UNITED
STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
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 every Interactive Data File required to be submitted 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 such files). ☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions 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
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name
of each exchange on which registered | ||
| Common Stock, par value $0.001 per share | CREG | Nasdaq Stock Market |
The number of shares outstanding of the registrant’s Common Stock, as of November 13, 2019 was 17,872,998.
INDEX
i
PART I – FINANCIAL INFORMATION
CHINA RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2019 (UNAUDITED) AND DECEMBER 31, 2018
| SEPTEMBER 30, 2019 | DECEMBER 31, 2018 | |||||||
| (UNAUDITED) | ||||||||
| ASSETS | ||||||||
| CURRENT ASSETS | ||||||||
| Cash and equivalents | $ | 50,845,538 | $ | 53,223,142 | ||||
| Accounts receivable, net | 43,670,925 | 11,755,251 | ||||||
| Interest receivable on sales type leases | 5,173,531 | 9,336,140 | ||||||
| Prepaid expenses | 51,126 | 32,395 | ||||||
| Other receivables | 1,013,369 | 1,559,116 | ||||||
| Total current assets | 100,754,489 | 75,906,044 | ||||||
| NON-CURRENT ASSETS | ||||||||
| Investment in sales-type leases, net | 8,174,254 | 24,962,056 | ||||||
| Long term investment | - | 475,635 | ||||||
| Long term deposit | 15,497 | 15,971 | ||||||
| Property and equipment, net | 26,674,637 | 27,495,049 | ||||||
| Construction in progress | 24,353,518 | 42,582,177 | ||||||
| Total non-current assets | 59,217,906 | 95,530,888 | ||||||
| TOTAL ASSETS | $ | 159,972,395 | $ | 171,436,932 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| CURRENT LIABILITIES | ||||||||
| Accounts payable | $ | 2,168,743 | $ | 5,591,876 | ||||
| Taxes payable | 3,451,111 | 3,636,559 | ||||||
| Accrued liabilities and other payables | 1,139,403 | 1,617,997 | ||||||
| Due to related parties | 41,179 | 41,168 | ||||||
| Interest payable on entrusted loans | 22,335,362 | 17,473,492 | ||||||
| Entrusted loan payable | 46,939,728 | 48,373,936 | ||||||
| Total current liabilities | 76,075,526 | 76,735,028 | ||||||
| NONCURRENT LIABILITIES | ||||||||
| Convertible note payable, net of unamortized OID and debt issuing costs | - | 1,016,589 | ||||||
| Accrued interest on notes | 326,620 | 40,572 | ||||||
| Income tax payable | 6,390,625 | 6,390,625 | ||||||
| Deferred tax liability, net | - | 3,040,346 | ||||||
| Notes payable, net of unamortized OID | 1,829,250 | - | ||||||
| Long term payable | 424,154 | - | ||||||
| Refundable deposits from customers for systems leasing | 537,262 | 1,034,503 | ||||||
| Total noncurrent liabilities | 9,507,911 | 11,522,635 | ||||||
| Total liabilities | 85,583,437 | 88,257,663 | ||||||
| CONTINGENCIES AND COMMITMENTS (NOTE 21 & 22) | ||||||||
| STOCKHOLDERS’ EQUITY | ||||||||
| Common stock, $0.001 par value; 100,000,000 shares authorized, 16,510,498 shares and 10,295,280 shares issued and outstanding as of September 30, 2019 and December 31, 2018, respectively | 16,510 | 10,295 | ||||||
| Additional paid in capital | 116,031,772 | 114,484,018 | ||||||
| Statutory reserve | 14,525,712 | 14,525,712 | ||||||
| Accumulated other comprehensive loss | (7,203,689 | ) | (4,620,930 | ) | ||||
| Accumulated deficit | (48,981,347 | ) | (37,675,202 | ) | ||||
| Total Company stockholders’ equity | 74,388,958 | 86,723,893 | ||||||
| Noncontrolling interest | - | (3,544,624 | ) | |||||
| Total equity | 74,388,958 | 83,179,269 | ||||||
| TOTAL LIABILITIES AND EQUITY | $ | 159,972,395 | $ | 171,436,932 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
1
CHINA RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(UNAUDITED)
| NINE MONTHS ENDED SEPTEMBER 30, | THREE MONTHS ENDED SEPTEMBER 30, | |||||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Revenue | ||||||||||||||||
| Contingent rental income | $ | 702,973 | $ | 3,948,505 | $ | - | $ | 1,144,237 | ||||||||
| Interest income on sales-type leases | 173,360 | 2,771,452 | - | 506,971 | ||||||||||||
| Total operating income | 876,333 | 6,719,957 | - | 1,651,208 | ||||||||||||
| Operating expenses | ||||||||||||||||
| Bad debts | 5,508,377 | 3,299,458 | 2,683,474 | 2,463,587 | ||||||||||||
| Loss on disposal of systems | 1,250,731 | - | - | - | ||||||||||||
| General and administrative | 2,160,017 | 4,128,345 | 142,681 | 1,271,810 | ||||||||||||
| Total operating expenses | 8,919,125 | 7,427,803 | 2,826,155 | 3,735,397 | ||||||||||||
| Loss from operations | (8,042,792 | ) | (707,846 | ) | (2,826,155 | ) | (2,084,189 | ) | ||||||||
| Non-operating income (expenses) | ||||||||||||||||
| Gain on note conversion | 24,240 | - | 24,240 | - | ||||||||||||
| Interest income | 120,903 | 113,942 | 38,293 | 36,722 | ||||||||||||
| Interest expense | (5,888,819 | ) | (4,035,107 | ) | (2,094,899 | ) | (1,116,642 | ) | ||||||||
| Interest expense – inducement on note conversion | (893,958 | ) | - | - | - | |||||||||||
| Other income (expense), net | 332,397 | 622 | 1,919 | 1,903 | ||||||||||||
| Total non-operating expenses, net | (6,305,237 | ) | (3,920,543 | ) | (2,030,447 | ) | (1,078,017 | ) | ||||||||
| Loss before income tax | (14,348,029 | ) | (4,628,389 | ) | (4,856,602 | ) | (3,162,206 | ) | ||||||||
| Income tax benefit | (3,041,884 | ) | (272,998 | ) | (755,840 | ) | (540,916 | ) | ||||||||
| Loss before noncontrolling interest | (11,306,145 | ) | (4,355,391 | ) | (4,100,762 | ) | (2,621,290 | ) | ||||||||
| Less: loss attributable to noncontrolling interest | - | (273,235 | ) | - | (86,052 | ) | ||||||||||
| Net loss attributable to China Recycling Energy Corporation | (11,306,145 | ) | (4,082,156 | ) | (4,100,762 | ) | (2,535,238 | ) | ||||||||
| Other comprehensive items | ||||||||||||||||
| Foreign currency translation loss attributable to China Recycling Energy Corporation | (2,582,759 | ) | (8,090,700 | ) | (2,486,200 | ) | (6,110,231 | ) | ||||||||
| Foreign currency translation gain attributable to noncontrolling interest | - | 35,361 | - | 22,735 | ||||||||||||
| Comprehensive loss attributable to China Recycling Energy Corporation | $ | (13,888,904 | ) | $ | (12,172,856 | ) | $ | (6,586,962 | ) | $ | (8,645,469 | ) | ||||
| Comprehensive loss attributable to noncontrolling interest | $ | - | $ | (237,874 | ) | $ | - | $ | (63,317 | ) | ||||||
| Basic weighted average shares outstanding | 14,671,142 | 8,310,198 | 16,159,194 | 8,310,198 | ||||||||||||
| Diluted weighted average shares outstanding | 14,671,142 | 8,310,198 | 16,159,194 | 8,310,198 | ||||||||||||
| Basic loss per share | $ | (0.77 | ) | $ | (0.49 | ) | $ | (0.25 | ) | $ | (0.31 | ) | ||||
| Diluted loss per share * | $ | (0.77 | ) | $ | (0.49 | ) | $ | (0.25 | ) | $ | (0.31 | ) | ||||
| * The basic and diluted loss per share are the same due to antidilutive options and warrants resulting from the Company’s net loss. |
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)
| NINE MONTHS ENDED SEPTEMBER 30, | ||||||||
| 2019 | 2018 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
| Loss including noncontrolling interest | $ | (11,306,145 | ) | $ | (4,355,391 | ) | ||
| Adjustments to reconcile loss including noncontrolling interest to net cash used in operating activities: | ||||||||
| Depreciation | - | 2,049 | ||||||
| Amortization of OID and debt issuing costs of convertible note | 84,661 | 7,767 | ||||||
| Bad debt expense | 5,508,377 | 3,262,588 | ||||||
| Loss on disposal of 40% ownership of Fund Management Co | 46,761 | - | ||||||
| Investment loss | - | 10,962 | ||||||
| Loss on transfer of Chengli Boxing system | 628,170 | - | ||||||
| Loss on transfer of Xuzhou Huayu system | 399,601 | - | ||||||
| Loss on transfer of Shenqiu Phase I & II systems | 209,707 | - | ||||||
| Loss on disposal of fixed assets | 289 | - | ||||||
| Gain on note conversion | (24,240 | ) | - | |||||
| Interest expense – inducement on note conversion | 893,958 | |||||||
| Changes in deferred tax | (3,044,371 | ) | (1,589,864 | ) | ||||
| Changes in assets and liabilities: | ||||||||
| Interest receivable on sales type leases | (171,506 | ) | 367,877 | |||||
| Collection of principal on sales type leases | - | 2,453,103 | ||||||
| Accounts receivable | 64,306 | (1,020,973 | ) | |||||
| Prepaid expenses | (20,320 | ) | 699,076 | |||||
| Other receivables | (132,920 | ) | (249,966 | ) | ||||
| Notes receivable | - | 333,674 | ||||||
| Construction in progress | - | (7,156,966 | ) | |||||
| Accounts payable | (2,857,402 | ) | 3,522,376 | |||||
| Taxes payable | (1,323,919 | ) | 608,798 | |||||
| Interest payable on entrusted loan | 5,551,651 | 5,851,446 | ||||||
| Accrued liabilities and other payables | (109,867 | ) | 647,733 | |||||
| Refundable deposit for systems leasing | (481,462 | ) | - | |||||
| Net cash provide by (used in) operating activities | (6,084,671 | ) | 3,394,289 | |||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
| Proceeds from disposal of property & equipment | 5,106 | - | ||||||
| Net cash provided by investing activities | 5,106 | - | ||||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
| Convertible note payable | - | 1,000,000 | ||||||
| Issuance of notes payable | 2,000,000 | - | ||||||
| Issuance of common stock | 3,309,475 | - | ||||||
| Net cash provided by financing activities | 5,309,475 | 1,000,000 | ||||||
| EFFECT OF EXCHANGE RATE CHANGE ON CASH AND EQUIVALENTS | (1,607,514 | ) | (3,281,877 | ) | ||||
| NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS | (2,377,604 | ) | 1,112,412 | |||||
| CASH AND EQUIVALENTS, BEGINNING OF PERIOD | 53,223,142 | 49,830,243 | ||||||
| CASH AND EQUIVALENTS, END OF PERIOD | $ | 50,845,538 | $ | 50,942,655 | ||||
| Supplemental cash flow data: | ||||||||
| Income tax paid | $ | 223,369 | $ | 1,160,017 | ||||
| Interest paid | $ | - | $ | - | ||||
| Supplemental disclosure of non-cash operating activities | ||||||||
| Transfer of Xuzhou Huayu Project and Shenqiu Phase I & II project to Mr. Bai | $ | 34,931,358 | ||||||
| Supplemental disclosure of non-cash financing activities | ||||||||
| Conversion of notes into common shares | $ | 1,272,000 | $ | - | ||||
The accompanying notes are an integral part of these consolidated financial statements.
