ltd., a subsidiary of Xi’an Hanneng is delisted from The National Equities Exchange And Quotations Co., Ltd., a Chinese over-the-counter trading system (the “NEEQ”); (iii) any of the Buyers or its affiliates has a credit problem, including not being able to issue an auditor report or standard auditor report or any control person or executive of the Buyers is involved in crimes and is under prosecution or has other material credit problems, to HYREF’s reasonable belief; (iv) if Xi’an Zhonghong fails to timely make repayment on principal or interest of the loan agreement, its supplemental agreement or extension agreement; (v) the Buyers or any party to the Debt Repayment Agreement materially breaches the Debt Repayment Agreement or its related transaction documents, including but not limited to the Share Transfer Agreement, the Pledged Assets Transfer Agreement, the Entrusted Loan Agreement and their guarantee agreements and supplemental agreements.

 

25

 

 

On December 29, 2018, Xi’an TCH entered into a Share Transfer Agreement with Hongyuan Huifu Venture Capital Co. Ltd (“Hongyuan Huifu”), pursuant to which Xi’an TCH agreed to transfer its 40% ownership in Hongyuan Recycling Energy Investment Management Beijing Co., Ltd. (the “Fund Management Company”) to Hongyuan Huifu for consideration of RMB 3,453,867.31 ($504,000) (the “Fund Management Company Transfer Price”).

 

On December 29, 2018, Xi’an TCH, Hongyuan Huifu and Fund Management Company entered into a supplemental agreement to the Share Transfer Agreement. Xi’an TCH owes the Fund Management Company RMB 18,306,666,67 ($2,672,000) in financial advisory fees, and the parties agreed that the Fund Management Company Transfer Price could be used to off-set the outstanding financial advisory fees. Upon the completion of this transaction, the Fund Management Company will owe RMB 3,453,867 to Hongyuan Huifu, and Xi’an TCH will owe RMB 14,852,799.36 ($2,168,000) to the Fund Management Company.

 

On December 29, 2018, Shanghai TCH entered into a Share Transfer Agreement with Hongyuan Huifu, pursuant to which Hongyuan Huifu agreed to transfer its 10% ownership in Xi’an Zhonghong to Shanghai TCH for consideration of RMB 3 million ($437,956).

 

On January 4, 2019, Xi’an Zhonghong, Xi’an TCH, and Mr. Chonggong Bai, a resident of China, entered into a Projects Transfer Agreement (the “Agreement”), pursuant to which Xi’an Zhonghong will transfer a CDQ WHPG station (under construction) located in Xuzhou City for Xuzhou Huayu Coking Co., Ltd. (“Xuzhou Huayu Project”) to Mr. Bai for RMB 120,000,000 ($17,518,248) and Xi’an TCH will transfer two Biomass Power Generation Projects in Shenqiu (“Shenqiu Phase I and II Projects”) to Mr. Bai for RMB 127,066,000 ($18,549,000). Mr. Bai agreed to transfer all the equity shares of his wholly owned company, Xi’an Hanneng Enterprises Management Consulting Co. Ltd. (“Xi’an Hanneng”) to Beijing Hongyuan Recycling Energy Investment Center, LLP (the “HYREF”) as repayment for the RMB 247,066,000 ($36,068,029) loan made by Xi’an Zhonghong to HYREE as consideration for the transfer of the Xuzhou Huayu Project and Shenqiu Phase I and II Projects.

 

On January 22, 2019, Xi’an TCH completed the transaction contemplated in a Share Transfer Agreement (the “Fund Management Company Share Transfer Agreement”) which was entered on December 29, 2018. Pursuant to the Fund Management Company Share Transfer Agreement, Xi’an TCH transferred its 40% ownership in Hongyuan Recycling Energy Investment Management Beijing Co., Ltd. to Hongyuan Huifu Venture Capital Co. Ltd (“Hongyuan Huifu”) for RMB 3,453,867 ($504,214).

 

On January 22, 2019, Shanghai TCH contemplated in a Share Transfer Agreement (the “Xi’an Zhonghong Share Transfer Agreement”) which was entered on December 29, 2018.  Pursuant to the Xi’an Zhonghong Share Transfer Agreement, Hongyuan Huifu transferred its 10% ownership in Xi’an Zhonghong New Energy Technology Co., Ltd. to Shanghai TCH for RMB 3 million ($437,956).

 

On January 22, 2019, Xi’an Zhonghong, completed the transaction contemplated in a CDQ WHPG Station Fixed Assets Transfer Agreement (the “Fixed Assets Transfer Agreement”) which was entered on December 29, 2018.   Pursuant to the Fixed Assets Transfer Agreement, Xi’an Zhonghong transferred a CDQ WHPG station to Beijing Hongyuan Recycling Energy Investment Center, LLP (“HYREF”) as the repayment of a loan for RMB 188,639,400 ($27,538,598) owed to HYREF. Xi’an TCH is a secondary limited partner of HYREF. The consideration of the CDQ WHPG station is determined by the parties based upon the appraisal report issued by Zhonglian Assets Appraisal Group (Shaanxi) Co., Ltd. as of August 15, 2018.

 

On February 15, 2019, Xi’an TCH and Xi’an Zhonghong completed the transfer of assets contemplated in a Projects Transfer Agreement (the “Agreement”) which was entered on January 4, 2019.   Pursuant to the Agreement, Xi’an Zhonghong transferred a CDQ WHPG station (under construction) located in Xuzhou City for Xuzhou Huayu Coking Co., Ltd. (“Xuzhou Huayu Project”) to Mr. Chonggong Bai for RMB 120,000,000 (US$17,518,248) and Xi’an TCH transferred two Biomass Power Generation Projects in Shenqiu (“Shenqiu Phase I and II Projects”) to Mr. Bai for RMB 127,066,000 ($18,549,781). Mr. Bai agreed to transfer all the equity shares of his wholly owned company, Xi’an Hanneng to Beijing Hongyuan Recycling Energy Investment Center, LLP (the “HYREF”) as repayment by Xi’an Zhonghong for the RMB 247,066,000 ($36,068,029) loan to HYREE as consideration for the transfer of the Xuzhou Huayu Project and Shenqiu Phase I and II Projects.

 

26

 

 

Securities Purchase Agreement

 

On January 31, 2019, the Company entered into a Securities Purchase Agreement with Iliad Research and Trading, L.P., a Utah limited partnership (the “Purchaser”), pursuant to which the Company sold and issued to the Purchaser a Convertible Promissory Note (the “Note”) in the amount of $1,050,000. The Purchaser purchased the Note with an original issue discount of $50,000. The Note was sold to the Purchaser pursuant to an exemption from registration under Regulation D, promulgated under the Securities Act of 1933, as amended.  The Note bears interest at the rate of 8% per annum. All outstanding principal and accrued interest on the Note will become due and payable on January 30, 2021, subject to a potential one-year extension period during which interest would not accrue. The Company’s obligations under the Note may be prepaid at any time, provided that in such circumstance the Company would pay a 125% premium on any amounts outstanding under the Note. Amounts outstanding under the Note may be converted at any time, at the Lender’s option, into shares of the Company’s common stock at a conversion price of $3.00 per share, subject to certain adjustments.

 

On February 13, 2019, China Recycling Energy Corporation entered into a Securities Purchase Agreement (the “Agreement”) with Great Essential Investment, Ltd. a company incorporated in the British Virgin Islands (the “Purchaser”), pursuant to which the Company agreed to sell to the Purchaser in a private placement 1,600,000 shares (the “Shares”) of the Company’s common stock, par value $0.001 per share (the “Common Stock”), at $1.013 per share for $1,620,800 (the “Private Placement”). The Company shall file a registration statement for the registration of the Shares for their resale by the Purchaser within 100 days from the effective date of this Agreement. The Private Placement will be completed pursuant to the exemption from registration provided by Regulation S promulgated under the Securities Act of 1933, as amended.

 

On February 27, 2019, the Company entered into a Securities Purchase Agreement with Iliad Research and Trading, L.P., a Utah limited partnership (the “Purchaser”), pursuant to which the Company sold and issued to the Purchaser a Convertible Promissory Note (the “Note”) in the amount of $1,050,000. The Purchaser purchased the Note with an original issue discount of $50,000. The Note was sold to the Purchaser pursuant to an exemption from registration under Regulation D, promulgated under the Securities Act of 1933, as amended.  The Note bears interest at the rate of 8% per annum. All outstanding principal and accrued interest on the Note will become due and payable on February 26, 2021, subject to a potential one-year extension period during which interest would not accrue. The Company’s obligations under the Note may be prepaid at any time, provided that in such circumstance the Company would pay a 125% premium on any amounts outstanding under the Note. Amounts outstanding under the Note may be converted at any time, at the Lender’s option, into shares of the Company’s common stock at a conversion price of $3.00 per share, subject to certain adjustments.

 

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 22. RESTATEMENT

 

On April 28, 2016, Erdos TCH and Erdos entered a supplemental agreement, effective on May 1, 2016, Erdos TCH cancelled monthly minimum lease payments from Erdos, and charges Erdos based on actual electricity sold at RMB 0.30 / Kwh.

