NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER
30, 2016 (UNAUDITED) AND DECEMBER 31, 2015
1. ORGANIZATION
AND DESCRIPTION OF BUSINESS
China
Recycling Energy Corporation (the “Company” or “CREG”) was incorporated on May 8, 1980 as Boulder Brewing
Company under the laws of the State of Colorado. On September 6, 2001, the Company changed its state of incorporation to the State
of Nevada. In 2004, the Company changed its name from Boulder Brewing Company to China Digital Wireless, Inc. and on March 8,
2007, again changed its name from China Digital Wireless, Inc. to its current name, China Recycling Energy Corporation. The Company,
through its subsidiaries, provides energy saving solutions and services, including selling and leasing energy saving systems and
equipment to customers, project investment, investment management, economic information consulting, technical services, financial
leasing, purchase of financial leasing assets, disposal and repair of financial leasing assets, consulting and ensuring of financial
leasing transactions in the Peoples Republic of China (“PRC”).
Erdos
TCH – Joint Venture
On
April 14, 2009, the Company formed a joint venture (the “JV”) with Erdos Metallurgy Co., Ltd. (“Erdos”)
to recycle waste heat from Erdos’ metal refining plants to generate power and steam to be sold back to Erdos. The name of
the JV was Inner Mongolia Erdos TCH Energy Saving Development Co., Ltd. with a term of 20 years. Total investment for the project
was estimated at $79 million (RMB 500 million) with an initial investment of $17.55 million (RMB 120 million). Erdos contributed
7% of the total investment of the project, and Xi’an TCH Energy Technology Co., Ltd. (“Xi’an TCH”) contributed
93%. According to the parties’ agreement on profit distribution, Xi’an TCH and Erdos will receive 80% and 20%, respectively,
of the profit from the JV until Xi’an TCH receives the complete return of its investment. Xi’an TCH and Erdos will
then receive 60% and 40%, respectively, of the profit from the JV. On June 15, 2013, Xi’an TCH and Erdos entered into a
share transfer agreement, pursuant to which Erdos 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 the JV. In addition, Xi’an TCH paid Erdos accumulated profits
from inception up to June 30, 2013 in accordance with a supplementary agreement entered on August 6, 2013. In August 2013,
Xi’an TCH paid 20% of the accumulated profit (calculated under PRC GAAP) of $226,000 to Erdos. The JV currently has two
power generation systems in Phase I with a total of 18MW power capacity, and three power generation systems in Phase II with a
total of 27MW power capacity. On April 28, 2016, Erdos TCH and Erdos entered a supplemental agreement, effective on May 1, 2016,
Erdos TCH cancelled monthly minimum lease payments from Erdos, and charges Erdos based on actual electricity sold at RMB 0.30
/ Kwh. The selling price of each Kwh will be determined annually based on market condition.
Pucheng
Biomass Power Generation Projects
On
June 29, 2010, Xi’an TCH entered into a Biomass Power Generation (“BMPG”) Project Lease Agreement with PuchengXinHeng
Yuan Biomass Power Generation Co., Ltd. (“Pucheng”), a limited liability company incorporated in China. Under
this lease agreement, Xi’an TCH leased a set of 12MW BMPG systems to Pucheng at a minimum of $279,400 (RMB 1,900,000) per
month for a term of 15 years.
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 12MW BMPG systems
with 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 the price of $1.87 per share. These shares were issued to Pucheng on October 29, 2013. Also
on September 11, 2013, Xi’an TCH entered into a BMPG Project Lease Agreement with Pucheng (the “Pucheng Lease”).
Under the Pucheng Lease, Xi’an TCH leases this same set of 12MW BMPG system to Pucheng, and combined this lease with the
lease for the 12MW 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 12MW station from Pucheng Phase I project terminated upon the effective date of the Pucheng Lease. The
ownership of two 12 MW BMPG systems will be transferred to Pucheng at no additional charge when the Pucheng Lease expires.
Shenqiu
Yuneng Biomass Power Generation Projects
On
May 25, 2011, Xi’an TCH entered into a Letter of Intent with ShenqiuYuNeng Thermal Power Co., Ltd. (“Shenqiu”)
to reconstruct and transform a Thermal Power Generation System owned by Shenqiu into a 75T/H BMPG System for $3.57 million (RMB
22.5 million). The project commenced in June 2011 and was completed in the third quarter of 2011. On September 28, 2011, Xi’an
TCH entered into a BMPG Asset Transfer Agreement with Shenqiu (the “Shenqiu Transfer Agreement”). Pursuant to the
Shenqiu Transfer Agreement, Shenqiu sold Xi’an TCH a set of 12 MW BMPG systems (after Xi’an TCH converted the system
for BMPG purposes). As consideration for the BMPG systems, Xi’an TCH agreed to pay Shenqiu $10,937,500 (RMB 70 million)
in cash in three installments within six months upon the transfer of ownership of the systems. By the end of 2012, all of
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 12MW BMPG systems
to Shenqiu at a monthly rental rate of $286,000 (RMB 1,800,000) for 11 years. Upon expiration of the 2011 Shenqiu Lease, ownership
of this system will be transferred from Xi’an TCH to Shenqiu at no additional cost. In connection with the 2011 Shenqiu
Lease, Shenqiu paid one month’s rent as a security deposit to Xi’an TCH, in addition to providing personal guarantees.
On
October 8, 2012, Xi’an TCH entered into a Letter of Intent for technical reformation of Shenqiu Project Phase II with Shenqiu
for technical reformation to enlarge the capacity of the Shenqiu Project Phase I (the “Shenqiu Phase II Project”).
The technical reformation involved the construction of another 12MW BMPG system. After the reformation, the generation capacity
of the power plant increased to 24MW. 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 12MW 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 be transferred from Xi’an TCH to Shenqiu at no additional
cost.