3
CHINA RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
NINE AND THREE MONTHS ENDED SEPTEMBER 30, 2019 AND 2018
| Common Stock | Other | |||||||||||||||||||||||||||||||
| Shares | Amount | Paid in Capital | Statutory Reserves | Comprehensive Loss | Accumulated Deficit | Total | Noncontrolling Interest | |||||||||||||||||||||||||
| Balance at December 31, 2018 | 10,295,820 | $ | 10,295 | $ | 114,484,018 | $ | 14,525,712 | $ | (4,620,930 | ) | $ | (37,675,202 | ) | $ | 86,723,893 | $ | (3,544,624 | ) | ||||||||||||||
| Issuance of common stock | 1,600,000 | 1,600 | 1,619,200 | - | - | - | 1,620,800 | - | ||||||||||||||||||||||||
| Conversion of note payable into shares | 1,851,946 | 1,852 | 2,013,124 | - | - | - | 2,014,976 | - | ||||||||||||||||||||||||
| Purchase of noncontrolling interest | - | - | (3,948,242 | ) | - | - | - | (3,948,242 | ) | 3,544,624 | ||||||||||||||||||||||
| Net loss for the quarter | - | - | - | - | - | (1,942,294 | ) | (1,942,294 | ) | - | ||||||||||||||||||||||
| Transfer to statutory reserves | - | - | - | 213,360 | - | (213,360 | ) | - | - | |||||||||||||||||||||||
| Foreign currency translation gain | - | - | - | - | 1,810,626 | - | 1,810,626 | - | ||||||||||||||||||||||||
| Balance at March 31, 2019 | 13,747,766 | 13,747 | 114,168,100 | 14,739,072 | (2,810,304 | ) | (39,830,856 | ) | 86,279,759 | - | ||||||||||||||||||||||
| Issuance of common stock | 2,358,732 | 2,359 | 1,686,316 | - | - | - | 1,688,675 | - | ||||||||||||||||||||||||
| Net loss for the quarter | - | - | - | - | - | (5,263,089 | ) | (5,263,089 | ) | - | ||||||||||||||||||||||
| Transfer to statutory reserves | - | - | - | (250,321 | ) | - | 250,321 | - | - | |||||||||||||||||||||||
| Foreign currency translation loss | - | - | - | - | (1,907,185 | ) | - | (1,907,185 | ) | - | ||||||||||||||||||||||
| Balance at June 30, 2019 | 16,106,498 | 16,106 | 115,854,416 | 14,488,751 | (4,717,489 | ) | (44,843,624 | ) | 80,798,160 | - | ||||||||||||||||||||||
| Issuance of common stock for partial note conversion | 404,000 | 404 | 177,356 | - | - | - | 177,760 | - | ||||||||||||||||||||||||
| Net loss for the quarter | - | - | - | - | - | (4,100,762 | ) | (4,100,762 | ) | - | ||||||||||||||||||||||
| Transfer to statutory reserves | - | - | - | 36,961 | - | (36,961 | ) | - | - | |||||||||||||||||||||||
| Foreign currency translation loss | - | - | - | - | (2,486,200 | ) | - | (2,486,200 | ) | - | ||||||||||||||||||||||
| Balance at September 30, 2019 | 16,510,498 | $ | 16,510 | $ | 116,031,772 | $ | 14,525,712 | $ | (7,203,689 | ) | $ | (48,981,347 | ) | $ | 74,388,958 | $ | - | |||||||||||||||
| Common Stock | Other | |||||||||||||||||||||||||||||||
| Shares | Amount | Paid in Capital | Statutory Reserves | Comprehensive Income (loss) | Retained Earning | Total | Noncontrolling Interest | |||||||||||||||||||||||||
| Balance at December 31, 2017 | 8,310,198 | $ | 8,310 | $ | 111,796,813 | $ | 14,525,712 | $ | 860,553 | $ | 28,321,696 | $ | 155,513,084 | $ | (478,637 | ) | ||||||||||||||||
| Net loss for the quarter | - | - | - | - | - | (114,237 | ) | (114,237 | ) | (91,258 | ) | |||||||||||||||||||||
| Transfer to statutory reserves | - | - | - | 75,990 | - | (75,990 | ) | - | - | |||||||||||||||||||||||
| Foreign currency translation gain | - | - | - | - | 6,405,278 | - | 6,405,278 | (21,922 | ) | |||||||||||||||||||||||
| Balance at March 31, 2018 | 8,310,198 | 8,310 | 111,796,813 | 14,601,702 | 7,265,831 | 28,131,469 | 161,804,125 | (591,817 | ) | |||||||||||||||||||||||
| Net loss for the quarter | - | - | - | - | - | (1,432,681 | ) | (1,432,681 | ) | (95,925 | ) | |||||||||||||||||||||
| Transfer to statutory reserves | - | - | - | (39,791 | ) | - | 39,791 | - | - | |||||||||||||||||||||||
| Foreign currency translation loss | - | - | - | - | (8,385,747 | ) | - | (8,385,747 | ) | 34,547 | ||||||||||||||||||||||
| Balance at June 30, 2018 | 8,310,198 | 8,310 | 111,796,813 | 14,561,911 | (1,119,916 | ) | 26,738,579 | 151,985,697 | (653,195 | ) | ||||||||||||||||||||||
| Net loss for the quarter | - | - | - | - | - | (2,535,238 | ) | (2,535,238 | ) | (86,052 | ) | |||||||||||||||||||||
| Transfer to statutory reserves | - | - | - | (36,199 | ) | - | 36,199 | - | - | |||||||||||||||||||||||
| Foreign currency translation loss | - | - | - | - | (6,110,231 | ) | - | (6,110,231 | ) | 22,735 | ||||||||||||||||||||||
| Balance at September 30, 2018 | 8,310,198 | $ | 8,310 | $ | 111,796,813 | $ | 14,525,712 | $ | (7,230,147 | ) | $ | 24,239,540 | $ | 143,340,228 | $ | (716,512 | ) | |||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
4
CHINA RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2019 (UNAUDITED) AND DECEMBER 31, 2018
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
China Recycling Energy Corporation (the “Company” or “CREG”) was incorporated 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, 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, and project investment in the Peoples Republic of China (“PRC”).
The Company’s organizational chart as of September 30, 2019 is as follows:
5
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 a 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 into 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 May 1, 2016, whereby Erdos TCH cancelled monthly minimum lease payments from Erdos, and started to charge 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. Since May 2019, Erdos TCH has ceased its operations due to renovations and furnace safety upgrades of Erdos, and the Company expects the resumption of operations in February 2020. During this period, Erdos will compensate Erdos TCH RMB 1 million ($145,460) per month, until operations resume.
In addition, Erdos TCH has 30% ownership in DaTangShiDai (BinZhou) Energy Savings Technology Co., Ltd. (“BinZhou Energy Savings”), 30% ownership in DaTangShiDai DaTong Recycling Energy Technology Co., Ltd. (“DaTong Recycling Energy”), and 40% ownership in DaTang ShiDai TianYu XuZhou Recycling Energy Technology Co, Ltd. (“TianYu XuZhou Recycling Energy”). These companies were incorporated in 2012 but there have not been any operations since then nor has any registered capital contribution been made.
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. 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 systems 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 the Pucheng Phase I project terminated upon the effective date of the Pucheng Lease. The ownership of the two 12 MW BMPG systems will transfer to Pucheng at no additional charge when the Pucheng Lease expires.
On September 29, 2019, Xi’an TCH entered into a Termination Agreement of the Lease Agreement of the Biomass Power Generation Project (the “Termination Agreement”) with Pucheng.
Pucheng failed to pay fees it owed to Xi’an TCH for leasing two biomass power generation systems from Xi’an TCH with total capacity of 24 MW, due to its long suspension of production resulting from the significant reduction of raw material supplies for its biomass power generation operation in Pucheng County, which caused the biomass power generation project to no longer be suitable. Pursuant to the Termination Agreement, the parties agreed that: (i) Pucheng shall pay off outstanding lease fees of RMB 97.6 million ($14 million) owed as of December 31, 2018 to Xi’an TCH before January 15, 2020; (ii) Xi’an TCH will waive the lease fees owed after January 1, 2019; (iii) Xi’an TCH will not return RMB 3.8 million ($542,857) in cash deposits paid by Pucheng; (iv) Xi’an TCH will transfer the Project to Pucheng at no additional cost after receiving RMB 97.6 million ($14 million) from Pucheng, and the original lease agreement between the parties will be formally terminated; and (v) if Pucheng fails to pay off RMB 97.6 million ($14 million) to Xi’an TCH before January 15, 2020, Xi’an TCH will still hold ownership of the Project and the original lease agreement shall still be valid. The Company recorded an additional $2.63 million bad debt expense for Pucheng during the quarter ended September 30, 2019. As of the date of this report, Puchang has not paid off RMB 97.6 million and Xi’an TCH still holds ownership of the Project.
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Shenqiu Yuneng Biomass Power Generation Projects
On May 25, 2011, Xi’an TCH entered into a Letter of Intent (“LOI”) 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 paid 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 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.
On October 8, 2012, Xi’an TCH entered into a LOI 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.
On January 4, 2019, Xi’an Zhonghong, Xi’an TCH, and Mr. Chonggong Bai (or “Mr. Bai”), a resident of China, entered into a Projects Transfer Agreement (the “Agreement”), pursuant to which Xi’an TCH transferred two BMGP in Shenqiu (“Shenqiu Phase I and II Projects”) to Mr. Bai for RMB 127,066,000 ($18.55 million). As consideration for the transfer of the Shenqui Phase I and II Projects to Mr. Bai (Note 12), Mr. Bai transferred 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 a loan made by Xi’an Zhonghong to HYREF on January 10, 2019. The transfer of the projects was completed on February 15, 2019. The Company recorded $213,044 loss from the transfer during the nine months ended September 30, 2019.
The Fund Management Company
On June 25, 2013, Xi’an TCH and Hongyuan Huifu Venture Capital Co. Ltd. (“Hongyuan Huifu”) 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 held 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.
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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. 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 Hongyuan Huifu formed Beijing Hongyuan Recycling Energy Investment Management Company Ltd. to manage this Fund, which 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. However, the HYREF Fund’s partnership will not terminate until the HYREF loan is fully repaid and the buy-back period is over pursuant to the Buy-back Agreement entered on December 29, 2018 (see Note 12). 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 ($77 million). The HYREF Fund was formed to invest in Xi’an Zhonghong New Energy Technology Co., Ltd., a then 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”).
On December 29, 2018, Xi’an TCH entered into a Share Transfer Agreement with Hongyuan Huifu, pursuant to which Xi’an TCH transferred its 40% ownership in the Fund Management Company to Hongyuan Huifu for RMB 3,453,867 ($0.53 million). The transfer was completed January 22, 2019. The Company recorded approximately $47,500 loss from the sale of a 40% equity interest in Fund Management Company. The Company does not have any ownership in the Fund Management Company after this transaction.
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. On December 29, 2018, Shanghai TCH entered into a Share Transfer Agreement with HYREF, pursuant to which HYREF transferred its 10% ownership in Xi’an Zhonghong to Shanghai TCH for RMB 3 million ($0.44 million). The transfer was completed January 22, 2019. The Company owns 100% of Xi’an Zhonghong after the transaction.
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, as mutually agreed upon by Zhonghong. In addition, Chengli will provide the land for the CDQ WHPG systems at no cost to Zhonghong. The term of the Agreements is 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. Due to intensifying environmental protection, the local environmental authorities required the project owner constructing CDQ sewage treatment to complete supporting works, which were completed and passed acceptance inspection during the quarter ended September 30, 2018. However, the owner of Chengli Project changed from Chengli to Shandong Boxing Shengli Technology Company Ltd. (“Shengli”) in March 2014. This change resulted from transfer of the equity ownership of Chengli to Shengli (a private company). Chengli, as a state-owned enterprise that is 100% owned by the local Power Supply Bureau, is no longer allowed to carry out business activities, and Shengli, the new owner, is not entitled to the high on-grid prices, and thus demanded a renegotiation of the settlement terms for the project.
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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 and CDQ WHPG systems 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.