 

The Company evaluated the modified terms for payments based on actual electricity sold as minimum lease payments as defined in ASC 840-10-25-4, since lease payments that depend on a factor directly related to the future use of the leased property are contingent rentals and are excluded from minimum lease payments in their entirety; accordingly, the Company wrote off the net investment receivables of these leases at lease modification date. The consolidated financial statements for the six and three months ended June 30, 2018 and 2017, and as of June 30, 2018 were restated to reflect the above determination.

 

The following table presents the effects of the restatement on the accompanying consolidated balance sheet at June 30, 2018:

 

    As Previously Reported    Restated    Net Adjustment  
Accounts receivable   $ 13,203,156     $ 16,998,804     $ 3,795,648  
Current portion of investment in sales-type leases, net     14,234,089       12,220,921       (2,013,168 )
Interest receivable on sales type leases     10,295,813       9,845,608       (450,205 )
Other receivables     4,735,493       1,338,442       (3,397,051 )
                      -  
Investment in sales-type leases net (Non-current)     95,238,937       42,241,411       (52,997,526 )
                         
Total Assets   $ 286,031,716     $ 230,969,414     $ (55,062,302 )
                         
Deferred tax liability, net   $ 8,115,286     $ 1,500,680     $ (6,614,606 )
                         
Total Liabilities     86,251,518       79,636,912       (6,614,606 )
                         
Statutory reserve     14,791,889       14,561,911       (229,978 )
Accumulated other comprehensive income     (952,416 )     (1,119,916 )     (167,500 )
Retained earnings     74,788,797       26,738,579       (48,050,218 )
                         
Total Company stockholders’ equity     200,433,393       151,985,697       (48,447,696 )
                         
Total liabilities and equity   $ 286,031,716     $ 230,969,414     $ (55,062,302 )

 

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The following table presents the effects of the restatement on the accompanying consolidated statement of income and comprehensive income for the six months ended June 30, 2018:

 

    As Previously Reported    Restated    Net Adjustment  
Contingent rental income   $ -     $ 2,804,268     $ 2,804,268  
                
Interest income on sales-type leases     2,747,008       2,264,481       (482,527 )
Total operating income     2,747,008       5,068,749       2,321,741  
General and administrative expenses     1,331,792       3,692,406       2,360,614  
Income from operations     1,415,216       1,376,343       (38,873 )
                         
Loss before income tax     (1,427,310 )     (1,466,183 )     (38,873 )
Income tax expense     493,490       267,918       (225,572 )
                         
Net loss attributable to China Recycling Energy Corporation     (1,733,617 )     (1,546,918 )     186,699  
Foreign currency translation loss     (2,587,043 )     (1,980,469 )     606,574  
Comprehensive loss attributable to China Recycling Energy Corporation   $ (4,320,660 )   $ (3,527,387 )   $ 793,273  

 

 

The following table presents the effects of the restatement on the accompanying consolidated statement of income and comprehensive income for the six months ended June 30, 2017:

 

    As Previously Reported    Restated    Net Adjustment  
Contingent rental income   $ -     $ 3,309,272     $ 3,309,272  
                
Interest income on sales-type leases     4,331,011       3,327,583       (1,003,428 )
Total operating income     4,331,011       6,636,855       2,305,844  
General and administrative expenses     339,301       2,534,750       2,195,449  
Income from operations     3,991,710       4,102,105       110,395  
                         
Income before income tax     1,347,643       1,458,038       110,395  
Income tax expense     781,966       610,995       (170,971 )
                         
Net income attributable to China Recycling Energy Corporation     743,932       1,025,298       281,366  
Foreign currency translation gain     4,632,435       3,484,452       (1,147,983 )
Comprehensive income attributable to China Recycling Energy Corporation   $ 5,376,367     $ 4,509,750     $ (866,617 )

 

 

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The following table presents the effects of the restatement on the accompanying consolidated statement of income and comprehensive income for the three months ended June 30, 2018:

 

    As Previously Reported    Restated    Net Adjustment  
Contingent rental income   $ -     $ 1,381,437     $ 1,381,437  
                
Interest income on sales-type leases     740,969       657,866       (83,103 )
Total operating income     740,969       2,039,303       1,298,334  
General and administrative expenses     978,285       2,186,175       1,207,890  
Loss from operations     (237,316 )     (146,872 )     90,444  
                         
Loss before income tax     (1,690,677 )     (1,600,233 )     90,444  
Income tax benefit     (14,669 )     (71,627 )     (56,958 )
                         
Net loss attributable to China Recycling Energy Corporation     (1,580,083 )     (1,432,681 )     147,402  
Foreign currency translation loss     (10,918,114 )     (8,385,747 )     2,532,367  
Comprehensive loss attributable to China Recycling Energy Corporation   $ (12,498,197 )   $ (9,818,428 )   $ 2,679,769  

 

 

The following table presents the effects of the restatement on the accompanying consolidated statement of income and comprehensive income for the three months ended June 30, 2017:

 

    As Previously Reported    Restated    Net Adjustment  
Contingent rental income   $ -     $ 1,538,240     $ 1,538,240  
                         
Interest income on sales-type leases     2,202,995       1,648,608       (554,387 )
Total operating income     2,202,995       3,186,848       983,853  
General and administrative expenses     230,240       1,331,583       1,101,343  
Income from operations     1,972,755       1,855,265       (117,490 )
                         
Income before income tax     645,342       527,852       (117,490 )
Income tax expense     365,663       293,750       (71,913 )
                         
Net income attributable to China Recycling Energy Corporation     369,511       323,934       (45,577 )
Foreign currency translation gain     3,526,451       4,327,559       801,108  
Comprehensive income attributable to China Recycling Energy Corporation   $ 3,895,962     $ 4,651,493     $ 755,531  

 

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The following table presents the effects of the restatement on the accompanying consolidated statement of cash flows for the six months ended June 30, 2018:

 

    As Previously Reported    Restated    Net Adjustment  
Loss including noncontrolling interest   $ (1,920,800 )   $ (1,734,101 )   $ 186,699  
Changes in deferred tax     (427,551 )     (653,123 )     (225,572 )
Interest receivable on sales type leases     (569,647 )     (358,904 )     210,743  
Collection of principal on sales type leases     2,084,149       1,716,968       (367,181 )
Accounts receivable     -       (1,386,881 )     (1,386,881 )
Other receivables     (1,772,310 )     (190,118 )     1,582,192  
                         
 Net cash provided by operating activities   $ 1,752,281     $ 1,752,281     $ -  

 

The following table presents the effects of the restatement on the accompanying consolidated statement of cash flows for the six months ended June 30, 2018:

 

    As Previously Reported    Restated    Net Adjustment  
Income including noncontrolling interest   $ 565,677     $ 847,043     $ 281,366  
Changes in deferred tax     117,315       (53,656 )     (170,971 )
Interest receivable on sales type leases     (2,922,393 )     (2,730,500 )     191,893  
Collection of principal on sales type leases     574,006       370,139       (203,867 )
Accounts receivable     -       (1,469,996 )     (1,469,996 )
Other receivables     (1,692,112 )     (320,537 )     1,371,575  
                         
Net cash used in operating activities   $ (1,182,172 )   $ (1,182,172 )   $ -  

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Note Regarding Forward-Looking Statements

 

This quarterly report on Form 10-Q and other reports filed by the Company from time to time with the SEC (collectively the “Filings”) contain or may contain forward-looking statements and information that are based upon beliefs of, and information currently available to, Company’s management as well as estimates and assumptions made by Company’s management. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. When used in the filings, the words “may”, “will”, “should”, “would”, “anticipate”, “believe”, “estimate”, “expect”, “future”, “intend”, “plan”, or the negative of these terms and similar expressions as they relate to Company or Company’s management identify forward-looking statements. Such statements reflect the current view of Company with respect to future events and are subject to risks, uncertainties, assumptions, and other factors (including the statements in the section “results of operations” below), and any businesses that Company may acquire. Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended, or planned. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those listed under the heading “Risk Factors” and those listed in our Annual Report on Form 10-K for the year ended December 31, 2017 (the “2017 Form 10-K”). The following discussion should be read in conjunction with our Financial Statements and related Notes thereto included elsewhere in this report and in our 2017 Form 10-K.

 

Although the Company believes the expectations reflected in the forward-looking statements are based on reasonable assumptions, the Company cannot guarantee future results, levels of activity, performance, or achievements. Except as required by applicable law, including the securities laws of the United States, the Company does not intend to update any of the forward-looking statements to conform these statements to actual results. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this report, which attempts to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations, and prospects.

 

Our financial statements are prepared in US Dollars and in accordance with accounting principles generally accepted in the United States. See “Foreign Currency Translation and Comprehensive Income (Loss)” below for information concerning the exchange rates at which Renminbi (“RMB”) were translated into US Dollars (“USD”) at various pertinent dates and for pertinent periods.

 

OVERVIEW OF BUSINESS BACKGROUND

 

China Recycling Energy Corporation (the “Company” or “CREG”) was incorporated on May 8, 1980 as Boulder Brewing Company under the laws of the State of Colorado. On September 6, 2001, the Company changed its state of incorporation to Nevada. In 2004, the Company changed its name from Boulder Brewing Company to China Digital Wireless, Inc. and on March 8, 2007, the Company again changed its name from China Digital Wireless, Inc. to its current name, China Recycling Energy Corporation. The Company, through its subsidiaries, sells and leases energy saving systems and equipment to its customers in the People’s Republic of China (“PRC”). Typically, the Company transfers ownership of the waste energy recycling power generating projects to its customers at the end of each sales-type lease and provides financing to its customers for the cost of the projects as described below. 