Shanxi
Datong Coal Group Power Generation Projects
In
February 2011, Xi’an TCH entered into an agreement with Shanxi Datong Coal Group Steel Co., Ltd. (“Shanxi Datong”)
to recycle gas and steam from groups of blast-furnaces and converters at Shanxi Datong’s metal refining plants to generate
power and pursuant to which Xi’an TCH agreed to install two 3MW Blast Furnace Power Recovery Turbine (the “BPRT”)
systems and, one 15MW Waste Gas Power Generation (“WGPG”) system with a total of 21MW power capacity for an estimated
total investment of $28.6 million (RMB 180 million). In June 2013, the two 3MW BPRT power generation systems were completed. The
lease term is 30 years, during which time Shanxi Datong will pay a service fee to Xi’an TCH. The service fee was based on
an average of 8,000 electricity-generating hours per year and $0.05 (RMB 0.33) per kilowatt hour (“kWh”) for the first
five years from the completion of each power generation station. For each of the leases, at the 6th, 11th and 21st year anniversary
of the date of the lease, the rates will change to RMB 0.3 kWh, 0.27 kWh and 0.25 kWh, respectively. In May 2012, Shanxi Datong
and Tianjin Construction Materials Group (Holding) Co., Ltd. were restructured and renamed as Datong Coal Mine Tianjian Iron &
Steel Co., Ltd. (“Datong”). On June 10, 2013, Xi’an TCH and Shanxi Datong entered into a supplemental agreement
relating to the minimum service fee. The minimum service fee per month for the first five years was $0.19 million (RMB 1.2 million),
$0.18 million (RMB 1.1 million) for the second five years, $0.16 million (RMB 1.0 million) for the following 10 years and $0.15
million (RMB 0.9 million) for the last 10 years. After 30 years, the units will be transferred to Datong at no additional charge.
On May 26, 2015, the 15MW WGPG system was completed.
Due
to the change of its strategic plan, Datong notified Xi’an TCH that it would not be able to fulfill its obligations under
the Cooperative Agreement and requested to repurchase the two 3MW BPRT systems and one 15MW WGPG system (the “Systems”)
from Xi’an TCH and terminate the Cooperative Agreement. On May 29, 2015, Xi’an TCH entered into a Repurchase Agreement
for the Recycling Economy Project with Datong. Under the Repurchase Agreement, Datong agreed to repurchase the Systems from
Xi’an TCH and pay outstanding energy saving service fees of RMB 1.2 million ($193,548) to Xi’an TCH within five business
days from the execution of the Repurchase Agreement. The Systems were transferred to Datong for a total price of RMB 250 million
($40.32 million) with RMB 100 million for two BPRT systems and RMB 150 million for one WGPG system. As of June 30, 2015, Xi’an
TCH received payment in full and the systems were transferred. The outstanding balance of net investment receivable at the date
of transfer was $13.37 million. The Company recorded a $2.98 million gain from two BPRT systems as non-operating income and a
$3.02 million gain from the WGPG system as gross profit from the sale .
Jitie
Power Generation Projects
In
May 2013, Xi’an TCH signed a contract with Sinosteel Jilin Ferroalloys Co., Ltd. (“Jitie”) to build furnace
gas WHPG systems for electricity generation from recycled heat and steam from groups of ferroalloy furnaces and electric furnaces
(the “Jitie Project”). According to the contract, Xi’an TCH installed a 7.5 MW and a 3 MW turbine power generation
system with a total of 10.5 MW power capacity for an estimated total investment of $9.71 million (RMB 60 million). The lease term
is 24 years. During the term of this lease, Jitie will pay a service fee to Xi’an TCH based on the actual generating capacity
with a minimum service fee per month of $300,000 (RMB 1.8 million). Xi’an TCH is responsible for the systems operation and
will own the power generation systems. In December 2013, the Jitie Project was completed and began operations.
On
June 18, 2015, Xi’an TCH entered into a WHPG system Repurchase Agreement with Jitie. Under the Repurchase Agreement, Jitie
repurchased the Jitie Project from Xi’an TCH and paid outstanding energy saving service fees of RMB 1.8 million ($294,599)
to Xi’an TCH within five business days from the execution of the Repurchase Agreement on June 18, 2015. The Jitie Project
was transferred to Jitie for a total price of RMB 90 million ($14.73 million). In July 2015, Xi’an TCH received payment
in full and the systems were transferred. The outstanding balance of net investment receivable on the date of the transfer was
$13.10 million. The Company recorded a $1.62 million gain from this transaction.
Yida
Coke Oven Gas Power Generation Projects
On
June 28, 2014, Xi’an TCH entered into an Asset Transfer Agreement (the “Transfer Agreement”) with Qitaihe City
BoliYida Coal Selection Co., Ltd. (“Yida”), a limited liability company incorporated in China. The Transfer Agreement
provided for the sale to Xi’an TCH of a 15 MW coke oven gas power generation station, which had been converted from a 15
MW coal gangue power generation station from Yida. As consideration for the Transfer Asset, Xi’an TCH was to pay to Yida
RMB 115 million ($18.69 million) in the form of the common stock shares of the Company at the average closing price per share
of the Stock for the 10 trading days prior to the closing date of the transaction ($2.27 per share). The exchange rate between
the US Dollar and Chinese RMB in connection with the stock issuance is the rate equal to the middle rate published by the People’s
Bank of China on the closing date of the assets transfer. Accordingly, the Company issued 8,233,779 shares (the “Shares”)
for the Yida 15 MW coke oven gas power generation station, the fair value of 8,233,779 shares was $14.49 million based on the
stock price at agreement date ($1.76 per share), and was the cost of the power generation station.
On
June 28, 2014, Xi’an TCH also entered into a Coke Oven Gas Power Generation Project Lease Agreement (the “Lease Agreement”)
with Yida. Under the Lease Agreement, Xi’an TCH leased the Transfer Asset to Yida for RMB 3 million ($0.49 million) per
month, and the term of the lease is from June 28, 2014 to June 27, 2029. Yida provided an RMB 3 million ($0.49 million) security
deposit (without interest) for the lease. Xi’an TCH will transfer the Transfer Asset back to Yida at no cost at the
end of the lease term.