On December 29, 2018, Xi’an Zhonghong, Xi’an TCH, HYREF, Guohua Ku, and Mr. Chonggong Bai entered into a CDQ WHPG Station Fixed Assets Transfer Agreement, pursuant to which Xi’an Zhonghong transferred Chengli CDQ WHPG station as the repayment for the loan of 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 (see Note 12). The transfer of the Station was completed January 22, 2019, the Company recorded $638,166 loss from this transfer.
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 Projects 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 overcapacity and pollution of the iron and steel and related industries, the Chinese 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 second quarter of 2020. 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 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, in exchange for 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 stricter administration of environmental protection policies and recent increases in environmental protections for the coking industry in Xuzhou, all local coking, as well as steel iron enterprises, are facing similar situations of suspended production while they rectify technologies and procedures.
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 will 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.
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On January 4, 2019, Xi’an Zhonghong, Xi’an TCH, and Mr. Chonggong Bai entered into a Projects Transfer Agreement (the “Agreement”), pursuant to which 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. Bai for RMB 120,000,000 ($17.52 million). Mr. Bai agreed that as consideration for the transfer of the Xuzhou Huayu Project to him (Note 12), he would transfer all the equity shares of his wholly owned company, Xi’an Hanneng, to HYREF as repayment for the loan made by Xi’an Zhonghong to HYREF. The transfer of the project was completed on February 15, 2019. The Company recorded $405,959 loss from this transfer during the nine months ended September 30, 2019. On January 10, 2019, Mr. Chonggong Bai transferred all the equity shares of his wholly owned company, Xi’an Hanneng, to HYREF as repayment for the loan. Xi’an Hanneng will own 47,150,000 shares of Xi’an Huaxin New Energy Co., Ltd for the repayment. As of September 30, 2019, Xi’an Hanneng already owns 29,948,000 shares of Huaxin, and is in the process of obtaining the remaining 17,202,000 shares; however, Huaxin stock is halted trading by NEEQ until its 2018 annual report is filed. As of the date of this report, the partners of HYREF and the Company orally agreed to extend the due date of the equity share transfer of Xi’an Hanneng until Xi’an Hanneng obtains the remaining 17,202,000 shares of Huaxin or until December 31, 2019, whichever comes earlier. Since the debt settlement agreement is not fully implemented, the loan was deemed unpaid at September 30, 2019.
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 smoke pipeline’s waste heat 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 for 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 with 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).
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 obligations under the EPC Contract to Zhongtai. As consideration for the transfer of the Project, Zhongtai agreed to pay to Xi’an TCH 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 was 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. The Company recorded a $2.82 million loss from this transaction in 2016. In 2016, Xi’an TCH had received the first payment of $7.70 million and the second payment of $4.32 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. In August 2018, the Company received $1,070,000 from Zhongtai; as of September 30, 2019, the Company had receivable from Zhongtai for $11.64 million (with bad debt allowance of $5.82 million). Zhongtai provided an acknowledgement letter to the Company stating it expected to repay the remaining balance of $11.88 million by the end of October 2019, once it resumes normal production. In mid September 2019, Zhongtai had resumed production, and on October 31, 2019, Zhongtai repaid RMB 5.00 million ($0.71 million).
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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 nor has any capital contribution been made 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 nor has any capital contribution been made as of the date of this report.
Formation of ShengYa Energy
On July 1, 2016, Xi’an Zhonghong incorporated a subsidiary, Xi’an ShengYa Energy Co., Ltd. (“ShengYa Energy”) with registered capital of $29.42 million (RMB 200,000,000), ShengYa Energy has not yet commenced operations nor has any capital contribution been made as of the date of this report.
Summary of Sales-Type Leases at September 30, 2019
As of September 30, 2019, the Company had the following sales-type leases: BMPG systems to Pucheng Phase I and II (15 and 11-year terms, respectively).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated interim financial information as of September 30, 2019 and for the nine and three month periods ended September 30, 2019 and 2018 was prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures which are normally included in consolidated financial statements (“CFS”)prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) were not included. The interim consolidated financial information should be read in conjunction with the Financial Statements and the notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018, previously filed with the SEC on April 16, 2019. In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the Company’s consolidated financial position as of September 30, 2019, results of operations for the nine and three months ended September 30, 2019 and 2018, and cash flows for the nine months ended September 30, 2019 and 2018, as applicable, were made. The interim results of operations are not necessarily indicative of the operating results for the full fiscal year or any future periods.
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The financial statements included herein were prepared by the Company, pursuant to the rules and regulations of the 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 US GAAP were omitted pursuant to such rules and regulations.
Basis of Consolidation
The 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, 1) Erdos TCH Energy Saving Development Co., Ltd (“Erdos TCH”), 100% owned by Xi’an TCH (See note 1), 2) Zhonghong, 90% owned by Xi’an TCH and 10% owned by Shanghai TCH, and 3) 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 September 30, 2019. 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
On January 1, 2019, the Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 842 using the modified retrospective transition approach by applying the new standard to all leases existing at the date of initial application. Results and disclosure requirements for reporting periods beginning after January 1, 2019 are presented under ASC Topic 842, while prior period amounts have not been adjusted and continue to be reported in accordance with our historical accounting under Topic 840. The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.
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. Prior to January 1, 2019, the investment in these projects was recorded as investment in sales-type leases in accordance with 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.
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Leases
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company adopted this ASU on CFS on January 1, 2019 and concluded the adoption of this new AUS did not have a material impact to the Company’s CFS.
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
The Company’s accounts receivable arise from sale of the system and sale of electricity of Erdos. The Company does not adjust its receivables for the effects of a significant financing component at contract inception if it expects to collect the receivables in one year or less from the time of sale. The Company does not expect to collect receivables more than one year from the time of sale.
The Company’s policy is to maintain an allowance for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable 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 September 30, 2019, the Company had gross accounts receivable of $49.67 million; of which, $34.93 million was for transferring the ownership of Huayu and Shenqiu Phase I and II systems to Mr. Bai; $11.31 million was from the sales of CDQ and a CDQ WHPG system to Zhongtai, and $3.43 million accounts receivable of Erdos TCH for the electricity sold. As of December 31, 2018, the Company had accounts receivable of $15,252,162 (from the sales of CDQ and a CDQ WHPG system to Zhongtai, and accounts receivable of Erdos TCH for electricity sold). As of September 30, 2019, the Company had bad debt allowance of $5,655,389 for Zhongtai and $342,686 for Erdos TCH due to not making the payments as scheduled. As of December 31, 2018, the Company had bad debt allowance of $3,496,911 for Zhongtai due to not making the payments as scheduled.
Interest Receivable on Sales Type Leases
As of September 30, 2019, the interest receivable on sales type leases was $5,173,531, mainly from recognized but not yet collected interest income for the Pucheng systems. As of December 31, 2018, the interest receivable on sales type leases was $9,336,140, mainly from recognized but not yet collected interest income for the Pucheng and Shenqiu systems. As of April 1, 2018, the Company stopped accruing interest receivable on the Pucheng lease as the Pucheng lease was at least one year overdue in its payments.
Investment in sales-type leases, net
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 September 30, 2019, the Company had bad debt allowance for net investment receivable on sales-type leases of $24,082,622 for the Pucheng systems (including $2.63 million additional bade debt recorded in the quarter ended September 30, 2019 due to the possible sale of the Pucheng System described in Note 1). As of December 31, 2018, the Company had bad debt allowance for net investment receivable of $29,276,658 ($7,274,872 for the Shenqiu systems and $22,071,360 for the Pucheng systems) due to lessees’ tight working capital and continuous delay in making the payment.
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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 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 are 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 recorded no asset impairment loss for the nine months ended September 30, 2019. The Company recorded asset impairment loss of $28,429,789 for three projects for the year ended December 31, 2018.
On January 4, 2019, Xi’an Zhonghong, Xi’an TCH, and Mr. Chonggong Bai entered into a Projects Transfer Agreement for Xi’an Zhonghong to transfer the Xuzhou Huayu Project to Mr. Bai for RMB 120,000,000 ($17.52 million), which transfer price was considered the fair value (“FV”) of the project. The Company compared the carrying value and FV of the Huayu project, and recorded asset impairment loss of $6,528,120 for the project for the year ended December 31, 2018.
On December 29, 2018, Xi’an Zhonghong, Xi’an TCH, HYREF, Guohua Ku, and Mr. Chonggong Bai entered into a CDQ WHPG Station Fixed Assets Transfer Agreement for Xi’an Zhonghong to transfer Chengli CDQ WHPG station as the repayment of a loan for RMB 188,639,400 ($27.54 million) to HYREF. The transfer price was considered the FV of the system. The Company compared the carrying value and FV of the Chengli system, and recorded asset impairment loss of $8,124,968 for the system for the year ended December 31, 2018.
As of December 31, 2018, the progress of the Xuzhou Tian’an project is slow due to strict environmental protection policies. The Company estimated the FV of the Xuzhou Tian’an project to be around RMB 172,250,000 ($25.58 million). The Company compared the carrying value and FV of the Tian’an Project, and recorded asset impairment loss of $13,512,592 for the project for the year ended December 31, 2018.
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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.
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 FASB 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 FASB 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 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. 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.
The Act also created new taxes on certain foreign-sourced earnings such as global intangible low-taxed income (“GILTI”) under IRC Section 951A, which is effective for the Company for tax years beginning after January 1, 2018. For the nine and three months ended September 30, 2019, the Company calculated its best estimate of the impact of the GILTI in its income tax provision in accordance with its understanding of the Act and guidance available as of the date of this filing.
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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. There is no NCI for the nine and three months ended September 30, 2019.
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 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 FASB ASC 480, “Distinguishing Liabilities from Equity,” and ASC 815, “Derivatives and Hedging.”
As of September 30, 2019 and December 31, 2018, the Company did not have any long-term debt obligations; and the Company did not identify any assets or liabilities that are required to be presented on the balance sheet at FV.
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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.
For the nine and three months ended September 30, 2019 and 2018, the basic and diluted loss per share were the same due to antidilutive options and warrants resulting from the Company’s net loss. For the nine and three months ended September 30, 2019, 4,067,641 shares purchasable under warrants and options were excluded from the EPS calculation, as their effects were anti-dilutive. For the nine and three months ended September 30, 2018, 9,000 shares purchasable under options were excluded from the EPS calculation, as their effects were anti-dilutive.
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.
Reclassification
Certain prior period balance sheet accounts were reclassified for the purpose of consistency with the current year’s presentation.
New Accounting Pronouncements
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326), which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Early application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the impact that the standard will have on its CFS.
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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.
In June 2018, the FASB issued ASU 2018-07, “Compensation — Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting,” which expands the scope of ASC 718 to include share-based payment transactions for acquiring goods and services from non-employees. An entity should apply the requirements of ASC 718 to non-employee awards except for specific guidance on inputs to an option pricing model and the attribution of cost. The amendments specify that ASC 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. The new guidance is effective for SEC filers for fiscal years, and interim reporting periods within those fiscal years, beginning after December 15, 2019 (i.e., January 1, 2020, for calendar year entities). Early adoption is permitted. The Company is evaluating the effects of the adoption of this guidance and currently believes that it will impact the accounting of the share-based awards granted to non-employees.
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 RECEIVABLES – BANK ACCEPTANCE
From time to time, the Company has some notes receivables, 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 September 30, 2019 and December 31, 2018, the Company had outstanding notes receivable on-hand of $0.