 

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Our Subsidiaries

 

Our business is primarily conducted through our wholly-owned subsidiaries, Sifang Holdings Co., Ltd. (“Sifang”) and Shanghai Yinghua Financial Leasing Co., Ltd (“Yinghua”); Sifang’s wholly-owned subsidiaries, Huahong New Energy Technology Co., Ltd. (“Huahong”) and Shanghai TCH Energy Tech Co., Ltd. (“Shanghai TCH”); Shanghai TCH’s wholly-owned subsidiary, Xi’an TCH Energy Technology Company, Ltd (“Xi’an TCH”), Xi’an TCH’s wholly-owned subsidiaries, Erdos TCH Energy Saving Development Co., Ltd (“Erdos TCH”) and Zhongxun Energy Investment (Beijing) Co., Ltd (“Zhongxun”); and Xi’an TCH’s 90% owned subsidiary, Xi’an Zhonghong New Energy Technology Co., Ltd. (“Zhonghong”). Zhonghong provides energy saving solutions and services, including constructing, selling and leasing energy saving systems and equipment to customers, project investment, investment management, economic information consulting, technical services, financial leasing, purchase of financial leasing assets, disposal and repair of financial leasing assets, consulting and ensuring of financial leasing transactions. 

 

The Company’s current organizational chart is as follows:

 

CREG Legal

Structure

 

 

Shanghai TCH and its Subsidiaries

 

Shanghai TCH was established as a foreign investment enterprise in Shanghai under the laws of the PRC on May 25, 2004 and has a registered capital of $29.80 million. Xi’an TCH was incorporated in Xi’an, Shaanxi Province under the laws of the PRC on November 8, 2007. In February 2009, Huahong was incorporated in Xi’an, Shaanxi province. Erdos TCH was incorporated in April 2009 in Erdos, Inner Mongolia Autonomous Region. On July 19, 2013, Xi’an TCH formed Xi’an Zhonghong New Energy Technology Co., Ltd (“Zhonghong”). Xi’an TCH owns 90% of Zhonghong, which provides energy saving solutions and services, including constructing, selling and leasing energy saving systems and equipment to customers.

 

As of June 30, 2018, Shanghai TCH, through its subsidiaries, had sales or sales-type leases with the following parties: (i) Pucheng (for two biomass power generation (“BMPG”) systems); and (ii) Shenqiu (for two BMPG systems).

 

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The Fund Management Company and the HYREF Fund

 

On June 25, 2013, Xi’an TCH and Hongyuan Huifu Venture Capital Co. Ltd (“Hongyuan Huifu”) jointly established Beijing Hongyuan Recycling Energy Investment Management Company Ltd. (the “Fund Management Company”) with registered capital of RMB 10 million ($1.45 million). Xi’an TCH made an initial capital contribution of RMB 4 million ($650,000) and has a 40% ownership interest in the Fund Management Company. With respect to the Fund Management Company, voting rights and dividend rights are allocated 80% and 20% between Hongyuan Huifu and Xi’an TCH, respectively.

 

The Fund Management Company is the general partner of Beijing Hongyuan Recycling Energy Investment Center, LLP (the “HYREF Fund”), a limited liability partnership established July 18, 2013 in Beijing. The Fund Management Company made an initial capital contribution of RMB 5 million ($830,000) to the HYREF Fund. An initial amount of RMB 460 million ($77 million) was fully subscribed by all partners for the HYREF Fund. The HYREF Fund has three limited partners: (1) China Orient Asset Management Co., Ltd., which made an initial capital contribution of RMB 280 million ($46.67 million) to the HYREF Fund and is a preferred limited partner; (2) Hongyuan Huifu, which made an initial capital contribution of RMB 100 million ($16.67 million) to the HYREF Fund and is an ordinary limited partner; and (3) the Company’s wholly-owned subsidiary, Xi’an TCH, which made an initial capital contribution of RMB 75 million ($12.5 million) to the HYREF Fund and is a secondary limited partner. In addition, Xi’an TCH and HongyuanHuifu formed Beijing Hongyuan Recycling Energy Investment Management Company Ltd. to manage this Fund and also subscribed in the amount of RMB 5 million ($830,000) from the Fund. The term of the HYREF Fund’s partnership is six years from the date of its establishment, expiring on July 18, 2019. The term is four years from the date of contribution for the preferred limited partner, and four years from the date of contribution for the ordinary limited partner. The size of the HYREF Fund is RMB 460 million ($76.66 million). The HYREF Fund was formed for the purpose of investing in Xi’an Zhonghong New Energy Technology Co., Ltd., a 90% owned subsidiary of Xi’an TCH, for the construction of two coke dry quenching (“CDQ”) waste heat power generation (“WHPG”) stations with Jiangsu Tianyu Energy and Chemical Group Co., Ltd. (“Tianyu”) and one CDQ WHPG station with Boxing County Chengli Gas Supply Co., Ltd. (“Chengli”).

 

Erdos TCH – Joint Venture

 

On April 14, 2009, the Company formed Erdos TCH as a joint venture (the “JV” or “Erdos TCH”) with Erdos Metallurgy Co., Ltd. (“Erdos”) to recycle waste heat from Erdos’ metal refining plants to generate power and steam to be sold back to Erdos. The JV has a term of 20 years with a total investment for the project estimated at $79 million (RMB 500 million) and an initial investment of $17.55 million (RMB 120 million). Erdos contributed 7% of the total investment for the project, and Xi’an TCH contributed 93%. According to Xi’an TCH and Erdos’ agreement on profit distribution, Xi’an TCH and Erdos will receive 80% and 20%, respectively, of the profit from the JV until Xi’an TCH receives the complete return of its investment. Xi’an TCH and Erdos will then receive 60% and 40%, respectively, of the profit from the JV. On June 15, 2013, Xi’an TCH and Erdos entered into a share transfer agreement, pursuant to which Erdos transferred and sold its 7% ownership interest in the JV to Xi’an TCH for $1.29 million (RMB 8 million), plus certain accumulated profits as described below. Xi’an TCH paid the $1.29 million in July 2013 and, as a result, became the sole stockholder of Erdos TCH. In addition, Xi’an TCH is required to pay Erdos accumulated profits from inception up to June 30, 2013 in accordance with the supplementary agreement entered on August 6, 2013. In August 2013, Xi’an TCH paid 20% of the accumulated profit (calculated under PRC GAAP) of $226,000 to Erdos. Erdos TCH currently has two power generation systems in Phase I with a total of 18 MW power capacity, and three power generation systems in Phase II with a total of 27 MW power capacity. 

 

With the current economic conditions in China, the government has limited and reduced over capacity and production in the iron and steel industry, which has resulted in a sharp decrease of Erdos Metallurgy Co., Ltd’s production of ferrosilicon, its revenue and cash flows, and has made it difficult for Erdos to make the monthly minimum lease payment.

 

After considering the challenging economic conditions facing Erdos, and to maintain the long-term cooperative relationship between the parties, which we believe will continue to produce long-term benefits, on April 28, 2016, Erdos TCH and Erdos entered into a supplemental agreement, effective May 1, 2016. Under the supplemental agreement, Erdos TCH cancelled monthly minimum lease payments from Erdos, and agreed to charge Erdos based on actual electricity sold at RMB 0.30 / KWH, which such price will be adjusted annually based on prevailing market conditions.   

 

The Company evaluated the modified terms for payments based on actual electricity sold as minimum lease payments as defined in ASC 840-10-25-4, since lease payments that depend on a factor directly related to the future use of the leased property are contingent rentals and, accordingly, are excluded from minimum lease payments in their entirety. The Company wrote off the net investment receivables of these leases at the lease modification date.

 

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Shenqiu Yuneng Biomass Power Generation Projects

 

On May 25, 2011, Xi’an TCH entered into a Letter of Intent with Shenqiu YuNeng Thermal Power Co., Ltd. (“Shenqiu”) to reconstruct and transform a Thermal Power Generation System owned by Shenqiu into a 75T/H BMPG System for $3.57 million (RMB 22.5 million). The project commenced in June 2011 and was completed in the third quarter of 2011. On September 28, 2011, Xi’an TCH entered into a Biomass Power Generation Asset Transfer Agreement with Shenqiu (the “Shenqiu Transfer Agreement”). Pursuant to the Shenqiu Transfer Agreement, Shenqiu sold Xi’an TCH a set of 12 MW BMPG systems (after Xi’an TCH converted the system for BMPG purposes). As consideration for the BMPG systems, Xi’an TCH paid Shenqiu $10.94 million (RMB 70 million) in cash in three installments within six months upon the transfer of ownership of the systems. By the end of 2012, all of the consideration was paid. On September 28, 2011, Xi’an TCH and Shenqiu also entered into a Biomass Power Generation Project Lease Agreement (the “2011 Shenqiu Lease”). Under the 2011 Shenqiu Lease, Xi’an TCH agreed to lease a set of 12 MW BMPG systems to Shenqiu at a monthly rental rate of $286,000 (RMB 1.8 million) for 11 years. Upon expiration of the 2011 Shenqiu Lease, ownership of this system will transfer from Xi’an TCH to Shenqiu at no additional cost. In connection with the 2011 Shenqiu Lease, Shenqiu paid one month’s rent as a security deposit to Xi’an TCH, in addition to providing personal guarantees.