On
June 22, 2016, Xi’an TCH entered into a Coal Oven Gas Power Generation Project Repurchase Agreement (the “Repurchase
Agreement”) with Yida. Under the Repurchase Agreement, Xi’an TCH agreed to transfer to Yida all the project assets
for consideration of RMB 112,000,000 ($16.89 million) (the “Transfer Price”) with Yida’s retention of ownership
of the Shares. Yida agreed to make the following payments: (i) the outstanding monthly leasing fees for April and May 2016 in
total of RMB 6,000,000 ($0.90 million) to Xi’an TCH within 5 business days from the execution of the Repurchase Agreement;
(ii) a payment of RMB 50,000,000 ($7.54 million) of the Transfer Price to Xi’an TCH within 5 business days from the execution
of the Repurchase Agreement; and (iii) a payment of the remaining RMB 62,000,000 ($9.35 million) of the Transfer Price to Xi’an
TCH within 15 business days from the execution of the Repurchase Agreement. Under the Repurchase Agreement, ownership of the project
assets will be transferred from Xi’an TCH to Yida within 3 business days after Xi’an TCH receives the full Transfer
Price and the outstanding monthly leasing fees. As of June 30, 2016, Xi’an TCH had received the outstanding monthly leasing
fees for April and May 2016 in the amount of $0.90 million and the first payment of the Transfer Price in the amount of $7.54
million. On July 11, 2016, the Company received the second payment of the Transfer Price in the amount of $9.35 million. The Company
recorded a $0.42 million loss from this transaction.
The
Fund Management Company
On
June 25, 2013, Xi’an TCH and HongyuanHuifu Venture Capital Co. Ltd. (“HongyuanHuifu”) jointly established Hongyuan
Recycling Energy Investment Management Beijing Co., Ltd. (the “Fund Management Company”) with registered capital
of RMB 10 million. Xi’an TCH made an initial capital contribution of RMB 4 million ($650,000) and has a 40% ownership interest
in the Fund Management Company. With respect to the Fund Management Company, voting rights and dividend rights are allocated 80%
and 20% between HongyuanHuifu and Xi’an TCH, respectively.
The
Fund Management Company serves as the general partner of Beijing Hongyuan Recycling Energy Investment Center, LLP (the “HYREF
Fund”), a limited liability partnership established on July 18, 2013 in Beijing. The Fund Management Company made an initial
capital contribution of RMB 5 million ($830,000) to the HYREF Fund. An initial total amount of RMB 460 million ($75 million) has
been fully subscribed by all partners for the HYREF Fund. The HYREF Fund has three limited partners: (1) China Orient Asset
Management Co., Ltd., which made an initial capital contribution of RMB 280 million ($46.67 million) to the HYREF Fund and is
a preferred limited partner; (2) HongyuanHuifu, which made an initial capital contribution of RMB 100 million ($16.67 million)
to the HYREF Fund and is an ordinary limited partner; and (3) the Company’s wholly-owned subsidiary, Xi’an TCH,
which made an initial capital contribution of RMB 75 million ($12.5 million) to the HYREF Fund and is a secondary limited partner.
The term of the HYREF Fund’s partnership is six years from the date of its establishment, expiring on July 18, 2019. The
term is three years from the date of contribution for the preferred limited partner, or four years from the date of contribution
for the ordinary limited partner. The total size of the HYREF Fund is RMB 460 million ($76.66 million). The HYREF Fund was formed
for the purpose of investing in Xi’an Zhonghong New Energy Technology Co., Ltd., a 90% owned subsidiary of Xi’an TCH,
for the construction of two coke dry quenching (“CDQ”) WHPG stations with Jiangsu Tianyu Energy and Chemical Group
Co., Ltd. (“Tianyu”) and one CDQ WHPG station with Boxing County Chengli Gas Supply Co., Ltd. (“Chengli”) .
Chengli
Waste Heat Power Generation Projects
On
July 19, 2013, Xi’an TCH formed a new company “Xi’an Zhonghong New Energy Technology Co., Ltd.” (“Zhonghong”)
with registered capital of RMB 30 million ($4.85 million). Xi’an TCH paid RMB 27 million ($4.37 million) and owns 90% of
Zhonghong. Zhonghong is engaged to provide energy saving solution and services, including constructing, selling and leasing energy
saving systems and equipment to customers.
On
July 24, 2013, Zhonghong entered into a Cooperative Agreement of CDQ and CDQ WHPG Project with Boxing County Chengli Gas Supply
Co., Ltd. (“Chengli”). The parties entered into a supplement agreement on July 26, 2013. Pursuant to these agreements,
Zhonghong will design, build and maintain a 25 MW CDQ system and a CDQ WHPG system to supply power to Chengli, and Chengli will
pay energy saving fees (the “Chengli Project”). Chengli will contract the operation of the system to a third party
contractor that is mutually agreed to by Zhonghong. In addition, Chengli will provide the land for the CDQ system and CDQ WHPG
system at no cost to Zhonghong. The term of the Agreements is for 20 years. The first 800 million watt hours generated by the
Chengli Project will be charged at RMB 0.42 ($0.068) per kilowatt hour (excluding tax); thereafter, the energy saving fee will
be RMB 0.20 ($0.036) per kilowatt hour (excluding tax). The operating time shall be based upon an average 8,000 hours annually.
If the operating time is less than 8,000 hours per year due to a reason attributable to Chengli, then time charged shall be 8,000
hours a year, and if it is less than 8,000 hours due to a reason attributable to Zhonghong, then it shall be charged at actual
operating hours. The construction of the Chengli Project was completed in the second quarter of 2015 and the project is currently
under commissioning tests which the Company expects to complete in the first quarter of 2017. When operations begin, Chengli shall
ensure its coking production line works properly and that working hours for the CDQ system are at least 8,000 hours per year,
and Zhonghong shall ensure that working hours and the CDQ WHPG system will be at least 7,200 hours per year.