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). On February 15, 2019, Xi’an TCH transferred the Shenqiu Phase I and II Projects to Mr. Bai for RMB 127,066,000 ($18.55 million). On January 10, 2019, Mr. Bai transferred all the equity shares of his wholly owned company, Xi’an Hanneng, to HYREF as repayment for the loan made by Xi’an Zhonghong to HYREF. The components of the net investment in sales-type leases as of September 30, 2019 and December 31, 2018 are as follows:
| 2019 | 2018 | |||||||
| Total future minimum lease payments receivable | $ | 55,705,580 | $ | 88,661,266 | ||||
| Less: executory cost | (3,573,565 | ) | (5,687,704 | ) | ||||
| Less: unearned interest | (14,701,608 | ) | (19,398,707 | ) | ||||
| Less: realized interest income but not yet received | (5,173,531 | ) | (9,336,141 | ) | ||||
| Less: allowance for net investment receivable | (24,082,622 | ) | (29,276,658 | ) | ||||
| Investment in sales-type leases, net | 8,174,254 | 24,962,056 | ||||||
| Current portion | - | - | ||||||
| Noncurrent portion | $ | 8,174,254 | $ | 24,962,056 | ||||
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As of September 30, 2019, the gross future minimum rentals not including bad debt allowances to be received on non-cancelable sales-type leases by years were as follows:
| 2020 | $ | 25,081,650 | ||
| 2021 | 6,447,143 | |||
| 2022 | 6,447,143 | |||
| 2023 | 6,447,143 | |||
| 2024 | 6,447,143 | |||
| Thereafter | 4,835,358 | |||
| Total | $ | 55,705,580 |
5. PREPAID EXPENSES
The Company had $51,126 and $32,395 prepaid taxes as of September 30, 2019 and December 31, 2018, respectively.
6. OTHER RECEIVABLES
As of September 30, 2019, other receivables mainly consisted of (i) advances to third parties of $7,069, bearing no interest, payable upon demand, and (i) tax and maintenance cost receivable of $987,834 for Xi’an TCH. As of December 31, 2018, other receivables mainly consisted of (i) advances to third parties of $7,285, bearing no interest, payable upon demand, and (ii) tax and maintenance cost receivable of $1,528,368 for Xi’an TCH.
7. LONG TERM INVESTMENT
On June 25, 2013, Xi’an TCH with 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 ($1.6 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 had a 40% ownership interest in the Fund Management Company. Voting rights and dividend rights are allocated between Hongyuan Huifu and Xi’an TCH at 80% and 20%, respectively. The Company accounted for this investment using the equity method. The Company recorded $0 equity-based investment income (loss) during the nine and three months ended September 30, 2019, respectively. The Company recorded $(10,962) and $(6,147) equity-based investment loss during nine and three months ended September 30, 2018, 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 had 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) Hongyuan Huifu, 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 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. However, the HYREF Fund’s partnership will not terminate until the HYREF loan is fully repaid and the buy-back period is over pursuant to the Buy-back Agreement entered on December 29, 2018 (see Note 12). The total size of the HYREF Fund is RMB 460 million ($77 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.
On December 29, 2018, Xi’an TCH entered into a Share Transfer Agreement with Hongyuan Huifu, pursuant to which Xi’an TCH agreed to transfer its 40% ownership in the Fund Management Company to Hongyuan Huifu for RMB 3,453,867 ($0.53 million). The transfer was completed on January 22, 2019. The Company had approximately $47,200 loss from the sale of a 40% equity interest in Fund Management Company during the nine months ended September 30, 2019.
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8. PROPERTY AND EQUIPMENT AND CONSTRUCTION IN PROGRESS
Property and Equipment
As of September 30, 2019 and December 31, 2018, the Company had net property and equipment (after impairment loss of $8.12 million recorded in 2018) of approximately $26.67 million, which was for the Chengli project.
The Chengli project finished construction, and was transferred to the Company’s fixed assets at a cost of $35.24 million (without impairment loss) and ready to be put into operation as of December 31, 2018. On January 22, 2019, Xi’an Zhonghong completed the transfer of Chengli CDQ WHPG project as the partial repayment for the loan of RMB 188,639,400 ($27.54 million) to HYREF (see Note 12). However, because the loan was not deemed repaid (See Note 12 for explanation), the Company kept the Chengli project in its books as fixed assets for accounting purposes as of September 30, 2019.
Construction in Progress
Construction in progress was for constructing power generation systems. The Xuzhou Huayu project was sold in February 2019. In 2018, the progress of the Xuzhou Tian’an project was slow due to strict environmental protection policies. The Company estimated the FV of the Xuzhou Tian’an project to be around RMB 172,250,000.00 ($25.58 million). The Company compared the carrying value and FV of the Tian’an Project, and recorded asset impairment loss of $13,512,592 for the project for the year ended December 31, 2018. As of September 30, 2019 and December 31, 2018, the Company’s construction in progress included:
| 2019 | 2018 | |||||||
| Xuzhou Huayu | $ | - | $ | 23,778,899 | ||||
| Xuzhou Tian’an | 37,243,036 | 38,380,969 | ||||||
| Less: assets impairment allowance | (12,889,518 | ) | (19,577,691 | ) | ||||
| Total | $ | 24,353,518 | $ | 42,582,177 | ||||
As of September 30, 2019, the Company was committed to pay an additional $3.92 million for the Xuzhou Tian’an project. The construction of the Xuzhou Tian’an Project is anticipated to be completed by the second quarter of 2020.
9. TAXES PAYABLE
Taxes payable consisted of the following as of September 30, 2019 and December 31, 2018:
| 2019 | 2018 | |||||||
| Income tax – current | $ | 1,508,825 | $ | 1,718,051 | ||||
| Value-added tax | 1,684,941 | 1,666,695 | ||||||
| Other taxes | 257,345 | 251,813 | ||||||
| Total – current | 3,451,111 | 3,636,559 | ||||||
| Income tax – noncurrent | $ | 6,390,525 | $ | 6,390,625 | ||||
Income tax payable was approximately $7.90 million at September 30, 2019, including $1.51 million current and $6.39 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. shareholders 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 made such election.
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10. ACCRUED LIABILITIES AND OTHER PAYABLES
Accrued liabilities and other payables consisted of the following as of September 30, 2019 and December 31, 2018:
| 2019 | 2018 | |||||||
| Employee training, labor union expenditure and social insurance payable | $ | 816,912 | $ | 844,997 | ||||
| Consulting, auditing, and legal expenses | 39,420 | 488,052 | ||||||
| Accrued payroll and welfare | 233,839 | 261,152 | ||||||
| Other | 49,232 | 23,796 | ||||||
| Total | $ | 1,139,403 | $ | 1,617,997 | ||||
11. DEFERRED TAX LIABILITY, NET
Deferred tax assets resulted from asset impairment loss which was temporarily non-tax deductible for tax purposes but expensed in accordance with US GAAP, interest income in sales-type leases which was recognized as income for tax purposes but not for book purpose as it did not meet revenue recognition in accordance with US GAAP, 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 September 30, 2019, and December 31, 2018, deferred tax liability consisted of the following:
| 2019 | 2018 | |||||||
| Deferred tax asset — current (accrual of employee social insurance) | $ | 181,241 | $ | 186,779 | ||||
| Deferred tax liability — current (net investment in sales-type leases) | (751,984 | ) | (1,639,057 | ) | ||||
| Deferred tax liability — current, net of current deferred tax asset | $ | (570,743 | ) | $ | (1,452,278 | ) | ||
| Deferred tax asset — noncurrent (depreciation of fixed assets) | $ | 3,045,899 | $ | 6,176,064 | ||||
| Deferred tax asset — noncurrent (asset impairment loss) | 7,434,503 | 15,003,497 | ||||||
| Deferred tax asset — noncurrent (capitalized interest on CIP) | - | 2,531,120 | ||||||
| Deferred tax asset — noncurrent (interest income in sales-type leases) | 841,599 | 658,307 | ||||||
| Deferred tax asset — noncurrent (US NOL) | 3,204,942 | 3,114,083 | ||||||
| Deferred tax asset — noncurrent (PRC NOL) | 10,097,716 | 1,617,861 | ||||||
| Less: valuation allowance on deferred tax assets | (18,212,276 | ) | (21,353,059 | ) | ||||
| Deferred tax assets — noncurrent, net | 6,412,383 | 7,747,873 | ||||||
| Deferred tax liability — noncurrent (net investment in sales-type leases) | (5,841,640 | ) | (9,335,941 | ) | ||||
| Deferred tax liability — noncurrent, net of noncurrent deferred tax assets | $ | 570,743 | $ | (1,588,068 | ) | |||
| Total Deferred tax liability, noncurrent under ASU 2015-17 | $ | - | $ | (3,040,346 | ) | |||
12. LOANS PAYABLE
Entrusted Loan Payable (HYREF Loan)
The HYREF Fund (Beijing Hongyuan Recycling Energy Investment Center, LLP) was established in July 2013 with a total fund size of RMB 460 million ($77 million) invested 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 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 the loan amount as a 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 ($4.39 million) capital contribution made by Xi’an TCH in Zhonghong. 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 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.
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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 was for 60 months from July 31, 2013 to July 30, 2018. On August 6, 2016, Zhonghong was required 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 December 31, 2018, the entrusted loan payable had an outstanding balance of $59.29 million, of which, $10.92 million was from the investment of Xi’an TCH; accordingly, the Company netted the loan payable of $10.92 million with the long-term investment to the HYREF Fund made by Xi’an TCH. For the year ended December 31, 2018, the Company recorded interest expense of $5.19 million on this loan and $2.43 million penalty interest on past due loan, and capitalized $2.38 million interest to construction in progress. The Company had 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 to further extend 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 until August 2019 with an adjusted annual interest rate of 9%, subject to the final approval from its headquarters. The headquarters did not approve the extension proposal with an adjusted annual interest rate of 9%; however, on December 29, 2018 the Company worked out with the lender an alternative repayment proposal as described below. As of September 30, 2019, the interest payable for this loan was $22.34 million and the outstanding balance for this loan was $46.94 million.
Repayment of HYREF loan
| 1. | Transfer of Chengli project as partial repayment |
On December 29, 2018, Xi’an Zhonghong, Xi’an TCH, HYREF, Guohua Ku, and Chonggong Bai entered into a CDQ WHPG Station Fixed Assets Transfer Agreement, pursuant to which Xi’an Zhonghong transferred Chengli CDQ WHPG station as the repayment for the loan of 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 Chengli CDQ WHPG Station when conditions under the Buy Back Agreement are met.
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On January 22, 2019, Xi’an Zhonghong, completed the transfer of Chengli CDQ WHPG station to HYREF as the repayment of a loan for RMB 188,639,400 ($27.54 million) owed to HYREF. Xi’an TCH is a secondary limited partner of HYREF. The consideration of the CDQ WHPG station was determined by the parties based upon the appraisal report issued by Zhonglian Assets Appraisal Group (Shaanxi) Co., Ltd. as of August 15, 2018.
| 2. | Buy Back Agreement |
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 (see 5 below), 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., is delisted from The National Equities Exchange And Quotations Co., Ltd., a Chinese over-the-counter trading system (the “NEEQ”); (iii) Xi’an Huaxin New Energy, or 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.
| 3. | Xi’an TCH transferred 40% ownership in the Fund Management Company to Hongyuan Huifu for partial payment of financial advisory fee |
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 transferred 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 ($504,000) (the “Fund Management Company Transfer Price”). On January 22, 2019, Xi’an TCH completed the 40% ownership transfer transaction.
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 18,306,667 ($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 owed RMB 3,453,867 ($502,400) to Hongyuan Huifu, and Xi’an TCH owed RMB 14,852,800 ($2,168,000) to the Fund Management Company.
| 4. | HYREF Fund transferred 10% ownership in Xi’an Zhonghong to Shanghai TCH |
On December 29, 2018, Shanghai TCH entered into a Share Transfer Agreement with HYREF, pursuant to which HYREF agreed to transfer its 10% ownership in Xi’an Zhonghong to Shanghai TCH for RMB 3 million ($437,956). On January 22, 2019, Hongyuan Huifu completed the transfer of its 10% ownership in Xi’an Zhonghong to Shanghai TCH.
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| 5. | Transfer of Xuzhou Huayu Project and Shenqiu Phase I & II project to Mr. Bai for partial repayment of HYREF loan |
On January 4, 2019, Xi’an Zhonghong, Xi’an TCH, and Mr. Chonggong Bai entered into a Projects Transfer Agreement, pursuant to which 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. Bai for RMB 120,000,000 ($17.52 million) 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 ($18.55 million). Mr. Bai agreed to transfer all the equity shares of his wholly owned company, Xi’an Hanneng, to HYREF as repayment for the RMB 247,066,000 ($36.07 million) loan made by Xi’an Zhonghong to HYREF as consideration for the transfer of the Xuzhou Huayu Project and Shenqiu Phase I and II Projects.