 

On October 8, 2012, Xi’an TCH entered into a Letter of Intent for technical reformation of Shenqiu Project Phase II with Shenqiu for technical reformation to enlarge the capacity of the Shenqiu Project Phase I (the “Shenqiu Phase II Project”). The technical reformation involved the construction of another 12 MW BMPG system. After the reformation, the generation capacity of the power plant increased to 24 MW. The project commenced on October 25, 2012 and was completed during the first quarter of 2013. The total cost of the project was $11.1 million (RMB 68 million). On March 30, 2013, Xi’an TCH and Shenqiu entered into a BMPG Project Lease Agreement (the “2013 Shenqiu Lease”). Under the 2013 Shenqiu Lease, Xi’an TCH agreed to lease the second set of 12 MW BMPG systems to Shenqiu for $239,000 (RMB 1.5 million) per month for 9.5 years. When the 2013 Shenqiu Lease expires, ownership of this system will transfer from Xi’an TCH to Shenqiu at no additional cost. 

 

Pucheng Biomass Power Generation Projects

 

On June 29, 2010, Xi’an TCH entered into a Biomass Power Generation (“BMPG”) Project Lease Agreement with PuchengXinHeng Yuan Biomass Power Generation Co., Ltd. (“Pucheng”), a limited liability company incorporated in China. Under this lease agreement, Xi’an TCH leased a set of 12MW BMPG systems to Pucheng at a minimum of $279,400 (RMB 1,900,000) per month for a term of 15 years. (“Pucheng Phase I”).

  

On September 11, 2013, Xi’an TCH entered into a BMPG Asset Transfer Agreement (the “Pucheng Transfer Agreement”) with Pucheng Xin Heng Yuan Biomass Power Generation Corporation (“Pucheng”), a limited liability company incorporated in China. The Pucheng Transfer Agreement provided for the sale by Pucheng to Xi’an TCH of a set of 12 MW BMPG systems with the completion of system transformation for a purchase price of RMB 100 million ($16.48 million) in the form of 8,766,547 shares of common stock of the Company at $1.87 per share. Also on September 11, 2013, Xi’an TCH also entered into a BMPG Project Lease Agreement with Pucheng (the “Pucheng Lease”). Under the Pucheng Lease, Xi’an TCH leases this same set of 12 MW BMPG system to Pucheng, and combines this lease with the lease for the 12 MW BMPG station of Pucheng Phase I project, under a single lease to Pucheng for RMB 3.8 million ($0.63 million) per month (the “Pucheng Phase II Project”). The term for the consolidated lease is from September 2013 to June 2025. The lease agreement for the 12 MW station from Pucheng Phase I project terminated upon the effective date of the Pucheng Lease. The ownership of two 12 MW BMPG systems will transfer to Pucheng at no additional charge when the Pucheng Lease expires. 

 

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Chengli Waste Heat Power Generation Projects

 

On July 24, 2013, Zhonghong entered into a Cooperative Agreement of CDQ and CDQ WHPG Project with Boxing County Chengli Gas Supply Co., Ltd. (“Chengli”). The parties entered into a supplement agreement on July 26, 2013. Pursuant to these agreements, Zhonghong agreed to design, build and maintain a 25 MW CDQ system and a CDQ WHPG system to supply power to Chengli, and Chengli agreed to pay energy saving fees (the “Chengli Project”). Chengli will contract the operation of the system to a third party contractor that is mutually agreed to by Zhonghong. In addition, Chengli will provide the land for the CDQ system and CDQ WHPG system at no cost to Zhonghong. The term of the Agreements is for 20 years. The watt hours generated by the Chengli Project will be charged at RMB 0.42 ($0.068) per KWH (excluding tax). The operating time shall be based upon an average 8,000 hours annually. If the operating time is less than 8,000 hours per year due to a reason attributable to Chengli, then time charged shall be 8,000 hours a year, and if it is less than 8,000 hours due to a reason attributable to Zhonghong, then it shall be charged at actual operating hours. The construction of the Chengli Project was completed in the second quarter of 2015 and the project successfully completed commissioning tests in the first quarter of 2017. The Chengli Project is now operational, however, due to the environmental protection intensifies, the local environmental authorities required the project owner constructing CDQ sewage treatment supporting works, which must be completed and passed through acceptance inspection before the project is allowed to put into operation. So far, the project owner has completed the bidding of the sewage treatment supporting works and started construction on or about July 20, 2018. We anticipate that the construction will need three months to complete. The Company expects the Boxing project will be put into operation in the fourth quarter of 2018. When operations begin, Chengli shall ensure its coking production line works properly and that working hours for the CDQ system are at least 8,000 hours per year, and Zhonghong shall ensure that working hours for the CDQ WHPG system are at least 7,200 hours per year.

 

On July 22, 2013, Zhonghong entered into an Engineering, Procurement and Construction (“EPC”) General Contractor Agreement for the Boxing County Chengli Gas Supply Co., Ltd. CDQ Power Generation Project (the “Chengli Project”) with Xi’an Huaxin New Energy Co., Ltd. (“Huaxin”). Zhonghong, as the owner of the Chengli Project, contracted EPC services for a CDQ system and a 25 MW CDQ WHPG system for Chengli to Huaxin. Huaxin shall provide construction, equipment procurement, transportation, installation and adjustment, test run, construction engineering management and other necessary services to complete the Chengli Project and ensure the CDQ system and CDQ WHPG system for Chengli meet the inspection and acceptance requirements and work normally. The Chengli Project is a turn-key project in which Huaxin is responsible for monitoring the quality, safety, duration and cost of the Chengli Project. The total contract price is RMB 200 million ($33.34 million), which includes all materials, equipment, labor, transportation, electricity, water, waste disposal, machinery and safety costs.

 

Tianyu Waste Heat Power Generation Project

 

On July 19, 2013, Zhonghong entered into a Cooperative Agreement (the “Tianyu Agreement”) for Energy Management of CDQ and CDQ WHPG with Jiangsu Tianyu Energy and Chemical Group Co., Ltd (“Tianyu”). Pursuant to the Tianyu Agreement, Zhonghong will design, build, operate and maintain two sets of 25 MW CDQ and CDQ WHPG systems for two subsidiaries of Tianyu – Xuzhou Tian’an Chemical Co., Ltd (“Xuzhou Tian’an”) and Xuzhou Huayu Coking Co., Ltd. (“Xuzhou Huayu”) – to be located at Xuzhou Tian’an and Xuzhou Huayu’s respective locations (the “Tianyu Project”). Upon completion of the Tianyu Project, Zhonghong will charge Tianyu an energy saving fee of RMB 0.534 ($0.087) per KWH (excluding tax). The operating time will be based upon an average 8,000 hours annually for each of Xuzhou Tian’an and Xuzhou Huayu. If the operating time is less than 8,000 hours per year due to a reason attributable to Tianyu, then time charged will be 8,000 hours a year. Because of the control of the overcapacity and pollution of the iron and steel and related industries, the government has imposed production limitations for the energy-intensive enterprises with heavy pollution, including Xuzhou Tian’an. Xuzhou Tian’an has slowed the construction process for its dry quenching production line which caused the delay of our project. The construction of the Xuzhou Tian’an Project is anticipated to be completed by the fourth quarter of 2018. Xuzhou Tian’an will provide the land for the CDQ and CDQ WHPG systems for free. Xuzhou Tian’an has also guaranteed that it will purchase all of the power generated by the CDQ WHPG systems. The Xuzhou Huayu Project is currently on hold due to a conflict between Xuzhou Huayu Coking Co., Ltd. and local residents on certain pollution-related issues. The local government has acted in its capacity to coordinate the resolution of this issue. The local residents were requested to move from the hygienic buffer zone of the project location with compensatory payments from the government. Xuzhou Huayu was required to stop production and implement technical innovations to mitigate pollution discharge including sewage treatment, dust collection, noise control, and recycling of coal gas. Currently, some local residents have moved. Xuzhou Huayu has completed the implementation of the technical innovations of sewage treatment, dust collection, and noise control, and the Company is waiting for local governmental agencies to approve these technical innovations so that we can resume construction. Due to the strict administration of environmental protection policies and recent increase of environmental protections for the coking industry in Xuzhou, all local coking, as well as steel iron enterprises, are facing a similar situation of suspended production while rectifying technologies and procedures. The Company expects to receive governmental acceptance and approval and to resume construction in the fourth quarter of 2018.  

 

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On July 22, 2013, Xi’an Zhonghong New Energy Technology Co., Ltd. entered into an EPC General Contractor Agreement for the Xuzhou Tianyu Group CDQ Power Generation Project (the “Project”) with Xi’an Huaxin New Energy Co., Ltd. (“Huaxin”). Zhonghong as the owner of the Project contracted EPC for the two sets of CDQ and 25 MW CDQ WHPG systems for Tianyu to Huaxin—one for Xuzhou Tian’an and one for Xuzhou Huayu. Huaxin shall provide construction, equipment procurement, transportation, installation and adjustment, test run, construction engineering management and other necessary works to complete the Project and ensure the CDQ and CDQ WHPG systems for Tianyu meet the inspection and acceptance requirements and work normally. The Project is a turn-key project and Huaxin is responsible for the quality, safety, duration and cost of the Project. The total contract price is RMB 400 million ($66.67 million), of which RMB 200 million ($33.34 million) is for the Xuzhou Tian’an system and RMB 200 million is for the Xuzhou Huayu system. The price is a cover-all price, which includes but not limited to all the materials, equipment, labor, transportation, electricity, water, waste disposal, machinery and safety matters. 