On
July 22, 2013, Zhonghong entered into an Engineering, Procurement and Construction (“EPC”) General Contractor Agreement
for the Boxing County Chengli Gas Supply Co., Ltd. CDQ Power Generation Project (the “Huaxin Project”) with Xi’an
Huaxin New Energy Co., Ltd. (“Huaxin”). Zhonghong, as the owner of the Huaxin Project, contracted EPC services for
a CDQ system and a 25 MW CDQ WHPG system for Chengli to Huaxin. Huaxin shall provide construction, equipment procurement, transportation,
installation and adjustment, test run, construction engineering management and other necessary services to complete the Huaxin
Project and ensure the CDQ system and CDQ WHPG system for Chengli meet the inspection and acceptance requirements and work normally.
The Huaxin Project is a turn-key project where Huaxin is responsible for monitoring the quality, safety, duration and cost of
the project. The total contract price is RMB 200 million ($33.34 million), which includes all the materials, equipment, labor,
transportation, electricity, water, waste disposal, machinery and safety costs.
Tianyu
Waste Heat Power Generation Project
On
July 19, 2013, Zhonghong entered into a Cooperative Agreement (the “Tianyu Agreement”) for Energy Management of CDQ
and CDQ WHPG Project with Jiangsu Tianyu Energy and Chemical Group Co., Ltd. (“Tianyu”). Pursuant to the Tianyu Agreement,
Zhonghong will design, build, operate and maintain two sets of 25 MW CDQ systems and CDQ WHPG systems for two subsidiaries of
Tianyu – Xuzhou Tian’an Chemical Co., Ltd. (“Xuzhou Tian’an”) and Xuzhou Huayu Coking Co., Ltd (“Xuzhou
Huayu”) – to be located at Xuzhou Tian’an and Xuzhou Huayu’s respective locations (the “Tianyu Project”).
Upon completion of the Tianyu Project, Zhonghong will charge Tianyu an energy saving service 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. The term of the Tianyu Agreement is 20 years. The construction of the Xuzhou Tian’an Project
is anticipated to be completed in the first quarter of 2017. Xuzhou Tian’an will provide the land for the CDQ and CDQ WHPG systems
for free. Xuzhou Tian’an also guarantees 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. Xuzhou Huayu Coking Co., Ltd is working actively to resolve the conflict, and we will resume construction as soon as the
possible; however, if the conflict cannot be resolved, either Xuzhou Huayu Coking Co., Ltd or the local residents will be forced
to relocate. A relocation of Xuzhou Huayu Coking Co., Ltd would likely impact the Xuzhou Huayu Project.
On
July 22, 2013, Zhonghong entered into an EPC General Contractor Agreement for the Tianyu Project with Xi’an Huaxin New Energy
Co., Ltd. (“Huaxin”). Zhonghong, as the owner of the Tianyu Project, contracted EPC services for two CDQ systems and
two 25 MW CDQ WHPG systems for Tianyu to Huaxin. Huaxin shall provide construction, equipment procurement, transportation, installation
and adjustment, test run, construction engineering management and other necessary services to complete the Tianyu Project and
ensure the CDQ and CDQ WHPG systems for Tianyu meet the inspection and acceptance requirements and work normally. The Tianyu Project
is a turn-key project where Huaxin is responsible for monitoring the quality, safety, duration and cost of the project. The total
contract price is RMB 400 million ($66.68 million), which includes all the materials, equipment, labor, transportation, electricity,
water, waste disposal, machinery and safety costs.
Zhongtai
Waste Heat Power Generation Energy Management Cooperative Agreement
On
December 6, 2013, Xi’an entered into a CDQ and WHPG Energy Management Cooperative Agreement (the “Zhongtai Agreement”)
with Xuzhou Zhongtai Energy Technology Co., Ltd. (“Zhongtai”), a limited liability company incorporated in Jiangsu
Province, China.
Pursuant
to the Zhongtai Agreement, Xi’an TCH will design, build and maintain a 150 ton per hour CDQ system and a 25 MW CDQ WHPG
system and sell the power to Zhongtai, and Xi’an TCH will also build a furnace to generate steam from the waste heat of
the smoke pipeline and sell the steam to Zhongtai.
The
construction period of the Project is expected to be 18 months from the date when conditions are ready for construction to begin.
Zhongtai will start to pay an energy saving service fee from the date when the WHPG station passes the required 72-hour test run.
The payment term is 20 years. For the first 10 years, Zhongtai shall pay an energy saving service fee at RMB 0.534 ($0.089) per
kilowatt hour (including value added tax) for the power generated from the system. For the second 10 years, Zhongtai shall pay
an energy saving service fee at RMB 0.402 ($0.067) per kilowatt hour (including value added tax). During the term of the contract
the energy saving service 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 Agreement will be extended accordingly.
If Zhongtai wants to terminate the Zhongtai Agreement early, it shall provide Xi’an TCH a 60 day notice and pay the termination
fee and compensation for the damages to Xi’an TCH according to the following formula: (1) if it is less than five years
into the term when Zhongtai requests termination, Zhongtai shall pay: Xi’an TCH’s total investment amount plus Xi’an
TCH’s annual investment return times five years minus the years in which the system has already operated); or 2) if it is
more than five years into the term when Zhongtai requests the termination, Zhongtai shall pay: Xi’an TCH’s total investment
amount minus total amortization cost (the amortization period is 10 years).