On February 15, 2019, Xi’an Zhonghong completed the transfer of the Xuzhou Huayu Project and Xi’an TCH completed the transfer of Shenqiu Phase I and II Projects to Mr. Bai, and on January 10, 2019, Mr. Bai transferred all the equity shares of his wholly owned company, Xi’an Hanneng, to HYREF as repayment of Xi’an Zhonghong’s loan to HYREF as consideration for the transfer of the Xuzhou Huayu Project and Shenqiu Phase I and II Projects.
Xi’an Hanneng is a holding company and was supposed to own 47,150,000 shares of Xi’an Huaxin New Energy Co., Ltd. (“Huaxin”), so that HYREF will indirectly receive and own such shares of Xi’an Huaxin as the repayment for the loan of Zhonghong. As of September 30, 2019, Xi’an Hanneng already owns 29,948,000 shares of Huaxin, and is in the process of obtaining the remaining 17,202,000 shares; however, Huaxin stock is halted trading by NEEQ until its 2018 annual report is filed. As of the date of this report, the partners of HYREF and the Company orally agreed to extend the due date of the equity share transfer of Xi’an Hanneng until December 31, 2019, when Xi’an Hanneng obtains the remaining 17,202,000 shares of Huaxin. Since the debt settlement agreement is not fully implemented, the loan was deemed unpaid at September 30, 2019.
| 6. | The lender agreed to extend the repayment of RMB 77.00 million ($10.89 million) to July 8, 2023. |
A reconciliation of repayment of HYREF loan (entrusted loan) by three Projects at September 30, 2019 was as follows:
| Transfer price for Chengli Project | $ | 26,670,729 | Entrusted loan payable at September 30, 2019, net with Xi’an TCH investment in entrusted loan | $ | 46,939,728 | |||||
| Transfer price for Xuzhou Huayu Project | 16,966,167 | Interest payable on entrusted loan at September 30, 2019 | 22,335,362 | |||||||
| Transfer price for Shenqiu Phase I and II Projects | 17,965,191 | Add back: Xi’an TCH investment in entrusted loan | 10,603,854 | |||||||
| Less: interest accrued from September 20, 2018 to September 30, 2019 due to cut-off date for interest calculation for repayment was September 20, 2018 | (7,390,233 | ) | ||||||||
| Less: portion of loan repayment due date extended to year 2023 | (10,886,624 | ) | ||||||||
| $ | 61,602,087 | $ | 61,602,087 |
13. REFUNDABLE DEPOSITS FROM CUSTOMERS FOR SYSTEMS LEASING
As of September 30, 2019 and December 31, 2018, the balance of refundable deposits from customers for systems leasing was $537,262 (for Pucheng systems) and $1,034,503 (for Pucheng and Shenqiu systems), respectively.
14. RELATED PARTY TRANSACTIONS
As of September 30, 2019, and December 31, 2018, the Company had $41,179 and $41,168, respectively, in advances from the Company’s management, which bear no interest, are unsecured, and are payable upon demand.
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15. NOTE PAYABLES, NET
Convertible Note in July 2018
On July 11, 2018, the Company entered into a Securities Purchase Agreement with a Purchaser (Iliad Research and Trading, L.P), pursuant to which the Company sold and issued to the Purchaser a Convertible Promissory Note of $1,070,000. The Purchaser purchased the Note with an original issue discount (“OID”) of $50,000, and the Company paid to the Purchaser $20,000 for fees and costs incurred by Purchaser in connection with the consummation of the Purchase Agreement.
The Note bears interest at 8%. 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 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 125% of any amounts outstanding under the Note and being prepaid. 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.
During the first quarter of 2019, the Company amortized OID of $38,151 and loan issuing cost of $15,260, and recorded $10,446 interest expense for this convertible note. From January 16, 2019 through March 6, 2019, the investors converted the convertible note with principal of $1,070,000 and accrued interest of $51,018 into 1,851,946 common shares at conversion prices from $0.86 to $1.42, and the Company recorded $893,958 interest expense due to change in the conversion price, which was the difference between the market price and the conversion rate as of the conversion date, which was mutually agreed by the lender and borrower.
Convertible Notes / Promissory Notes in January and February 2019
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 of $1,050,000. The Purchaser purchased the Note with an original issue discount of $50,000. The Note bears interest at 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 125% of any amounts outstanding under the Note and being prepaid. 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. The conversion feature did not require bifurcation and derivative accounting and as the conversion price was greater than the market value of the Company common shares, there was no beneficial conversion feature to recognize.
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 of $1,050,000. The Purchaser purchased the Note with an original issue discount of $50,000. The Note bears interest at 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 125% of any amounts outstanding under the Note and being prepaid. 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. The conversion feature did not require bifurcation and derivative accounting and as the conversion price was greater than the market value of the Company common shares, there was no beneficial conversion feature to recognize.
Pursuant to an Exchange Agreement dated April 14, 2019 (the “Exchange Agreement”), the Company and Iliad Research and Trading, L.P. agreed to exchange the above two notes (the “Original Notes”) with two new promissory notes (the “Exchange Notes”). Upon execution of the agreement, the notes holder surrendered the Convertible Notes to the Company and the Company issued to the holder the Exchange Notes. Upon surrender, the two Convertible Notes were cancelled and the remaining amount owed to Holder hereafter be evidenced solely by the Exchange Notes. All outstanding principal and accrued interest on the Exchange Notes will become due and payable on January 31, 2021 and February 27, 2021, respectively. The Exchange Notes bore interest at 8% and did not grant conversion options to the Purchaser. The Company’s obligations under the Exchange Notes could be prepaid at any time, provided that in such circumstance the Company would have paid 125% of any amounts outstanding under the Exchange Notes. Beginning on the date that is six months from the issue date of the respective Original Notes (the “Issue Dates”) and at any time thereafter until the Exchange Notes are paid in full, Purchaser shall have the right to redeem up to $750,000 of the outstanding balance during months six to eight following the respective Issue Date and any amount thereafter. The exchange of the Convertible Notes with Promissory Notes did not cause substantially different terms, and did not meet the conditions described in ASC 405-20-10-1; accordingly, the Company did not recognize any gain or loss for the exchange of the notes under ASC 470-50-40-8.
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During the nine months ended September 30, 2019, the Company amortized OID of $31,250 and recorded $326,620 interest expense (including $106,680 and $105,944 in exchange fees, respectively) for these two notes.
As a result of default in the redemption request by the lender made on August 1, 2019, the Company and the lender entered into a forbearance agreement in which the lender agreed not to enforce its rights under the agreement and agreed not to make any Redemptions pursuant to the Section 4 of the Note before October 1, 2019. Under the term of the forbearance agreement, in the event Lender delivers after October 1, 2019 a Redemption Notice to Borrower and the Redemption Amount set forth therein is not paid in cash to Lender within three Trading Days, then the applicable Redemption Amount shall be increased by 25% (the “First Adjustment,” and such increase to the Redemption Amount, the “First Adjusted Redemption Amount”). In the event the First Adjusted Redemption Amount is not paid within three Trading Days after the date of First Adjustment, then the First Adjusted Redemption Amount shall be increased in accordance with the following formula: $0.50 divided by the lowest Closing Trade Price of the Common Stock during the 20 Trading Days prior to the date of the Second Adjustment and the resulting quotient multiplied by the First Adjusted Redemption Amount (the “Second Adjustment,” and such increase to the First Adjusted Redemption Amount, the “Second Adjusted Redemption Amount”), provided, however, that such formula shall only be applied if the resulting quotient is greater than one and such formula shall in no event be used to reduce the First Adjusted Redemption Amount.
On September 19, 2019, the Company entered into an Exchange Agreement with Iliad Research and Trading, L.P (“Lender”). Pursuant to the Agreement, the Company and Lender agreed to partition a new Promissory Note in the original principal amount of $202,000 (the “Partitioned Note”) from a Promissory Note (the “Note”) issued by the Company on April 14, 2019, which was exchanged from a Convertible Note originally issued by Company on January 31, 2019, whereupon the outstanding balance of the Note was reduced by an amount equal to the initial outstanding balance of the Partitioned Note. The Company and Lender further agreed to exchange the Partitioned Note for 404,000 shares of the Company’s Common Stock. The Company recorded $24,240 gain on this partitioned note settlement, which was the difference between the market price and the conversion price.
16. SHARES ISSUED FOR EQUITY FINANCING
Registered Director Offering and Private Placement in October 2018
On October 29, 2018, CREG entered into Securities Purchase Agreements with certain purchasers (the “Purchasers”), pursuant to which the Company offered to the Purchasers, in a registered direct offering, 1,985,082 shares of the Company’s common stock. The Shares were 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 also issued to the each of the Purchasers a warrant (“Investor Warrants”) 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 a purchase price of $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 are exercisable on the date of issuance at an initial 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 was the Company’s exclusive placement agent in connection with the offerings under the Purchase Agreement and received a fee of 7% of the gross proceeds ($208,433) received by the Company from the offerings and warrants to purchase the Company’s Common Stock in an amount of 7% of the Company’s 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”).
The warrants issued in this private placement are classified as equity instruments. The Company accounted for the warrants issued in the private placement based on the fair value method under ASC Topic 505, and the FV of the warrants was calculated using the Black-Scholes model under the following assumptions: estimated life of 5.5 years for Investor Warrants and 5 years for Placement Agent Warrants, volatility of 98%, risk-free interest rate of 2.91% and dividend yield of 0%. The FV of the warrants issued to investors at grant date was $2,499,238, and the FV of the warrants issued to the placement agent at grant date was $161,027.
Private Placement in February 2019
On February 13, 2019, CREG 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 sold to the Purchaser in a private placement 1,600,000 shares of the Company’s common stock, par value $0.001 per share, at $1.013 per share, for $1,620,800. The Company was required to 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 was completed pursuant to the exemption from registration provided by Regulation S promulgated under the Securities Act of 1933, as amended. The Company filed the registration statement on May 24, 2019, and was declared effective on June 4, 2019.
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Registered Direct Offering and Private Placement in April 2019
On April 15, 2019, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with certain purchasers (the “Purchasers”), pursuant to which the Company offered to the Purchasers, in a registered direct offering, 2,359,272 shares of common stock. The Shares were sold to the Purchasers at a negotiated purchase price of $0.80 per share, for gross proceeds to the Company of $1,887,417, before deducting $200,000 in placement agent fees and other estimated offering expenses payable by the Company.
In a concurrent private placement, the Company also issued to the each of the Purchasers a warrant to purchase 0.75 of a share of the Company’s Common Stock for each share purchased under the Purchase Agreement, or 1,769,454 warrants. The Warrants are exercisable beginning on the six month anniversary of the date of issuance at an initial exercise price of $0.9365 per share, and expire on the five and one-half year anniversary of the date of issuance.
H.C. Wainwright & Co., LLC acted as the Company’s exclusive placement agent in connection with the offerings under the Purchase Agreement and received cash fee of 7% of the gross proceeds received by the Company from the offerings (or $132,119), up to $75,000 for certain expenses, $10,000 for clearing expenses and warrants to purchase the Company’s Common Stock in an amount equal to 7% of our Shares sold to the Purchasers in the offerings, or 165,149 shares of Common Stock, on substantially the same terms as the Warrants, except that the Placement Agent Warrants have an initial exercise price of $1.00 per share, are exercisable commencing on the later of (i) six months of the issuance date or (ii) the date on which the Company increases the number of its authorized shares, and expire on April 15, 2024.
The warrants issued in this private placement were classified as equity instruments. The Company accounted for the warrants issued in the private placement based on the fair value method under ASC Topic 505, and the FV of the warrants was calculated using the Black-Scholes model under the following assumptions: estimated life of 5.5 years for Investor Warrants and 5 years for Placement Agent Warrants, volatility of 100%, risk-free interest rate of 2.41% and dividend yield of 0%. The FV of the warrants issued to investors at grant date was $855,246, and the FV of the warrants issued to the placement agent at grant date was $75,901.