   

Zhongtai WHPG Energy Management Cooperative Agreement

 

On December 6, 2013, Xi’an TCH entered into a CDQ and WHPG Energy Management Cooperative Agreement (the “Zhongtai Agreement”) with Xuzhou Zhongtai Energy Technology Co., Ltd. (“Zhongtai”), a limited liability company incorporated in Jiangsu Province, China.

 

Pursuant to the Zhongtai Agreement, Xi’an TCH will design, build and maintain a 150 ton per hour CDQ system and a 25 MW CDQ WHPG system (the “Project”) and sell the power to Zhongtai, and Xi’an TCH will also build a furnace to generate steam from the waste heat of the smoke pipeline and sell the steam to Zhongtai.

 

The construction period of the Project is expected to be 18 months from the date when conditions are ready for construction to begin. Zhongtai will start to pay an energy saving fee from the date when the WHPG station passes the required 72-hour test run. The term of payment is for 20 years. For the first 10 years of the term, Zhongtai shall pay an energy saving fee at RMB 0.534 ($0.089) per KWH (including value added tax) for the power generated from the system. For the second 10 years of the term, Zhongtai shall pay an energy saving fee at RMB 0.402 ($0.067) per KWH (including value added tax). During the term of the contract the energy saving fee shall be adjusted at the same percentage as the change of local grid electricity price. Zhongtai shall also pay an energy saving service fee for the steam supplied by Xi’an TCH at RMB 100 ($16.67) per ton (including value added tax). Zhongtai and its parent company will provide guarantees to ensure Zhongtai will fulfill its obligations under the Agreement. Upon the completion of the term, Xi’an TCH will transfer the systems to Zhongtai at RMB 1 ($0.16). Zhongtai shall provide waste heat to the systems for no less than 8,000 hours per year and waste gas volume no less than 150,000 Nm3 per hour with a temperature no less than 950°C. If these requirements are not met, the term of the Zhongtai Agreement will be extended accordingly. If Zhongtai wants to terminate the Zhongtai Agreement early, it shall provide Xi’an TCH a 60 day notice and pay the termination fee and compensation for the damages to Xi’an TCH according to the following formula: (i) if it is less than five years into the term when Zhongtai requests termination, Zhongtai shall pay: Xi’an TCH’s total investment amount plus Xi’an TCH’s annual investment return times five years minus the years in which the system has already operated; or (ii) if it is more than five years into the term when Zhongtai requests the termination, Zhongtai shall pay Xi’an TCH’s total investment amount minus total amortization cost (the amortization period is 10 years).  

 

On March 14, 2016, Xi’an TCH entered into a Xuzhou Zhongtai CDQ and Waste Heat Power Generation System Transfer Agreement (the “Transfer Agreement”) with Zhongtai and Xi’an Huaxin New Energy Co., Ltd., a limited liability company incorporated in China (the “Contractor”).

 

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The Transfer Agreement provides for the sale to Zhongtai of all the assets of the Project under construction from Xi’an TCH. Additionally, Xi’an TCH will transfer to Zhongtai the Engineering, Procurement and Construction (“EPC”) Contract for the Project, which Xi’an TCH had entered into with the Contractor in connection with the Project. As consideration for the transfer of the Project, Zhongtai is to pay to Xi’an TCH an aggregate purchase price of RMB 167,360,000 ($25.75 million and the “Transfer Price”), on the following schedule: (i) RMB 50,000,000 ($7.69 million) of the Transfer Price was paid within 20 business days from the execution of the Transfer Agreement; (ii) RMB 30,000,000 ($4.32 million) of the Transfer Price was paid within 20 business days upon the completion of the construction of the Project but not later than July 30, 2016; and (iii) RMB 87,360,000 ($13.45 million) of the Transfer Price will be paid before July 30, 2017. The temporary ownership of the Project was transferred from Xi’an TCH to Zhongtai after the Xi’an TCH received the first payment of RMB 50,000,000, and the full ownership of the Project is to be officially transferred to Zhongtai upon full payment of the Transfer Price. The Zhongtai Agreement is to be terminated and Xi’an TCH will agree not to pursue any breach of contract liability against the Zhongtai under the Zhongtai Agreement when Zhongtai fully pays the Transfer Price according to the terms of the Transfer Agreement. If the Transfer Price is not fully paid on time pursuant to the Transfer Agreement, the Transfer Agreement automatically terminates and Xi’an TCH retains ownership of the Project, and both parties would continue to possess their respective rights and obligations according to the Zhongtai Agreement and assume the liabilities for breach of the Zhongtai Agreement. Xuzhou Taifa Special Steel Technology Co., Ltd. (“Xuzhou Taifa”) has guaranteed the payments by Zhongtai. In 2017 Xi’an TCH had received the first payment of $7.70 million and the second payment of $4.32 million. The Company recorded a $2.82 million loss from this transaction in 2016. As of this report date, the Company has not yet received the remaining payment of RMB 87,360,000 ($13.45 million). However, the Company received a repayment commitment letter from Zhongtai on February 23, 2018, in which Zhongtai committed to pay the remaining payment of RMB 87,360,000 ($13.45 million) no later than the end of July 2018; in July 2018, Zhongtai and the Company reached a further oral agreement to extend the repayment term of RMB 87,360,000 ($13.45 million) by another two to three months.

 

Related Party Transactions

 

As of June 30, 2018, the Company had $41,152 in advances from the Company’s management, which bear no interest, are unsecured, and are payable upon demand. 

 

Critical Accounting Policies and Estimates

 

Our management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements (“CFS”), which were prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported net sales and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and assumptions. We base our estimates on historical experience and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

While our significant accounting policies are more fully described in Note 2 to our CFS, we believe the following accounting policies are the most critical to assist you in fully understanding and evaluating this management discussion and analysis.

 

Basis of Presentation

 

These accompanying CFS were prepared in accordance with US GAAP and pursuant to the rules and regulations of the SEC for financial statements.

 

Basis of Consolidation

 

The CFS include the accounts of CREG and, its subsidiary, Sifang Holdings and Yinghua; Sifang Holdings’ wholly-owned subsidiaries, Huahong and Shanghai TCH; Shanghai TCH’s wholly-owned subsidiary Xi’an TCH; and Xi’an TCH’s subsidiaries, Erdos TCH, Zhonghong, and Zhongxun. Substantially all of the Company’s revenues are derived from the operations of Shanghai TCH and its subsidiaries, which represent substantially all of the Company’s consolidated assets and liabilities as of June 30, 2018 and December 31, 2017, respectively. All significant inter-company accounts and transactions were eliminated in consolidation. 

 

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Use of Estimates

 

In preparing the CFS, management makes estimates and assumptions that affect the reported amounts of assets and liabilities in the balance sheets as well as revenues and expenses during the year reported. Actual results may differ from these estimates.

 

Concentration of Credit Risk

 

Cash includes cash on hand and demand deposits in accounts maintained within China. Balances at financial institutions within China are not covered by insurance. The Company has not experienced any losses in such accounts. 

 

Certain other financial instruments, which subject the Company to concentration of credit risk, consist of accounts and other receivables. The Company does not require collateral or other security to support these receivables. The Company conducts periodic reviews of its customers’ financial condition and customer payment practices to minimize collection risk on accounts receivable.

 

The operations of the Company are located in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC.

 

Accounts Receivable

 

As of June 30, 2018, the Company had accounts receivable of $16,998,804 from the sales of CDQ and a CDQ WHPG system to Zhongtai, and accounts receivable of Erdos TCH for electricity sold. As of December 31, 2017, the Company had accounts receivable of $15,858,804 from the sales of CDQ and a CDQ WHPG system to Zhongtai, and accounts receivable of Erdos TCH for electricity sold.

 

Interest Receivable on Sales Type Leases

 

As of June 30, 2018, the interest receivable on sales type leases was $9,845,608, mainly representing recognized but not yet collected interest income for the Pucheng, Shenqiu.

 

The Company maintains reserves for potential credit losses on receivables. Management reviews the composition of receivables and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves.  Based on an evaluation of the collectability of such receivables, as of June 30, 2018, the Company had bad debt allowance for net investment receivable of $2,586,479 for the Pucheng and Shenqiu systems.

 

Revenue Recognition

 

Sales-type Leasing and Related Revenue Recognition

 

The Company constructs and then leases waste energy recycling power generating projects to its customers. The Company typically transfers ownership of the waste energy recycling power generating projects to its customers at the end of each lease. Investment in these projects is recorded as investment in sales-type leases in accordance with “Accounting for Leases”, codified in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 840 and its various amendments and interpretations. The Company manufactures and constructs waste energy recycling power generating projects and finances its customers for the costs of the projects. The sales and cost of sales are recognized at the time of sale or inception of the lease. The investment in sales-type leases consists of the sum of the total minimum lease payments receivable less unearned interest income and estimated executory cost. Unearned interest income is amortized to income over the lease term so as to produce a constant periodic rate of return on the net investment in the lease. While a portion of revenue is recognized at the inception of the lease, the cash flow from the sales-type lease occurs over the course of the lease. Revenue is net of the Value Added Tax.