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. Xi’an Huaxin will continue to construct and complete the Project and Xi’an TCH agreed to
transfer all its rights and obligation under the “EPC” Contract to Zhongtai. As consideration for the transfer of
the Project, Zhongtai agreed to pay to Xi’an TCH an aggregate transfer price of RMB 167,360,000 ($25.77 million) including
payments of: (i) RMB 152,360,000 ($23.46 million) for the construction of the Project; and (ii) RMB 15,000,000 ($2.31 million)
as payment for partial loan interest accrued during the construction period. Those amounts have been, or will be, paid by Zhongtai
to Xi’an TCH according to the following schedule: (a) RMB 50,000,000 ($7.70 million) was paid within 20 business days after
the Transfer Agreement was signed; (b) RMB 30,000,000 ($4.62 million) will be paid within 20 business days after the Project is
completed, but no later than July 30, 2016 ; and (c) RMB 87,360,000 ($13.45 million) will be paid no later than July 30,
2017. Xuzhou Taifa Special Steel Technology Co., Ltd. (“Xuzhou Taifa”) has guaranteed the payments from Zhongtai to
Xi’an TCH. The ownership of the Project was conditionally transferred to Zhongtai following the initial payment of RMB 50,000,000
($7.70 million) by Zhongtai to Xi’an TCH and the full ownership of the Project will be officially transferred to Zhongtai
after it completes all payments pursuant to the Transfer Agreement. As of September 30, 2016, Xi’an TCH had received the
first payment of $7.70 million. As of the date of this report, the Company has not yet received the second payment of $4.62 million
due to adverse market conditions. The Company recorded a $2.82 million loss from this transaction.
Rongfeng
CDQ Power Generation Energy Management Cooperative Agreement
On
December 12, 2013, Xi’an TCH entered into a CDQ Power Generation Energy Management Cooperative Agreement with Tangshan Rongfeng
Iron & Steel Co., Ltd. (the “Rongfeng Agreement”), a limited liability company incorporated in Hebei Province,
China.
Pursuant
to the Rongfeng Agreement, Xi’an TCH will design, build and maintain a CDQ and a CDQ WHPG system and sell the power to Rongfeng.
The construction period of the Project is expected to be 18 months after the Agreement takes effect and from the date when conditions
are ready for construction to begin.
Rongfeng
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, Rongfeng shall pay an energy saving service fee at RMB 0.582 ($0.095) per kilowatt hour
(including tax) for the power generated from the system. For the second 10 years, Rongfeng shall pay an energy saving service
fee at RMB 0.432 ($0.071) per kWh (including tax). During the term of the contract the energy saving service fee shall be adjusted
at the same percentage as the change of local grid electricity price. Rongfeng and its parent company will provide guarantees
to ensure Rongfeng will fulfill its obligations under the Rongfeng Agreement. Upon the completion of the term, Xi’an TCH
will transfer the systems to Rongfeng at RMB 1. Rongfeng shall provide waste heat to the systems for no less than 8,000 hours
per year with a temperature no less than 950°C. If these requirements are not met, the term of the Agreement will be extended
accordingly. If Rongfeng wants to terminate the Agreement early, it shall provide Xi’an TCH a 60 day notice and pay the
termination fee and compensation for the damages to Xi’an TCH according to the following formula: 1) if it is less than
five years (including five years) into the term when Rongfeng requests termination, Rongfeng shall pay: Xi’an TCH’s
total investment amount plus Xi’an TCH’s average annual investment return times (five years minus the years of which
the system has already operated); 2) if it is more than five years into the term when Rongfeng requests the termination, Rongfeng
shall pay: Xi’an TCH’s total investment amount minus total amortization cost (the amortization period is 10 years).
On
November 16, 2015, Xi’an TCH entered into a Transfer Agreement of CDQ and a CDQ WHPG system with Rongfeng and Xi’an
Huaxin New Energy Co., Ltd., a limited liability company incorporated in China (“Xi’an Huaxin”). The Transfer
Agreement provided for the sale to Rongfeng of the CDQ Waste Heat Power Generation Project (the “Project”) from Xi’an
TCH. Additionally, Xi’an TCH would transfer to Rongfeng 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. As consideration for the transfer of the Project, Rongfeng is to pay to Xi’an TCH an aggregate purchase
price of RMB 165,200, 000 ($25.45 million), whereby (a) RMB 65,200,000 ($10.05 million) was to be paid by Rongfeng to Xi’an
TCH within 20 business days after signing the Transfer Agreement, (b) RMB 50,000,000 ($7.70 million) is to be paid by Rongfeng
to Xi’an TCH within 20 business days after the Project is completed, but no later than March 31, 2016 and (c) RMB 50,000,000
($7.70 million) will be paid by Rongfeng to Xi’an TCH no later than September 30, 2016. Mr. Cheng Li, the largest stockholder
of Rongfeng, has personally guaranteed the payments. The ownership of the Project was conditionally transferred to Rongfeng within
3 business days following the initial payment of RMB 65,200,000 ($10.05 million) by Rongfeng to Xi’an TCH and the full ownership
of the Project will be officially transferred to Rongfeng after it completes the entire payment pursuant to the Transfer Agreement.
As of December 31, 2015, Xi’an TCH had received the first payment of $10.05 million, and on April 6, 2016, the second payment
of $7.70 million was received. The Company recorded a $3.78 million loss from this transaction in 2015. As of the date of
this report, the Company has not yet received the third payment of $7.70 million.
Baoliyuan
CDQ Power Generation Energy Management Cooperative Agreement
On
March 26, 2014, Xi’an TCH entered into a CDQ Waste Heat Recycling Project Energy Management Cooperative Agreement with Tangshan
Baoliyuan Coking Co., Ltd. (“Baoliyuan”), a limited liability company incorporated in Hebei Province, China.
Pursuant
to the Agreement, Xi’an TCH agreed to design, build and maintain a CDQ and a CDQ WHPG system and sell the power to Baoliyuan
(the “CDQ Project”) and Xi’an TCH will also build a high scale waste water treatment system for Baoliyuan and
charge monthly payments for two years (the “Waste Water Treatment Project”).
Baoliyuan
agreed to pay an energy saving fee from the date when the WHPG station passed the required 72-hour test run. The payment term
was twenty years and Baoliyuan agreed to pay an energy saving fee at RMB 0.7 ($0.114) per kilowatt hour (including tax) for the
power generated from the system, from which Xi’an TCH shall take 92.86% and Baoliyuan was to take 7.14% as parties to share
the energy saving benefits. During the term of the contract the energy saving fee was to be adjusted at the same percentage as
the change of local grid electricity price. Baoliyuan was to provide guarantees to ensure it would fulfill its obligations under
the Agreement. Upon the completion of the term, Xi’an TCH was to transfer the systems to Baoliyuan at RMB 1.