Following is a summary of the warrant activity for the nine months ended September 30, 2019:
| Number of Warrants | Average Exercise Price | Weighted Average Remaining Contractual Term in Years | ||||||||||
| Granted | 2,124,038 | $ | 1.41 | 5.47 | ||||||||
| Exercised | - | - | - | |||||||||
| Forfeited | - | - | - | |||||||||
| Expired | - | - | - | |||||||||
| Outstanding at December 31, 2018 | 2,124,038 | $ | 1.41 | 5.29 | ||||||||
| Exercisable at December 31, 2018 | 2,124,038 | $ | 1.41 | 5.29 | ||||||||
| Granted | 1,934,603 | $ | 0.95 | 5.25 | ||||||||
| Exercised | - | - | - | |||||||||
| Forfeited | - | - | - | |||||||||
| Expired | - | - | - | |||||||||
| Outstanding at September 30, 2019 | 4,058,641 | $ | 1.19 | 4.77 | ||||||||
| Exercisable at September 30, 2019 | 4,058,641 | $ | 1.19 | 4.77 | ||||||||
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On July 8, 2019, the Company filed a Certificate of Amendment with the State of Nevada to (i) increase the total number of authorized shares of common stock, par value $0.001 per share, from 20,000,000 shares to 100,000,000 shares and (ii) authorize the issuance of up to 60,000,000 shares of blank check preferred stock, par value $0.001 per share, which were approved at the Company’s annual stockholders meeting held on July 2, 2019.
17. NONCONTROLLING INTEREST AND LONG TERM PAYABLE
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%.
On December 29, 2018, Shanghai TCH entered into a Share Transfer Agreement with HYREF, pursuant to which HYREF transferred its 10% ownership in Xi’an Zhonghong to Shanghai TCH (a wholly owned subsidiary of the Company) for RMB 3 million ($0.44 million), and Shanghai TCH record the purchase price as long term payable as of September 30, 2019. On January 22, 2019, HYREF completed the transfer of its 10% ownership in Xi’an Zhonghong to Shanghai TCH, Xi’an Zhongong then became a 100% subsidiary of Shanghai TCH. The Company did not record any gain or loss for this purchase as the controlling interest did not change.
18. 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 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 2019 and 2018 was 25%. Yinghua, Shanghai TCH, Xi’an TCH, Huahong, Zhonghong and Erdos TCH file separate income tax returns.
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, CREG is taxed in the US and, as of September 30, 2019, had net operating loss (“NOL”) carry forwards for income taxes of $14.91 million; for federal income tax purposes, the NOL arising in tax years beginning after 2017 may only reduce 80% of a taxpayer’s taxable income, and may be carried forward indefinitely. The 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.
As of September 30, 2019, the Company’s PRC subsidiaries had $40.39 million NOL that can be carried forward to offset future taxable income for five years from the year the loss is incurred. The NOL was mostly from Zhonghong, Zhonghong has not yet generated any sales yet; accordingly, the Company recorded a 100% deferred tax valuation allowance for PRC NOL.
The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the nine months ended September 30, 2019 and 2018, respectively:
| 2019 | 2018 | |||||||
| U.S. statutory rates | (21.0 | )% | (21.0 | )% | ||||
| Tax rate difference – current provision | (3.6 | )% | (3.7 | )% | ||||
| Reversal of temporary difference due to disposal of Shenqiu | (15.5 | )% | - | % | ||||
| Permanent differences | 1.3 | % | 3.7 | % | ||||
| Other | - | % | 2.0 | % | ||||
| Valuation allowance on PRC NOL | 17.0 | % | 11.4 | % | ||||
| Valuation allowance on US NOL | 0.6 | % | 1.7 | % | ||||
| Tax (benefit) per financial statements | (21.2 | )% | (5.9 | )% | ||||
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The provision for income tax expense for the nine months ended September 30, 2019 and 2018 consisted of the following:
| 2019 | 2018 | |||||||
| Income tax expense (benefit) – current | $ | 2,487 | $ | 1,316,866 | ||||
| Income tax benefit – deferred | (3,044,371 | ) | (1,589,864 | ) | ||||
| Total income tax expense (benefit) | $ | (3,041,884 | ) | $ | (272,998) | |||
The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the three months ended September 30, 2019 and 2018, respectively:
| 2019 | 2018 | |||||||
| U.S. statutory rates | (21.0 | )% | (21.0 | )% | ||||
| Tax rate difference – current provision | (3.7 | )% | (3.8 | )% | ||||
| Tax adjustment on PRC tax return | - | % | - | % | ||||
| Reversal of temporary difference due to disposal of Shenqiu | (2.1 | )% | - | % | ||||
| Permanent differences | (0.1 | )% | 0.6 | % | ||||
| Other | - | % | (0.7) | % | ||||
| Valuation allowance on PRC NOL | 9.8 | % | 7.0 | % | ||||
| Valuation allowance on US NOL | 1.5 | % | 0.8 | % | ||||
| Tax (benefit) per financial statements | (15.6 | )% | (17.1 | )% | ||||
The provision for income taxes expense for the three months ended September 30, 2019 and 2018 consisted of the following:
| 2019 | 2018 | |||||||
| Income tax expense (benefit) – current | $ | (755,840 | ) | $ | 395,824 | |||
| Income tax expense (benefit) – deferred | - | (936,740 | ) | |||||
| Total income tax expense (benefit) | $ | (755,840 | ) | $ | (540,916 | ) | ||
19. STOCK-BASED COMPENSATION PLAN
Options to Employees and Directors
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 its adoption by the 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 their annual meeting on June 19, 2015.
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The following table summarizes option activity with respect to employees and independent directors, and 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 December 31, 2018 | 9,000 | $ | 5.4 | 5.41 | ||||||||
| Exercisable at December 31, 2018 | 9,000 | $ | 5.4 | 5.41 | ||||||||
| Granted | - | - | - | |||||||||
| Exercised | - | - | - | |||||||||
| Forfeited | - | - | - | |||||||||
| Outstanding at September 30, 2019 | 9,000 | $ | 5.4 | 4.66 | ||||||||
| Exercisable at September 30, 2019 | 9,000 | $ | 5.4 | 4.66 | ||||||||
20. 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.
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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. The table below discloses the statutory reserve amount in the currency type registered for each Chinese subsidiary as of September 30, 2019.
| Name of Chinese Subsidiaries | Registered Capital | Maximum Statutory Reserve Amount | Statutory reserve at September 30, 2019 | |||||||
| Shanghai TCH | $ | 29,800,000 | $ | 14,900,000 | ¥ 6,564,303 ($1,003,859) | |||||
| Xi’an TCH | ¥ | 202,000,000 | ¥ | 101,000,000 | ¥ 69,359,820 ($10,606,984) | |||||
| Erdos TCH | ¥ | 120,000,000 | ¥ | 60,000,000 | ¥ 19,035,814 ($2,914,869) | |||||
| Xi’an Zhonghong | ¥ | 30,000,000 | ¥ | 15,000,000 | Did not accrue yet due to accumulated deficit | |||||
| Shaanxi Huahong | $ | 2,500,300 | $ | 1,250,150 | Did not accrue yet due to accumulated deficit | |||||
| Zhongxun | ¥ | 35,000,000 | ¥ | 17,500,000 | Did not accrue yet due to accumulated deficit | |||||
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.
21. CONTINGENCIES
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. 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. Remittances in currencies other than RMB may require certain supporting documentation in order to make the remittance.
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 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.
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22. COMMITMENTS
Lease Commitment
The Company adopted this ASC 842 on CFS on January 1, 2019 and did not apply it to the leases, as the lease asset and liability were not material.
On November 20, 2017, Xi’an TCH entered into a lease for its office with a term from December 1, 2017 through November 30, 2020. The monthly rent is RMB 36,536 ($5,600) with quarterly payment in advance.
On August 2, 2018, the Company entered into a lease for its office use in Beijing with a term from August 4, 2018 through August 3, 2020. The monthly rent is RMB 22,000 ($3,205) with quarterly payment in advance.
At September 30, 2019, the future annual rental payments for the years ending were as follows:
| September 30, 2020 | $ | 102,507 | ||
| September 30, 2021 | 11,200 |
For the nine months ended September 30, 2019 and 2018, the rental expense of the Company was $79,288 and $56,643, respectively.
For the three months ended September 30, 2019 and 2018, the rental expense of the Company was $26,221 and $23,043, respectively.
Construction Commitment
Refer to Note 1 for additional details related to lease commitments with Xuzhou Tian’an, Note 8 for commitments on construction in progress.
23. SUBSEQUENT EVENTS
The Company follows the guidance in FASB ASC 855-10 for the disclosure of subsequent events. The Company evaluated subsequent events through the date the financial statements were issued and determined the Company has the following material subsequent events:
On October 16, 2019, the Company entered into two Exchange Agreements (the “Agreements”) with Iliad Research and Trading, L.P.
Pursuant to the Agreements, the Company and Lender agreed to partition two new Promissory Notes in the original principal amounts of $125,000 and $200,000 (collectively, as the “Partitioned Notes”) from a Promissory Note (the “Note”) issued by the Company on April 14, 2019. The outstanding balance of the Note shall be reduced by an amount equal to the total outstanding balance of the Partitioned Notes. The Company and Lender further agreed to exchange the Partitioned Notes for the delivery of 250,000 shares and 400,000 shares of the Company’s Common Stock. The Company recorded gain on conversion of $22,500 and $36,000, respectively.
In October 2019, the Company issued 312,500 shares of its restricted common stock and 100,000 shares of its restricted common stock, respectively, for consulting services and investment banking services.
On November 11, 2019, the Company entered into an Exchange Agreement (the “Agreement”) with Iliad Research and Trading, L.P.
Pursuant to the Agreement, the Company and Lender agreed to partition a new Promissory Note in the original principal amount of $150,000 (the “Partitioned Note”) from a Promissory Note (the “Note”) issued by the Company on April 14, 2019. The outstanding balance of the Note shall be reduced by an amount equal to the total outstanding balance of the Partitioned Note. The Company and Lender further agreed to exchange the Partitioned Note for the delivery of 300,000 shares of the Company’s Common Stock. The Company recorded $45,000 gain on conversion of this portion of note.
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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, 2018 (the “2018 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 2018 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.
The Company is in the process of transforming and expanding into an energy storage integrated solution provider. We plan to pursue disciplined and targeted expansion strategies for market areas we currently do not serve. We actively seek and explore opportunities to apply energy storage technologies to new industries or segments with high growth potential, including industrial and commercial complexes, large scale photovoltaic (PV) and wind power stations, remote islands without electricity, and smart energy cities with multi-energy supplies. By supporting and motivating all kinds of the electric power market to participate in resource development and utilization of demand response, we plan to provide services including peak shaving with compensation and frequency modulation. We intend to gradually form motor load performance for peak and low-hours, which will account for about 3% of the annual maximum power load on the demand side and to ensure the electricity supply and demand balance for situations of non-severe power shortages.
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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% and Shanghai TCH’s 10% 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.
The Company’s organizational chart as of September 30, 2019 is as follows:
CREG Legal Structure
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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 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% and Shanghai TCH owns 10% of Zhonghong.
As of September 30, 2019, Shanghai TCH, through its subsidiaries, had sales or sales-type leases with Pucheng for two biomass power generation (“BMPG”) systems.
The Fund Management Company and the HYREF Fund
On June 25, 2013, Xi’an TCH and Hongyuan Huifu Venture Capital Co. Ltd (“Hongyuan Huifu”) 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 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. 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 Hongyuan Huifu 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. However, the HYREF Fund’s partnership will not terminate until the HYREF loan is fully repaid and the buy-back period is over pursuant to the Buy-back Agreement entered on December 29, 2018 (see Note 12). 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 ($77 million). The HYREF Fund was formed for the purpose of investing in Xi’an Zhonghong New Energy Technology Co., Ltd., a then 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”).