 

Contingent Rental Income

 

The Company records the income from actual electricity usage in addition to minimum lease payment of each project as contingent rental income in the period earned. Contingent rent is not part of minimum lease payments. 

 

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Foreign Currency Translation and Comprehensive Income (Loss)

 

The Company’s functional currency is RMB. For financial reporting purposes, RMB figures were translated into USD as the reporting currency. Assets and liabilities are translated at the exchange rate in effect on the balance sheet date. Revenues and expenses are translated at the average rate of exchange prevailing during the reporting period. Translation adjustments arising from the use of different exchange rates from period to period are included as a component of stockholders’ equity as “Accumulated other comprehensive income.” Gains and losses from foreign currency transactions are included in income. There has been no significant fluctuation in exchange rate for the conversion of RMB to USD after the balance sheet date.

 

The Company uses “Reporting Comprehensive Income” (codified in FASB ASC Topic 220). Comprehensive income is comprised of net income and all changes to the statements of stockholders’ equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders. 

  

RESULTS OF OPERATIONS

 

Comparison of three months Ended June 30, 2018 and 2017

 

The following table sets forth the results of our operations for the periods indicated as a percentage of net sales, certain columns may not add due to rounding.

    2018 (Restated)    2017 (Restated)  
         % of Sales         % of Sales  
Sales   $ 1,381,437       100 %   $ 1,538,240       100 %
Sales of systems     -       - %     -       - %
Contingent rental income     1,381,437       100 %     1,538,240       100 %
Cost of sales     -       - %     -       - %
Cost of systems and contingent rental income     -       - %     -       - %
Gross profit     1,381,437       100 %     1,538,240       100 %
Interest income on sales-type leases     657,866       48 %     1,648,608       107 %
Total operating income     2,039,303       148 %     3,186,848       207 %
Total operating expenses     2,186,175       158 %     1,331,583       87 %
Income (loss) from operations     (146,872 )     (11 )%     1,855,265       120 %
Total non-operating expenses, net     (1,453,361 )     (105 )%     (1,327,413 )     (86 )%
Income (loss) before income tax     (1,600,233 )     (116 )%     527,852       34 %
Income tax expense (benefit)     (71,627 )     (5 )%     293,750       19 %
Less: net loss attributable to noncontrolling interest     (95,925 )     (7 )%     (89,832 )     (6 )%
Net income (loss) attributable to China Recycling Energy Corp   $ (1,432,681 )     (104 )%   $ 323,934       21 %

 

SALES. Total sales for the three months ended June 30, 2018 and 2017 were $1,381,437 and $1,538,240, respectively, which was from the actual electricity sold of Erdos TCH.

 

COST OF SALES. Cost of sales (“COS”) for the three months ended June 30, 2018 and 2017 were $0, respectively. We did not finish any new construction or sale any new system in the three months ended June 30, 2018.

 

GROSS PROFIT. Gross loss for the three months ended June 30, 2018 and 2017 were $1,381,437 and $1,538,240, representing a gross margin of 100% and 100%, respectively.

 

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INTEREST INCOME ON SALES-TYPE LEASES. Interest income on sales-type leases for the three months ended June 30, 2018 was $0.66 million, a $0.99 million decrease from $1.65 million for the three months ended June 30, 2017. During the three months ended June 30, 2018, interest income was derived from the following four (4) sales-type leases:

 

  i. Two BMPG systems to Pucheng Phase I and II (15 and 11.9 years, respectively);
     
  ii. One BMPG system to Shenqiu Phase I (11 years);
     
  iii. One BMPG system to Shenqiu Phase II (9.5 years); and

 

In comparison, during the three months ended June 30, 2017, interest income was derived from the following four (4) sales-type leases:

 

  i. Two BMPG systems to Pucheng Phase I and II (15 and 11.9 years, respectively);
     
  ii. One BMPG system to Shenqiu Phase I (11 years);
     
  iii. One BMPG system to Shenqiu Phase II (9.5 years); and

 

OPERATING EXPENSES. Operating expenses consisted of general and administrative expenses totaling $2,186,175 for the three months ended June 30, 2018, compared to $1,331,583 for the three months ended June 30, 2017, an increase of $854,592 or 64%. The increase was mainly due to an increase in bad debt allowance expenses of $735,992.

 

NET NON-OPERATING EXPENSES. Net non-operating expenses consisted of non-sales-type lease interest income, interest expenses and miscellaneous expenses. For the three months ended June 30, 2018, net non-operating expense was $1.45 million compared to net non-operating expense of $1.33 million for the three months ended June 30, 2017. For the three months ended June 30, 2018, we had $40,016 interest income and $460 other income but the amount was offset by $1.50 million interest expense on loans. For the three months ended June 30, 2017, we had $34,844 interest income and $3,275 other income, but the amounts were offset by a $1.37 million interest expense on loans.

 

INCOME TAX EXPENSE (BENEFIT). Income tax benefit was $71,627 for the three months ended June 30, 2018, compared with $0.29 million income tax expense for the three months ended June 30, 2017. The consolidated effective income tax rate for the three months ended June 30, 2018 and 2017 were (4.5) % and 55.7%, respectively. The increase in income tax benefit in the three months ended June 30, 2018 was due to increased taxable loss.

 

NET INCOME (LOSS). Net loss for the three months ended June 30, 2018 was $(1,432,681) compared to net income of $323,934 for the three months ended June 30, 2017, a decrease of income of $1,756,615. This decrease in net income was mainly due to the decreased interest income on sales-type leases and increased general and administrative expense in the three months ended June 30, 2018 as described above.

 

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Comparison of six months Ended June 30, 2018 and 2017

 

The following table sets forth the results of our operations for the periods indicated as a percentage of net sales, certain columns may not add due to rounding.

 

    2018     2017  
          % of Sales         % of Sales  
Sales   $ 2,804,268       100 %   $ 3,309,272       100 %
Sales of systems     -       - %     -       - %
Contingent rental income     2,804,268       100 %     3,309,272       100 %
Cost of sales     -       - %     -       - %
Cost of systems and contingent rental income     -       - %     -       -%  
Gross profit     2,804,268       100 %     3,309,272       100 %
Interest income on sales-type leases     2.264,481       81 %     3,327,583       101 %
Total operating income     5,068,749       181 %     6,636,855       201 %
Total operating expenses     3,692,406       132 %     2,534,750       77 %
Income from operations     1,376,343       49 %     4,102,105       124 %
Total non-operating expenses, net     (2,842,526 )     (101 )%     (2,644,067 )     (80 )%
Income (loss) before income tax     (1,466,183 )     (52 )%     1,458,038       44 %
Income tax expense (benefit)     267,918       10 %     610,995       18 %
Less: net loss attributable to noncontrolling interest     (187,183 )     (7 )%     (178,255 )     (5 )%
Net income (loss) attributable to China Recycling Energy Corp   $ (1,546,918 )     (55 )%   $ 1,025,298       31 %

 

SALES. Total sales for the six months ended June 30, 2018 and 2017 were $2,804,268 and $3,309,272, respectively, which was from the actual electricity sold of Erdos TCH.

 

COST OF SALES. Cost of sales (“COS”) for the six months ended June 30, 2018 and 2017 were $0, respectively. We did not finish any new construction or sale any new system in the six months ended June 30, 2018.

 

GROSS PROFIT (LOSS). Gross profit for the six months ended June 30, 2018 and 2017 were $2,804,268 and $3,309,272, representing a gross margin of 100% and 100%, respectively.

 

INTEREST INCOME ON SALES-TYPE LEASES. Interest income on sales-type leases for the six months ended June 30, 2018 was $2.26 million, a $1.06 million decrease from $3.33 million for the six months ended June 30, 2017. During the six months ended June 30, 2018, interest income was derived from the following four (4) sales-type leases:

 

  i. Two BMPG systems to Pucheng Phase I and II (15 and 11.9 years, respectively);
     
  ii. One BMPG system to Shenqiu Phase I (11 years);
     
  iii. One BMPG system to Shenqiu Phase II (9.5 years); and
     

 

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In comparison, during the six months ended June 30, 2017, interest income was derived from the following four (4) sales-type leases:

 

  i. Two BMPG systems to Pucheng Phase I and II (15 and 11.9 years, respectively);
     
  ii. One BMPG system to Shenqiu Phase I (11 years);
     
  iii. One BMPG system to Shenqiu Phase II (9.5 years); and

 

OPERATING EXPENSES. Operating expenses consisted of general and administrative expenses totaling $3,692,406 for the six months ended June 30, 2018, compared to $2,534,750 for the six months ended June 30, 2017, an increase of $1,157,656 or 46%. The increase was mainly due to an increase in bad debt allowance expenses of $835,871.

 

NET NON-OPERATING EXPENSES. Net non-operating expenses consisted of non-sales-type lease interest income, interest expenses and miscellaneous expenses. For the six months ended June 30, 2018, net non-operating expense was $2.84 million compared to net non-operating expense of $2.64 million for the six months ended June 30, 2017. For the six months ended June 30, 2018, we had $77,220 interest income but the amount was offset by $2.92 million interest expense on loans and other loss of $1,281. For the six months ended June 30, 2017, we had $70,877 interest income and $7,798 other income, but the amounts were offset by a $2.72 million interest expense on loans.