Baoliyuan
was to provide waste heat to the systems for no less than 8,000 hours per year and coking production was to reach 80% of its capacity.
If these requirements were not met, the energy saving fee was to be calculated according to such hours and capacity.
Baoliyuan
could terminate the Agreement prior to the end of the term by providing Xi’an TCH with 60 days’ notice and upon the
payment of the termination fee and compensation for the damages to Xi’an TCH according to the following formula: 1) if it
was less than five years (including five years) into the term when Baoliyuan requested termination, Baoliyuan was to pay Xi’an
TCH’s total investment amount plus Xi’an TCH’s average annual investment return times (five years minus the
years of which the system had already operated); 2) if it was more than five years into the term when Baoliyuan requested the
termination, Baoliyuan was to pay Xi’an TCH’s total investment amount minus total amortization cost (the amortization
period is twenty years).
From
the first month of the completion of Waste Water Treatment Project, Baoliyuan was to pay a fixed monthly fee for the waste water
treatment system at RMB 1.05 million per month ($171,010) for the first 12 months and RMB 940,000 per month ($153,094) for the
next 12 months.
The
Baoliyuan project was cancelled in May 2015 because the project required blasting and leveling of a mountain and Baoliyuan could
not obtain all the necessary permits for the construction from the local government due to environmental concerns of the government.
Formation
of Zhongxun
On
March 24, 2014, Xi’an TCH incorporated a new subsidiary, Zhongxun Energy Investment (Beijing) Co., Ltd (“Zhongxun”)
with registered capital of $5,695,502 (RMB 35,000,000). Zhongxun is 100% owned by Xi’an TCH and is mainly engaged in project
investment, investment management, economic information consulting, and technical services.
Formation
of Yinghua
On
February 11, 2015, the Company incorporated a new subsidiary, Shanghai Yinghua Financial Leasing Co., Ltd (“Yinghua”)
with registered capital of $30,000,000, to be paid within two years from the date the business license is issued. Yinghua is 100%
owned by the Company and is 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.
Summary
of Sales-Type Lease at September 30, 2016
Status
at September 30, 2016
As
of September 30, 2016, Xi’an TCH leases the following systems: (i) BMPG systems to Pucheng Phase I and II (15 and 11
year terms, respectively); (ii) BMPG systems to Shenqiu Phase I (11-year term); and (iii) Shenqiu Phase II (9.5-year
term). In addition, as of September 30, 2016, Erdos TCH leased power and steam generating systems from waste heat from metal refining
to Erdos (five systems) for a term of 20 years.
Asset
Repurchase Agreement
During
the year ended December 31, 2015 and the period ended September 30, 2016, the Company entered into the following Asset Repurchase
Agreements:
On
May 29, 2015, Xi’an TCH entered into a Repurchase Agreement for the Recycling Economy Project with Datong. Under the Repurchase
Agreement, Datong agreed to repurchase the two 3MW Blast Furnace Power Recovery Turbine (the “BPRT”) systems and one
15MW WGPG system (the “Systems”) from Xi’an TCH and pay outstanding energy saving service fees of RMB 1.2 million
($193,548) to Xi’an TCH within five business days from the execution of the Repurchase Agreement. The Systems would be transferred
to Datong for a total price of RMB 250 million ($40.32 million) with RMB 100 million for two BPRT systems and RMB 150 million
($24.54 million) for one WGPG system. Datong paid the repurchase price to Xi’an TCH and, as of June 30, 2015, the systems
were transferred. The outstanding balance of net investment receivable on the date of transfer was $13.37 million. The Company
recorded a $2.98 million gain from two BPRT systems as non-operating income and a $3.02 million gain from the WGPG system as gross
profit from the sale.
On
June 18, 2015, Xi’an TCH entered into a WHPG system Repurchase Agreement with Jitie. Under the Repurchase Agreement, Jitie
agreed to repurchase the Jitie Project from Xi’an TCH and pay outstanding energy saving service fees of RMB 1.8 million
($294,599) to Xi’an TCH within five business days from the execution of the Repurchase Agreement on June 18, 2015. The Jitie
Project would be transferred to Jitie for a total price of RMB 90 million ($14.73 million), and Jitie agreed to pay RMB 45 million
within five business days from the execution of the Repurchase Agreement and pay another RMB 45 million within 15 business days
from the execution of the Repurchase Agreement. As of June 30, 2015, Xi’an TCH received payment in full and the systems
were transferred. The outstanding balance of net investment receivable at date of transfer was $13.10 million. The Company recorded
a $1.62 million gain from this transaction.
On
November 16, 2015, Xi’an TCH entered into a Transfer Agreement of CDQ and a CDQ WHPG system with Rongfeng and Xi’an
Huaxin New Energy Co., Ltd., a limited liability company incorporated in China (“Xi’an Huaxin”). The Transfer
Agreement provided for the sale to Rongfeng of the CDQ Waste Heat Power Generation Project (the “Project”) from Xi’an
TCH. Additionally, Xi’an TCH agreed to transfer to Rongfeng 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. As consideration for the transfer of the Project, Rongfeng will pay to Xi’an TCH an aggregate purchase
price of RMB 165,200, 000 ($25.45 million), whereby (a) RMB 65,200,000 ($10.05 million) will be paid by Rongfeng to Xi’an
TCH within 20 business days after the Transfer Agreement is signed, (b) RMB 50,000,000 ($7.70 million) will be paid by Rongfeng
to Xi’an TCH within 20 business days after the Project is completed, but no later than March 31, 2016 and (c) RMB 50,000,000
($7.70 million) will be paid by Rongfeng to Xi’an TCH no later than September 30, 2016. Mr. Cheng Li, the largest stockholder
of Rongfeng, has personally guaranteed the payments. The ownership of the Project was conditionally transferred to Rongfeng within
3 business days following the initial payment of RMB 65,200,000 ($10.05 million) by Rongfeng to Xi’an TCH and the full ownership
of the Project will be officially transferred to Rongfeng after it completes the entire payment pursuant to the Transfer Agreement.