On December 29, 2018, Xi’an TCH entered into a Share Transfer Agreement with Hongyuan Huifu, pursuant to which Xi’an TCH transferred its 40% ownership in the Fund Management Company to Hongyuan Huifu for RMB 3,453,867 ($0.53 million). The transfer was completed January 22, 2019. The Company recorded approximately $47,500 loss from the sale of a 40% equity interest in Fund Management Company. The Company has no ownership in the Fund Management Company after this transaction.
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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 limited over-capacity and production in the iron and steel industry, which resulted in a decrease of Erdos Metallurgy Co., Ltd’s production of ferrosilicon and its revenue and cash flows, and 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 price will be adjusted annually based on prevailing market conditions. Since May 2019, Erdos TCH has ceased its operations due to renovations and furnace safety upgrades of Erdos, and the Company expects the resumption of operations in February 2020. During this period, Erdos will compensate Erdos TCH RMB 1 million ($145,460) per month, until operations resume.
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.
In addition, Erdos TCH has 30% ownership in DaTangShiDai (BinZhou) Energy Savings Technology Co., Ltd. (“BinZhou Energy Savings”), 30% ownership in DaTangShiDai DaTong Recycling Energy Technology Co., Ltd. (“DaTong Recycling Energy”), and 40% ownership in DaTang ShiDai TianYu XuZhou Recycling Energy Technology Co, Ltd. (“TianYu XuZhou Recycling Energy”). These companies were incorporated in 2012 but had no operations since then nor any registered capital contribution was made.
Shenqiu Yuneng Biomass Power Generation Projects
On May 25, 2011, Xi’an TCH entered into a Letter of Intent (“LOI”) 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 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 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.
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On October 8, 2012, Xi’an TCH entered into a LOI 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.
On January 4, 2019, Xi’an Zhonghong, Xi’an TCH, and Mr. Chonggong Bai entered into a Projects Transfer Agreement (the “Agreement”), pursuant to which 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 ($18.55 million). 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 loan made by Xi’an Zhonghong to HYREF as consideration for the transfer of the Shenqiu Phase I and II Projects (See Note 12). The transfer of projects was completed February 15, 2019. The Company recorded $213,044 loss from the transfer. Mr. Bai transferred all the equity shares of his wholly owned company, Xi’an Hanneng to the HYREF Fund as repayment for the loan on January 10, 2019.
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 12MW 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 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.
On September 29, 2019, Xi’an TCH entered into a Termination Agreement of the Lease Agreement of Biomass Power Generation Project (the “Termination Agreement”) with Pucheng.
Pucheng failed to pay fees it owed to Xi’an TCH for leasing two biomass power generation systems from Xi’an TCH with total capacity of 24MW due to its long suspension of production resulting from the significant reduction of raw material supplies for its biomass power generation operation in Pucheng County, which caused the biomass power generation project to no longer be suitable. Pursuant to the Termination Agreement, the parties agreed: (i) Pucheng shall pay off outstanding lease fees of RMB 97.6 million ($14 million) owed as of December 31, 2018 to Xi’an TCH before January 15, 2020; (ii) Xi’an TCH will waive the lease fees owed after January 1, 2019; (iii) Xi’an TCH will not return RMB 3.8 million ($542,857) in cash deposits paid by Pucheng; (iv) Xi’an TCH will transfer the Project to Pucheng at no additional cost after receiving RMB 97.6 million from Pucheng, and the original lease agreement between the parties will be formally terminated; and (v) if Pucheng fails to pay off RMB 97.6 million to Xi’an TCH before January 15, 2020, Xi’an TCH will still hold ownership of the Project and the original lease agreement shall still be valid. As of the date of this report, Puchang has not paid off RMB 97.6 million and Xi’an TCH still holds ownership of the Project.
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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. On December 29, 2018, Shanghai TCH entered into a Share Transfer Agreement with HYREF, pursuant to which HYREF agreed to transfer its 10% ownership in Xi’an Zhonghong to Shanghai TCH for RMB 3 million ($0.44 million). The transfer was completed January 22, 2019.
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 these Agreements is 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 intensifying environmental protection, the local environmental authorities required the project owner constructing CDQ sewage treatment to complete supporting works, which were completed and passed through acceptance inspection during the quarter ended September 30, 2018. However, the owner of Chengli Project changed from Chengli to Shandong Boxing Shengli Technology Company Ltd. (“Shengli”). This change resulted from transfer of the equity ownership of Chengli to Shengli (a private company) in March 2014. Chengli, a 100% state-owned enterprise that is 100% owned by the local Power Supply Bureau, is no longer allowed to carry out business activities, and Shengli, the new owner, is not entitled to the high on-grid prices, and thus demanded a renegotiation of the settlement terms for the project. The Company negotiated with the new project owner on the lease term, settlement method and settlement price, but no agreement has been reached.
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.
On December 29, 2018, Xi’an Zhonghong, Xi’an TCH, the “HYREF”, Guohua Ku, and Mr. Chonggong Bai entered into a CDQ WHPG Station Fixed Assets Transfer Agreement, pursuant to which Xi’an Zhonghong transferred Chengli CDQ WHPG station as the repayment for the loan of 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 (see Note 12). The transfer was completed January 22, 2019, and the Company recorded $638,166 loss from this transfer.
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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 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 second quarter of 2020. 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 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 in exchange for 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 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 stricter administration of environmental protection policies and recent increase in 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.
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.
On January 4, 2019, Xi’an Zhonghong, Xi’an TCH, and Mr. Chonggong Bai entered into a Projects Transfer Agreement (the “Agreement”), pursuant to which 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. Bai for RMB 120,000,000 ($17.52 million). Mr. Bai agreed to transfer all the equity shares of his wholly owned company, Xi’an Hanneng, to the HYREF Fund as repayment for the loan made by Xi’an Zhonghong to HYREF as consideration for the transfer of the Xuzhou Huayu Project (see Note 12). The transfer of the projects was completed February 15, 2019. The Company recorded $405,959 loss from this transfer. On January 10, 2019, Mr. Bai transferred all the equity shares of his wholly owned company, Xi’an Hanneng, to HYREF as repayment for the loan. Xi’an Hanneng will own 47,150,000 shares of Xi’an Huaxin New Energy Co., Ltd for the repayment. As of September 30, 2019, Xi’an Hanneng already owns 29,948,000 shares of Huaxin, and is in the process of obtaining the remaining 17,202,000 shares; however, Huaxin stock is halted trading by NEEQ until its 2018 annual report is filed. As of the date of this report, the partners of HYREF and the Company orally agreed to extend the due date of the equity share transfer of Xi’an Hanneng until December 31, 2019 when Xi’an Hanneng obtains the remaining 17,202,000 shares of Huaxin. Since the debt settlement agreement is not fully implemented, the loan was deemed unpaid at September 30, 2019.
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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 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”). 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 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 was to 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 Zhongtai under the Zhongtai Agreement once 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. The Company recorded a $2.82 million loss from this transaction in 2016. In 2016, Xi’an TCH had received the first payment of $7.70 million and the second payment of $4.32 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. In August 2018, the Company received $1,070,000 from Zhongtai; as of September 30, 2019, the Company had receivables from Zhongtai for $11.64 million (with bad debt allowance of $5.82 million). On January 23, 2019, Zhongtai provided an acknowledgement letter to the Company stating it expected to repay the remaining balance of $11.88 million by the end of October 2019, once it resumes the normal production. In mid September 2019, Zhongtai resumed production and on October 31, 2019, Zhongtai repaid RMB 5.00 million ($0.71 million).
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Related Party Transactions
As of September 30, 2019, the Company had $41,179 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 September 30, 2019. All significant inter-company accounts and transactions were eliminated in consolidation.
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.
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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 September 30, 2019, the Company had gross accounts receivable of $49.67 million; of which, $34.93 million was for transferring the ownership of Huayu and Shenqiu Phase I and II systems to Mr. Bai; $11.31 million was from the sales of CDQ and a CDQ WHPG system to Zhongtai, and $3.43 million accounts receivable of Erdos TCH for the electricity sold. As of September 30, 2019, the Company had bad debt allowance of $5,655,389 for Zhongtai and $342,686 for Erdos TCH due to not making the payments as scheduled.
Interest Receivable on Sales Type Leases
As of September 30, 2019, the interest receivable on sales type leases was $5,173,531, mainly representing recognized but not yet collected interest income for the Pucheng systems.
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 September 30, 2019, the Company had bad debt allowance for net investment receivable on sales-type leases of $24,082,622 for the Pucheng systems.
Revenue Recognition
Sales-type Leasing and Related Revenue Recognition
On January 1, 2019, the Company adopted Accounting Standards Codification (“ASC”) Topic 842 using the modified retrospective transition approach by applying the new standard to all leases existing at the date of initial application. Results and disclosure requirements for reporting periods beginning after January 1, 2019 are presented under ASC Topic 842, while prior period amounts have not been adjusted and continue to be reported in accordance with our historical accounting under Topic 840. The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.
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. Prior to January 1, 2019, the investment in these projects is recorded as investment in sales-type leases in accordance with ASC Topic 840, “Leases,” and its various amendments and interpretations.
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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 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.
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.
New Accounting Pronouncements
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326), which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Early application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the impact that the standard will have on its CFS.
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.
In June 2018, the FASB issued ASU 2018-07, “Compensation — Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting,” which expands the scope of ASC 718 to include share-based payment transactions for acquiring goods and services from non-employees. An entity should apply the requirements of ASC 718 to non-employee awards except for specific guidance on inputs to an option pricing model and the attribution of cost. The amendments specify that ASC 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. The new guidance is effective for SEC filers for fiscal years, and interim reporting periods within those fiscal years, beginning after December 15, 2019 (i.e., January 1, 2020, for calendar year entities). Early adoption is permitted. The Company is evaluating the effects of the adoption of this guidance and currently believes that it will impact the accounting of the share-based awards granted to non-employees.
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RESULTS OF OPERATIONS
Comparison of three months Ended September 30, 2019 and 2018
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.
| 2019 | 2018 | |||||||||||||||
| % of Sales | % of Sales | |||||||||||||||
| Sales | $ | - | - | % | $ | 1,144,237 | 100 | % | ||||||||
| Sales of systems | - | - | % | - | - | % | ||||||||||
| Contingent rental income | - | - | % | 1,144,237 | 100 | % | ||||||||||
| Cost of sales | - | - | % | - | - | % | ||||||||||
| Cost of systems and contingent rental income | - | - | % | - | - | % | ||||||||||
| Gross profit | - | - | % | 1,144,237 | 100 | % | ||||||||||
| Interest income on sales-type leases | - | - | % | 506,971 | 44 | % | ||||||||||
| Total operating income | - | - | % | 1,651,208 | 144 | % | ||||||||||
| Total operating expenses | (2,826,155 | ) | - | % | (3,735,397 | ) | (326 | )% | ||||||||
| Income (loss) from operations | (2,826,155 | ) | - | % | (2,084,189 | ) | (182 | )% | ||||||||
| Total non-operating expenses, net | (2,030,447 | ) | - | % | (1,078,017 | ) | (94 | )% | ||||||||
| Income (loss) before income tax | (4,856,602 | ) | - | % | (3,162,206 | ) | (276 | )% | ||||||||
| Income tax expense (benefit) | (755,840 | ) | - | % | (540,916 | ) | (47 | )% | ||||||||
| Less: loss attributable to noncontrolling interest | - | - | % | (86,052 | ) | (8 | )% | |||||||||
| Net loss attributable to China Recycling Energy Corp | $ | (4,100,762 | ) | - | % | $ | (2,535,238 | ) | (222 | )% | ||||||
SALES. Total sales for the three months ended September 30, 2019 and 2018 were $nil and $1,144,237, respectively. The sales were from the electricity sold by Erdos TCH. However, since May 2019, Erdos TCH has ceased its operations due to renovations and furnace safety upgrades of Erdos. During this period, Erdos will compensate Erdos TCH RMB 1 million ($145,460) per month, until operations resume. The Company expects the resumption of operations of Erdos TCH in February 2020.
COST OF SALES. Cost of sales (“COS”) for the three months ended September 30, 2019 and 2018 were $0.