 

INCOME TAX EXPENSE. Income tax expense was $0.27 million for the six months ended June 30, 2018, compared with $0.61 million income tax expense for the six months ended June 30, 2017. The consolidated effective income tax rate for the six months ended June 30, 2018 and 2017 were 18.3% and 41.9 %, respectively. The decrease in income tax in the six months ended June 30, 2018 was due to increased taxable loss.

 

NET INCOME (LOSS). Net loss for the six months ended June 30, 2018 was $1,546,918 compared to net income of $1,025,298 for the six months ended June 30, 2017, a decrease of income of $2,572,216. This decrease in net income was mainly due to the decreased interest income on sales-type leases and increased general and administrative expense in the six months ended June 30, 2018 as described above.

 

Liquidity and Capital Resources

 

Comparison of six months Ended June 30, 2018 and 2017

 

As of June 30, 2018, the Company had cash and equivalents of $51.14 million, other current assets of $41.46 million, current liabilities of $70.06 million, working capital of $22.53 million, a current ratio of 1.32:1 and a liability-to-equity ratio of 0.53:1.

 

The following is a summary of cash provided by or used in each of the indicated types of activities during the six months ended June 30, 2018 and 2017:

 

    2018 (Restated)     2017  
Cash provided by (used in):                
Operating Activities   $ 1,752,281     $ (1,182,172 )
Investing Activities     -       -  
Financing Activities     -       (727,834 )

   

Net cash provided by operating activities was $1.75 million during the six months ended June 30, 2018, compared to $1.18 million cash used in operating activities in the six months ended June 30, 2017. The increase in net cash inflow in the six months ended June 30, 2018 was mainly due to increased collection of principal on sales type lease by $1,346,829, a decrease in cash outflow on notes receivable by $848,747, and a decrease in cash outflow of interest receivable on sales type leases by $2,371,596, which was partly offset by increased net loss by $2,581,144.

 

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Net cash provided by investing activities was $0 for the six months ended June 30, 2018, compared to net cash provided by investing activities of $0 in 2017.

 

Net cash used in financing activities was $0 and $727,834 for six months ended June 30, 2018 and 2017, respectively. The cash outflow in the six months ended June 30, 2017 came from the repayment of bank loans in the amount of $0.73 million.

 

We believe we have sufficient cash to continue our current business through 2018 based on recurring receipts from existing sales-type leases. As of June 30, 2018, we had five recycling WHPG systems from the Erdos projects and four BMPG systems (two for Pucheng and two for Shenqiu), all of which generate cash flow. In addition, we have access to bank loans in case of an immediate, unanticipated need for working capital. We believe we have sufficient cash resources to cover our anticipated capital expenditures in 2018. The 9 systems that are currently in operation have minimum monthly lease payments of RMB 7.1 million ($1.07 million).

 

We do not believe inflation has had or will have a significant negative impact on our results of operations in 2018.

  

Transfers of Cash to and from Our Subsidiaries

 

The PRC has currency and capital transfer regulations that require us to comply with certain requirements for the movement of capital. The Company is able to transfer cash (US Dollars) to its PRC subsidiaries through: (i) an investment (by increasing the Company’s registered capital in a PRC subsidiary), or (ii) a stockholder loan. Except as described below, the Company’s subsidiaries in the PRC have not transferred any earnings or cash to the Company to date. The Company’s business is primarily conducted through its subsidiaries. The Company is a holding company and its material assets consist solely of the ownership interests held in its PRC subsidiaries. The Company relies on dividends paid by its subsidiaries for its working capital and cash needs, including the funds necessary: (i) to pay dividends or cash distributions to its stockholders, (ii) to service any debt obligations and (iii) to pay operating expenses. As a result of PRC laws and regulations (noted below) that require annual appropriations of 10% of after-tax income to be set aside in a general reserve fund prior to payment of dividends, the Company’s PRC subsidiaries are restricted in that respect, as well as in others respects noted below, in their ability to transfer a portion of their net assets to the Company as a dividend. 

 

With respect to transferring cash from the Company to its subsidiaries, increasing the Company’s registered capital in a PRC subsidiary requires the filing of the local commerce department, while a stockholder loan requires a filing with the state administration of foreign exchange or its local bureau.

 

With respect to the payment of dividends, we note the following:

 

  1. PRC regulations currently permit the payment of dividends only out of accumulated profits, as determined in accordance with accounting standards and PRC regulations (an in-depth description of the PRC regulations is set forth below);

 

  2. Our PRC subsidiaries are required to set aside, at a minimum, 10% of their net income after taxes, based on PRC accounting standards, each year as statutory surplus reserves until the cumulative amount of such reserves reaches 50% of their registered capital;

 

  3. Such reserves may not be distributed as cash dividends;

 

  4. Our PRC subsidiaries may also allocate a portion of their after-tax profits to fund their staff welfare and bonus funds; except in the event of a liquidation, these funds may also not be distributed to stockholders; the Company does not participate in a Common Welfare Fund;

 

  5. The incurrence of debt, specifically the instruments governing such debt, may restrict a subsidiary’s ability to pay stockholder dividends or make other cash distributions; and

 

  6. The Company is subject to covenants and consent requirements.

 

If, for the reasons noted above, our subsidiaries are unable to pay stockholder dividends and/or make other cash payments to the Company when needed, the Company’s ability to conduct operations, make investments, engage in acquisitions, or undertake other activities requiring working capital may be materially and adversely affected. However, our operations and business, including investment and/or acquisitions by our subsidiaries within China, will not be affected as long as the capital is not transferred in or out of the PRC.

 

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PRC Regulations

 

In accordance with PRC regulations on Enterprises with Foreign Investment and their articles of association, a foreign-invested enterprise (“FIE”) established in the PRC is required to provide statutory reserves, which are appropriated from net profit, as reported in the FIE’s PRC statutory accounts. A FIE is required to allocate at least 10% of its annual after-tax profit to the surplus reserve until such reserve has reached 50% of its respective registered capital (based on the FIE’s PRC statutory accounts). The aforementioned reserves may only be used for specific purposes and may not be distributed as cash dividends. Until such contribution of capital is satisfied, the FIE is not allowed to repatriate profits to its stockholders, unless approved by the State Administration of Foreign Exchange. After satisfaction of this requirement, the remaining funds may be appropriated at the discretion of the FIE’s board of directors. Our subsidiary, Shanghai TCH, qualifies as a FIE and is therefore subject to the above-mandated regulations on distributable profits. 

 

Additionally, in accordance with PRC corporate law, a domestic enterprise is required to maintain a surplus reserve of at least 10% of its annual after-tax profit until such reserve has reached 50% of its respective registered capital based on the enterprise’s PRC statutory accounts. A domestic enterprise is also required to provide discretionary surplus reserve, at the discretion of the board of directors, from the profits determined in accordance with the enterprise’s PRC statutory accounts. The aforementioned reserves can only be used for specific purposes and may not be distributed as cash dividends. Xi’an TCH, Huahong, and Erdos TCH were established as domestic enterprises; therefore, each is subject to the above-mentioned restrictions on distributable profits.

 

As a result of PRC laws and regulations that require annual appropriations of 10% of after-tax income to be set aside, prior to payment of dividends, in a general reserve fund, the Company’s PRC subsidiaries are restricted in their ability to transfer a portion of their net assets to the Company as a dividend or otherwise.

  

Chart of the Company’s Statutory Reserve

 

Pursuant to PRC corporate law, effective January 1, 2006, the Company is required to maintain a statutory reserve by appropriating from its after-tax profit before declaration or payment of dividends. The statutory reserve represents restricted retained earnings. Our restricted and unrestricted retained earnings under US GAAP are set forth below:

 

    As At  
    June 30,
2018 (Restated) 		   December 31,
2017 (Restated) 		 
Unrestricted retained earnings   $ 26,738,579     $ 28,321,696  
Restricted retained earnings (surplus reserve fund)     14,561,911       14,525,712  
Retained earnings (including surplus reserve fund)   $ 41,300,490     $ 42,847,408  

 

Off-Balance Sheet Arrangements

 

We have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as stockholders’ equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

 

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Contractual Obligations

 

The Company’s contractual obligations as of June 30, 2018 are as follows:

 

Contractual Obligation  1 year or
less		   More than
1 year		   See Note (for details) 
Entrusted loan   50,176,828    -    12 
Total  $50,176,828   $-      

 

The Company believes that it has a stable cash inflow each month and a sufficient channel to commercial institutions to obtain any loans that may be necessary to meet its working capital needs. Historically, we have been able to obtain loans or otherwise achieve our financing objectives due to the Chinese government’s support for energy-saving businesses with stable cash inflows, good credit ratings and history. The Company does not believe it will have difficulties related to the repayment of its outstanding short-term loans.

 

Commitments

 

Boxing Chengli Power Generation Projects

 

On July 24, 2013, Zhonghong entered into a Cooperative Agreement of CDQ and CDQ WHPG Project with Boxing County Chengli Gas Supply Co., Ltd. (“Chengli”), including a supplement agreement entered by the parties on July 26, 2013. 