As of September 30, 2016, Xi’an TCH received the first payment of $10.05 million and the second payment of $7.70 million.
The Company recorded a $3.78 million loss from this transaction. As of the date of this report, the Company has not yet received
the third payment of $7.70 million.
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. Xi’an Huaxin will continue to construct and complete the Project and Xi’an TCH agreed to
transfer all its rights and obligation under the “EPC” Contract to Zhongtai. As consideration for the transfer of
the Project, Zhongtai agreed to pay to Xi’an TCH an aggregate transfer price of RMB 167,360,000 ($25.77 million) including
payments of: (i) RMB 152,360,000 ($23.46 million) for the construction of the Project; and (ii) RMB 15,000,000 ($2.31 million)
as payment for partial loan interest accrued during the construction period. Those amounts have been, or will be, paid by Zhongtai
to Xi’an TCH according to the following schedule: (a) RMB 50,000,000 ($7.70 million) was paid within 20 business days after
the Transfer Agreement was signed; (b) RMB 30,000,000 ($4.62 million) will be paid within 20 business days after the Project is
completed, but no later than July 30, 2016; and (c) RMB 87,360,000 ($13.45 million) will be paid no later than July 30, 2017.
Xuzhou Taifa Special Steel Technology Co., Ltd. (“Xuzhou Taifa”) has guaranteed the payments from Zhongtai to Xi’an
TCH. The ownership of the Project was conditionally transferred to Zhongtai following the initial payment of RMB 50,000,000 ($7.70
million) by Zhongtai to Xi’an TCH and the full ownership of the Project will be officially transferred to Zhongtai after
it completes all payments pursuant to the Transfer Agreement. As of September 30, 2016, Xi’an TCH had received the first
payment of $7.70 million. As of this report date, the Company has not yet received the second payment of $4.62 million. The Company
recorded a $2.82 million loss from this transaction.
On
June 22 2016, Xi’an TCH entered into a Coal Oven Gas Power Generation Project Repurchase Agreement (the “Repurchase
Agreement”) with Yida. Under the Repurchase Agreement, Xi’an TCH agreed to transfer to Yida all the project assets
for consideration of RMB 112,000,000 ($16.89 million) (the “Transfer Price”) with Yida’s retention of ownership
of the Shares. Yida agreed to make the following payments: (i) the outstanding monthly leasing fees for April and May 2016 in
total of RMB 6,000,000 ($0.90 million) to Xi’an TCH within 5 business days from the execution of the Repurchase Agreement;
(ii) a payment of RMB 50,000,000 ($7.54 million) of the Transfer Price to Xi’an TCH within 5 business days from the execution
of the Repurchase Agreement; and (iii) a payment of the remaining RMB 62,000,000 ($9.35 million) of the Transfer Price to Xi’an
TCH within 15 business days from the execution of the Repurchase Agreement. Under the Repurchase Agreement, ownership of the project
assets will be transferred from Xi’an TCH to Yida within 3 business days after Xi’an TCH receives the full Transfer
Price and the outstanding monthly leasing fees. As of September 30, 2016, Xi’an TCH had received the outstanding monthly
leasing fees for April and May 2016 in the amount of $0.90 million and the first payment of the Transfer Price in the amount of
$7.54 million. On July 11, 2016, the Company received the second payment of the Transfer Price in the amount of $9.35 million.
The Company recorded a $0.42 million loss from this transaction.
Reverse
Stock Split
On
May 24, 2016, the Company filed a Certificate of Change with the Secretary of State of Nevada with an effective date of May 25,
2016 (the “Effective Date”), at which time a 1-for-10 reverse stock split of the Company’s authorized shares
of common stock, par value $0.001 (the “Common Stock”), accompanied by a corresponding decrease in the Company’s
issued and outstanding shares of Common Stock (the “Reverse Stock Split”), shall be effected.
The
Company has rounded up to the next full share of the Company’s Common Stock any fractional shares resulting from the Reverse
Stock Split. The reverse stock split was retroactively stated for the periods covered by the financial statements included herein.
2. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
Basis
of Presentation
The
unaudited financial statements included herein were prepared by the Company, pursuant to the rules and regulations of
the Securities and Exchange Commission (“SEC”). The information furnished herein reflects all adjustments (consisting
of normal recurring accruals and adjustments) that are, in the opinion of management, necessary to fairly present the operating
results for the respective periods. Certain information and footnote disclosures normally present in annual financial statements
prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) were
omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the audited financial
statements and footnotes included in the Company’s 2015 audited financial statements included in the Company’s
Annual Report on Form 10-K. The results for the nine months ended September 30, 2016 are not necessarily indicative of the
results expected for the full year ending December 31, 2016.
Basis
of Consolidation
The
consolidated financial statements include the accounts of CREG and its subsidiaries, Shanghai Yinghua Financial Leasing Co., Ltd.
(“Yinghua”) and Sifang Holdings, its wholly owned subsidiaries, Huahong New Energy Technology Co., Ltd. (“Huahong”)
and Shanghai TCH, Shanghai TCH’s wholly-owned subsidiary, Xi’an TCH Energy Tech Co., Ltd. (“Xi’an TCH”)
and Xi’an TCH’s subsidiaries, Erdos TCH Energy Saving Development Co., Ltd (“Erdos TCH”), 100% owned by
Xi’an TCH (See note 1), Zhonghong, 90% owned by Xi’an TCH, and Zhongxun, 100% owned by Xi’an TCH. Substantially
all 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, 2016 and December 31, 2015, respectively. All
significant inter-company accounts and transactions were eliminated in consolidation.
Use
of Estimates
In
preparing these consolidated financial statements in accordance with US GAAP, management makes estimates and assumptions that
affect the reported amounts of assets and liabilities in the balance sheets as well as revenues and expenses during the period
reported. Actual results may differ from these estimates.