GROSS PROFIT. Gross income for the three months ended September 30, 2019 and 2018 were $nil and $1,144,237, a gross margin of 100%.
INTEREST INCOME ON SALES-TYPE LEASES. Interest income on sales-type leases for the three months ended September 30, 2019 was $0, a $0.51 million decrease from $0.51 million for the three months ended September 30, 2018. During the three months ended September 30, 2019, there was no interest income; in February 2019, the Shenqiu Phase I and II systems were transferred to Mr. Bai, and the Company only had Pucheng Phase I and II systems during three months ended September 30, 2019, which the Company has ceased to accrue interest income since April 2018 because Pucheng power generation systems were suspended due to strict environmental protection policies and lack of supply of biomass waste raw materials. Pucheng has not resumed operations to date.
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The decreased interest income was due to the transfer of the Shenqiu Phase I and II systems to Mr. Bai in February, 2019.
During the three months ended September 30, 2018, interest income was derived from the following four 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); |
OPERATING EXPENSES. Operating expenses consisted of general and administrative expenses, bad debt expense totaling $2,826,155 for the three months ended September 30, 2019, compared to $3,735,397 for the three months ended September 30, 2018, a decrease of $909,242 or 24%. The decrease was mainly due to decreased operating expense by $1,129,129 of Erdos TCH due to cease of the operation, which was partly offset by increased bad expense of $219,887.
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 September 30, 2019, net non-operating expense was $2.03 million compared to $1.08 million for the three months ended September 30, 2018. For the three months ended September 30, 2019, we had $38,293 interest income but the amount was offset by $2.09 million interest expense on entrusted loan and long term notes. For the three months ended September 30, 2018, we had $36,722 interest income but the amounts were offset by a $1.12 million interest expense on loans.
INCOME TAX BENEFIT. Income tax benefit was $755,840 for the three months ended September 30, 2019, compared with $540,916 income tax benefit for the three months ended September 30, 2018. The consolidated effective income tax rates for the three months ended September 30, 2019 and 2018 were (15.6%) and (17.1%), respectively. The increase in income tax benefit for nine months ended September 30, 2019 was due to increased taxable loss.
NET LOSS. Net loss for the three months ended September 30, 2019 was $4,100,762 compared to $2,535,238 for the three months ended September 30, 2018, an increase of loss of $1,565,524. This increase in net loss was mainly due to the decrease operating income and increase interest expenses as described above.
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Comparison of nine months ended September 30, 2019 and 2018
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.
| 2019 | 2018 | |||||||||||||||
| % of Sales | % of Sales | |||||||||||||||
| Sales | $ | 702,973 | 100 | % | $ | 3,948,505 | 100 | % | ||||||||
| Sales of systems | - | - | % | - | - | % | ||||||||||
| Contingent rental income | 702,973 | 100 | % | 3,948,505 | 100 | % | ||||||||||
| Cost of sales | - | - | % | - | - | % | ||||||||||
| Cost of systems and contingent rental income | - | - | % | - | - | % | ||||||||||
| Gross profit | 702,973 | 100 | % | 3,948,505 | 100 | % | ||||||||||
| Interest income on sales-type leases | 173,360 | 25 | % | 2,771,452 | 70 | % | ||||||||||
| Total operating income | 876,333 | 125 | % | 6,719,957 | 170 | % | ||||||||||
| Total operating expenses | (8,919,125 | ) | (1,269 | )% | (7,427,803 | ) | (188 | )% | ||||||||
| Income (loss) from operations | (8,042,792 | ) | (1,144 | )% | (707,846 | ) | (18 | )% | ||||||||
| Total non-operating expenses, net | (6,305,237 | ) | (897 | )% | (3,920,543 | ) | (99 | )% | ||||||||
| Income (loss) before income tax | (14,348,029 | ) | (2,041 | )% | (4,628,389 | ) | (117 | )% | ||||||||
| Income tax expense (benefit) | (3,041,884 | ) | (433 | )% | (272,998 | ) | (7 | )% | ||||||||
| Less: loss attributable to noncontrolling interest | - | - | % | (273,235 | ) | (7 | )% | |||||||||
| Net loss attributable to China Recycling Energy Corp | $ | (11,306,145 | ) | (1,608 | )% | $ | (4,082,156 | ) | (103 | )% | ||||||
SALES. Total sales for the nine months ended September 30, 2019 and 2018 were $702,973 and $3,948,505, respectively. The sales were from the electricity sold by Erdos TCH. However, from May, Erdos TCH has ceased its operations due to renovations and furnace safety upgrades of Erdos. The Company expects the resumption of operation of Erdos TCH in Feburary 2020.
COST OF SALES. Cost of sales (“COS”) for the nine months ended September 30, 2019 and 2018 were $0.
GROSS PROFIT. Gross income for the nine months ended September 30, 2019 and 2018 were $702,973 and $3,948,505, a gross margin of 100% for each period.
INTEREST INCOME ON SALES-TYPE LEASES. Interest income on sales-type leases for the nine months ended September 30, 2019 was $173,360, a $2.60 million decrease, from $2.77 million for the nine months ended September 30, 2018. During the nine months ended September 30, 2019, interest income was derived from the Shenqiu Phase I and II systems (15 and 11.9 years, respectively) for the month of January 2019; in February 2019, the Shenqiu Phase I and II systems were transferred to Mr. Bai.
During the nine months ended September 30, 2018, interest income was derived from the following four 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); |
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The decreased interest income was due to the transfer of the Shenqiu Phase I and II systems to Mr. Bai in February, 2019 and the suspension of the Pucheng power generation systems due to strict environmental protection policies and lack of supply of biomass waste raw materials, as well as the Company’s ceasing to accrue interest income since April 2018. Pucheng has not resumed operations to date.
OPERATING EXPENSES. Operating expenses consisted of general and administrative expenses, loss on disposal of systems and bad debt expense totaling $8,919,125 for the nine months ended September 30, 2019, compared to $7,427,803 for the nine months ended September 30, 2018, an increase of $1,491,322 or 20%. The increase was mainly due to increased bad debt expense by $2,208,919 for the Pucheng and Zhongtai systems and increased loss on disposal of systems by $1,250,731, which was partly offset by decreased operating expense by $1,968,328 of Erdos TCH.
NET NON-OPERATING EXPENSES. Net non-operating expenses consisted of non-sales-type lease interest income, interest expenses and miscellaneous expenses. For the nine months ended September 30, 2019, net non-operating expense was $6.31 million compared to net non-operating expense of $3.92 million for the nine months ended September 30, 2018. For the nine months ended September 30, 2019, we had $120,903 interest income but the amount was offset by $5.89 million interest expense on entrusted loans and long term notes, interest expense on note beneficial conversion feature of $893,958. For the nine months ended September 30, 2018, we had $113,942 in interest income but the amounts were offset by a $4.03 million interest expense on loans.
INCOME TAX (BENEFIT) EXPENSE. Income tax benefit was $3.04 million for the nine months ended September 30, 2019, compared with $0.27 million income tax benefit for the nine months ended September 30, 2018. The consolidated effective income tax rates for the nine months ended September 30, 2019 and 2018 were (21.2)% and (5.9)%, respectively. The increase in income tax benefit for nine months ended September 30, 2019 was due to increased taxable loss.
NET LOSS. Net loss for the nine months ended September 30, 2019 was $11,306,145 compared to $4,082,156 for the nine months ended September 30, 2018, an increase of loss of $7,223,989. This increase in net loss was mainly due to decreased operating income and increased interest expenses, loss on disposal of systems and loss on note conversion as described above.
Liquidity and Capital Resources
Comparison of nine months Ended September 30, 2019 and 2018
As of September 30, 2019, the Company had cash and equivalents of $50.85 million, other current assets of $49.91 million, current liabilities of $76.08 million, working capital of $24.68 million, a current ratio of 1.32:1 and a liability-to-equity ratio of 1.15:1.
The following is a summary of cash provided by or used in each of the indicated types of activities during the nine months ended September 30, 2019 and 2018:
| 2019 | 2018 | |||||||
| Cash provided by (used in): | ||||||||
| Operating Activities | $ | (6,084,671 | ) | $ | 3,394,289 | |||
| Investing Activities | 5,106 | |||||||
| Financing Activities | 5,309,475 | 1,000,000 | ||||||
Net cash used in operating activities was $6.08 million during the nine months ended September 30, 2019, compared to $3.39 million cash provided by operating activities for the nine months ended September 30, 2018. The increase in net cash outflow for the nine months ended September 30, 2019 was mainly due to increased net loss of $6.95 million, decreased collection of principal on sales-type leases by $2.45 million, decreased cash inflow on accounts payable by $6.38 million and increased cash outflow of tax payable by $1.93 million, which was partly offset by decreased cash outflow on construction in progress by $7.16 million and increased cash inflow on accounts receivable by $1,085,279.
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Net cash provided by investing activities was $5,106 and $nil, respectively, for the nine months ended September 30, 2019 and 2018. For the nine months ended September 30, 2019, $5,106 was the proceeds from disposal of the fixed assets.
Net cash provided by financing activities was $5.31 million compared to net cash provided by financing activities of $1.00 million during the nine months ended September 30, 2019 and 2018, respectively. The cash inflow in the nine months ended September 30, 2019 came from the proceeds of issuance of notes of $2.00 million and proceeds from issuance of common stock of $3.31 million. The cash inflow in the nine months ended September 30, 2018 came from the issuance of a convertible note of $1,000,000.
We do not believe inflation has had or will have a significant negative impact on our results of operations in 2019.
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. 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. |
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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.
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. The aforementioned reserves can only be used for specific purposes and may not be distributed as cash dividends. Xi’an TCH, Huahong, Zhonghong 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 of | ||||||||
| September
30, 2019 | December 31, 2018 | |||||||
| Unrestricted retained earnings (accumulated deficit) | $ | (48,981,347 | ) | $ | (37,675,202 | ) | ||
| Restricted retained earnings (surplus reserve fund) | 14,525,712 | 14,525,712 | ||||||
| Total retained earnings (accumulated deficit) | $ | (34,455,635 | ) | $ | (23,149,490 | ) | ||
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 September 30, 2019 are as follows:
| Contractual Obligation | 1 year or less | More than 1 year | See Note (for details) | |||||||||
| Notes payable including accrued interest of $326,620 | $ | - | $ | 2,155,870 | 15 | |||||||
| Entrusted loan including interest payable of $22,335,362 | 69,275,090 | - | 12 | |||||||||
| Total | $ | 69,275,090 | $ | 2,155,870 | ||||||||
The Company believes 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
Xuzhou Tian’an 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 reasons 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 September 30, 2019, Zhonghong had $24.35 million (or $37.24 million if including capitalized interest) for the Tian’an project and is committed to pay an additional $3.92 million for the Tian’an project. The construction of the Xuzhou Tian’an Project is anticipated to be completed by the second quarter of 2020.
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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.
Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2019, 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 September 30, 2019, 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
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.
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, 2018. 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.
None.
| Exhibit Number |
Description | |
| 10.1 | Exchange Agreement by and between China Recycling Energy Corporation and Iliad Research and Trading, L.P. dated November 11, 2019 * | |
| 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.DEF | XBRL Taxonomy Extension Definition Linkbase Document* | |
| 101.LAB | XBRL Taxonomy Extension Label Linkbase Document* | |
| 101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document* |
| * | Filed 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: November 15, 2019 | /s/ Guohua Ku |
| Guohua Ku Chairman of the Board and Chief Executive Officer (Principal Executive Officer) | |
| Date: November 15, 2019 | /s/ Binfeng Gu |
| Binfeng Gu Chief Financial Officer, Principal Financial Officer and Secretary |
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EXHIBIT INDEX
| Exhibit Number |
Description | |
| 10.1 | Exchange Agreement by and between China Recycling Energy Corporation and Iliad Research and Trading, L.P. dated November 11, 2019* | |
| 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.DEF | XBRL Taxonomy Extension Definition Linkbase Document* | |
| 101.LAB | XBRL Taxonomy Extension Label Linkbase Document* | |
| 101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document* |
| * | Filed herewith |
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