 

Pursuant to the agreements, Zhonghong designed, built and maintained a CDQ system and a 25 MW CDQ WHPG system to supply power to Chengli, and Chengli will pay energy saving fees. Chengli will contract the operation of the system to a third party contractor that is mutually agreed to by Zhonghong. In addition, Chengli will provide the land for the CDQ and CDQ WHPG system at no cost to Zhonghong. The term of the Agreements is 20 years. The energy saving fees generated by the Project will be charged at RMB 0.42 ($0.068) per KWH (excluding tax). The operating time shall be based upon an average 8,000 hours annually. If the operating time is less than 8,000 hours due to a reason attributable to Chengli’s, then time charged shall be 8,000 hours a year, and if it is less than 8,000 hours due to a reason attributable to Zhonghong, then it shall be charged at actual operating hours. The construction of the Project was completed in the second quarter of 2015, and the commissioning tests were successfully completed in the first quarter of 2017. The Chengli Project is now operational, however, due to the environmental protection intensifies, the local environmental authorities required the project owner constructing CDQ sewage treatment supporting works, which must be completed and passed through acceptance inspection before the project is allowed to put into operation. So far, the project owner has completed the bidding of the sewage treatment supporting works and started construction on or about July 20, 2018. We anticipate that the construction will need three months to complete. The Company expects the Boxing project will be put into operation in the fourth quarter of 2018. From the date of the operation, Chengli shall ensure its coking production line works properly and that working hours for the CDQ system are no less than 8,000 hours/year, while Zhonghong shall ensure that working hours for the CDQ WHPG system are no less than 7,200 hours/year.

  

On July 22, 2013, Xi’an Zhonghong New Energy Technology Co., Ltd. entered into an EPC General Contractor Agreement for the Boxing County Chengli Gas Supply Co., Ltd. CDQ Power Generation Project (the “Project”) with Xi’an Huaxin New Energy Co., Ltd. (“Huaxin”). Zhonghong as the owner of the Project contracted EPC for a CDQ and a 25 MW CDQ WHPG system for Chengli to Huaxin. Huaxin shall provide construction, equipment procurement, transportation, installation and adjustment, test run, construction engineering management and other necessary works to complete the Project and ensure the CDQ and CDQ WHPG system for Chengli meet the inspection and acceptance requirements and work normally. The project is a turn-key project and Huaxin is responsible for the quality, safety, duration and cost of the Project. The total contract price is RMB 200 million ($28.83 million). The price is a cover-all price which includes but is not limited to all the materials, equipment, labor, transportation, electricity, water, waste disposal, machinery and safety matters. As of June 30, 2018, Zhonghong has paid $26.90 million (or $31.97 million if including capitalized interest) for the Chengli project and is committed to pay an additional $4.66 million. The Chengli project had finished construction, but was waiting for government approval before beginning operations.

 

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Xuzhou Tian’an and Xuzhou Huayu CDQ Power Generation Projects

 

On July 19, 2013, Zhonghong entered into a Cooperative Agreement for Energy Management of CDQ and CDQ WHPG Project with Jiangsu Tianyu Energy and Chemical Group Co., Ltd. (“Tianyu”).

 

Pursuant to the Tianyu Agreement, Zhonghong will design, build, operate and maintain two sets of 25 MW CDQ and CDQ WHPG systems for two subsidiaries of Tianyu: one is for and will be located at Xuzhou Tian’an Chemical Co., Ltd and one set is for and will be located at Xuzhou Huayu Coking Co., Ltd. (the “Tianyu Project”). Upon the completion of the Tianyu Project, Zhonghong will charge Tianyu an energy saving service fee of RMB 0.534 ($0.088) per KWH (excluding tax). The operating time shall be based upon an average 8,000 hours annually for each of Tian’an and Huayu. If the operating time for each of Tian’an and Huayu is less than 8,000 hours a year due to the reason attributable to Tianyu, then time charged shall be 8,000 hours a year for each of Tian’an and Huayu. Xuzhou Tian’an and Huayu will provide the land for the CDQ and CDQ WHPG systems for free. Xuzhou Tian’an and Huayu also guarantee that they will purchase all of the power generated by the CDQ WHPG systems.  

 

On July 22, 2013, Xi’an Zhonghong New Energy Technology Co., Ltd. entered into an EPC General Contractor Agreement for the Xuzhou Tianyu Group CDQ Power Generation Project (the “Project”) with Xi’an Huaxin New Energy Co., Ltd. (“Huaxin”). Zhonghong as the owner of the Project contracted EPC for the two sets of CDQ and 25 MW CDQ WHPG systems for Tianyu to Huaxin—one for Xuzhou Tian’an and one for Xuzhou Huayu. Huaxin shall provide construction, equipment procurement, transportation, installation and adjustment, test run, construction engineering management and other necessary works to complete the Project and ensure the CDQ and CDQ WHPG systems for Tianyu meet the inspection and acceptance requirements and work normally. The project is a turn-key project and Huaxin is responsible for the quality, safety, duration and cost of the Project. The total contract price is RMB 400 million ($66.67 million) of which RMB 200 million ($28.83 million) is for the Xuzhou Tian’an system and RMB 200 million is for the Xuzhou Huayu system. The price is a cover-all price which includes but is not limited to all the materials, equipment, labor, transportation, electricity, water, waste disposal, machinery and safety matters. As of June 30, 2018, Zhonghong had paid $19.08 million (or $24.67 million if including capitalized interest) for the Huayu project and $27.39 million (or $38.98 million if including capitalized interest) for the Tian’an project and is committed to pay an additional $12.09 million for the Huayu project and $4.19 million for the Tian’an project.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Exchange Rate Risk

 

Our operations are conducted mainly in the PRC. As such, our earnings are subject to movements in foreign currency exchange rates when transactions are denominated in RMB, which is our functional currency. Accordingly, our operating results are affected by changes in the exchange rate between the U.S. dollar and those currencies.

  

Item 4. Controls and Procedures.

 

Disclosure Controls and Procedures

 

The Company maintains disclosure controls and procedures which are designed to provide reasonable assurance that information required to be disclosed in the Company’s periodic SEC reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rules 13a – 15(e) and 15d – 15(e) of the Securities Exchange Act of 1934 (“Exchange Act”) at the end of the period covered by the report.

 

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Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2018, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that (i) the information required to be disclosed by us in this Report was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) information required to be disclosed by us in our reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control Over Financial Reporting

 

With the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the Company also conducted an evaluation of the Company’s internal control over financial reporting to determine whether any changes occurred during the Company’s fiscal quarter ended as of June 30, 2018, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.  Based on such evaluation, management concluded that, as of the end of the period covered by this report, there have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

Inherent Limitations on Effectiveness of Controls

 

Our management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

  

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PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

From time to time we may be subject to litigation, claims and assessments that arise in the ordinary course of business. Management believes that any liability resulting from such additional matters will not have a material adverse effect on our financial position, results of operations or cash flows. The Company is not a party to any legal proceedings that it believes will have a material adverse effect upon the conduct of its business or its financial position.

 

Item 1A. Risk Factors

 

There have been no material changes in our risk factors from those disclosed in Part I, Item 1A, of our Annual Report on Form 10-K as of and for the year ended December 31, 2017. An investment in our common stock involves various risks. When considering an investment in our company, you should consider carefully all of the risk factors described in our most recent Form 10-K. If any of those risks, incorporated by reference in this Form 10-Q, occur, the market price of our shares of common stock could decline and investors could lose all or part of their investment. These risks and uncertainties are not the only ones facing us and there may be additional matters that we are unaware of or that we currently consider immaterial. All of these could adversely affect our business, financial condition, results of operations and cash flows and, thus, the value of an investment in our company.

 

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

 

None. 

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. Mine Safety Disclosures.

 

Not Applicable.

 

Item 5. Other Information

 

None.

 

Item 6. Exhibits

 

Exhibit
Number		   Description
31.1   Certification of Chief Executive Officer pursuant to Rule 13a-14(a).*
     
31.2   Certification of Chief Financial Officer pursuant to Rule 13a-14(a).*
     
32.1   Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.†
     
32.2   Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350. †
     
101.INS   XBRL Instance Document.*
     
101.SCH   XBRL Taxonomy Extension Schema Document.*
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document.*
     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document.*
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document.*
     
101.DEF   XBRL Taxonomy Definitions Linkbase Document.*

 

*Filed herewith
†Furnished herewith.

 

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SIGNATURES

 

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

 

  CHINA RECYCLING ENERGY CORPORATION (Registrant)
   
Date: April 5, 2019 /s/ Guohua Ku
 

Guohua Ku

Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)

   
Date: April 5, 2019 /s/ Binfeng Gu
 

Binfeng Gu

Chief Financial Officer,
Principal Financial Officer and Secretary

 

50

 

 

EXHIBIT INDEX

 

Exhibit
Number		   Description
31.1   Certification of Chief Executive Officer pursuant to Rule 13a-14(a).*
     
31.2   Certification of Chief Financial Officer pursuant to Rule 13a-14(a).*
     
32.1   Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.†
     
32.2   Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.†
     
101.INS   XBRL Instance Document.*
     
101.SCH   XBRL Taxonomy Extension Schema Document.*
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document.*
     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document.*
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document.*
     
101.DEF   XBRL Taxonomy Definitions Linkbase Document.*

 

*Filed herewith
†Furnished herewith.

 

 

51