Revenue
Recognition
Sales-type
Leasing and Related Revenue Recognition
The
Company constructs and leases waste energy recycling power generating projects to its customers. The Company typically transfers
ownership of the waste energy recycling power generating projects to its customers at the end of the lease. The investment
in these projects is recorded as investment in sales-type leases in accordance with Financial Accounting Standards Board (“FASB”)
Accounting Standards Codification (“ASC”) Topic 840
, “Lease
s
,”
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 income is amortized to income over the lease term to
produce a constant periodic rate of return on net investment in the lease. While revenue is recognized at the inception of
the lease, the cash flow from the sales-type lease occurs over the course of the lease, which results in interest income and reduction
of receivables. Revenue is recognized net of sales tax.
Contingent
Rental Income
The
Company records income from actual electricity usage in addition to minimum lease payments of each project as contingent rental
income in the period contingent rental income is earned. Contingent rent is not part of minimum lease payments.
Cash
and Equivalents
Cash
and equivalents includes cash on hand, demand deposits placed with banks or other financial institutions and all highly liquid
investments with an original maturity of three months or less as of the purchase date of such investments.
Accounts
Receivable
As
of September 30, 2016, the Company had accounts receivable of $25,062,146 (mainly from sale of CDQ and a CDQ WHPG system to Rongfeng
and sale of CDQ and a CDQ WHPG system to Zhongtai) . As of December 31, 2015, the Company had accounts receivable of $15,399,778
(mainly from sale of CDQ and a CDQ WHPG system to Rongfeng), respectively.
Property
and Equipment
Property
and equipment are stated at cost, net of accumulated depreciation. Expenditures for maintenance and repairs are expensed as incurred;
additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related
cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation
of property and equipment is provided using the straight-line method over the estimated lives as follows:
Building
|
|
|
20 years
|
|
Vehicles
|
|
|
2 - 5 years
|
|
Office and Other Equipment
|
|
|
2 - 5 years
|
|
Software
|
|
|
2 - 3 years
|
|
Impairment
of Long-lived Assets
In
accordance with FASB ASC Topic 360,
“Property, Plant, and Equipment
,” the Company reviews its long-lived
assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying
amounts of the assets may not be fully recoverable. If the total expected undiscounted future net cash flows is less than the
carrying amount of the asset, a loss is recognized for the difference between the fair value and carrying amount of the asset.
There was no impairment as of September 30, 2016 and December 31, 2015.
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.
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.
Fair
Value of Financial Instruments
For
certain of the Company’s financial instruments, including cash and equivalents, restricted cash, accounts receivable, other
receivables, accounts payable, accrued liabilities and short-term debts, the carrying amounts approximate their fair values due
to their short maturities. Receivables on sales-type leases are based on interest rates implicit in the lease.
FASB
ASC Topic 820,
“Fair Value Measurements and Disclosures,”
requires disclosure of the fair value (“FV”)
of financial instruments held by the Company. FASB ASC Topic 825,
“Financial Instruments,”
defines
FV, and establishes a three-level valuation hierarchy for disclosures of FV measurement that enhances disclosure requirements
for FV measures. The carrying amounts reported in the consolidated balance sheets for receivables and current liabilities
each qualify as financial instruments and are a reasonable estimate of their FV because of the short period of time between the
origination of such instruments and their expected realization and their current market rate of interest. The three levels of
valuation hierarchy are defined as follows:
|
●
|
Level
1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
|
|
●
|
Level
2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs
that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial
instrument.
|
|
●
|
Level
3 inputs to the valuation methodology are unobservable and significant to FV measurement.
|
The
Company analyzes all financial instruments with features of both liabilities and equity under ASC 480,
“Distinguishing
Liabilities from Equity,”
and ASC 815,
“Derivatives and Hedging.”
The
following are the considerations with respect to disclosures of FV of long-term debt obligations:
As
of September 30, 2016, the Company’s long-term debt obligations consisted of the Zhonghong entrusted loan of $49.72 million.
As of December 31, 2015, the Company’s long-term debt obligations consisted of the following: (i) various long-term bank
loans and Zhongrong International Trust Co., Ltd. (“ZRIT”) trust loan payable of $18.19 million, and (ii) Zhonghong
entrusted loan of $58.83 million.
FV
measurements and approximations for certain financial instruments are based on what a reporting entity would likely have to pay
to transfer the financial obligation to an entity with a comparable credit rating. The Company’s bank loans and trust loans
payable are privately held (i.e., nonpublic) debt; therefore, pricing inputs are not observable. For this reason, the Company
classified bank loans and trust loans payable as a Level 3 FV measurement in the valuation hierarchy.
For
the Company’s long-term bank loans, ZRIT trust loan and Zhonghong entrusted loans noted above, the Company believes the
carrying amounts approximate their FV. Based on the Company’s understanding of the credit markets, the Company’s business
is in a sector (energy-saving green) that is supported by the PRC government and the lending bank, the Company believes it could
have obtained similar loans on similar terms and interest rates. In addition, in connection with the FV measurement, the Company
considered nonperformance risk (including credit risk) relating to the debt obligations, including the following: (i) the Company
is considered a low credit risk customer to the lending bank and its creditors; (ii) the Company has a good history of making
timely payments and have never defaulted on any loans; and (iii) the Company has a stable and continuous cash inflow from collections
from its sales-type lease of energy saving projects.
As
of September 30, 2016 and December 31, 2015, the Company did not identify any assets or liabilities that are required to be presented
on the balance sheet at FV.
Stock-Based
Compensation
The
Company accounts for its stock-based compensation in accordance with FASB ASC Topic 718
“Compensation—Stock
Compensation,”
and FASB ASC Topic 505, “
Equity.”
The Company recognizes in its statement
of operations FV at the grant date for stock options and other equity-based compensation issued to employees and non-employees.
Basic
and Diluted Earnings per Share
The
Company presents net income (loss) per share (“EPS”) in accordance with FASB ASC Topic 260,
“Earning
Per Share.”
Accordingly, basic income (loss) per share is computed by dividing income (loss) available to common
stockholders by the weighted average number of shares outstanding, without consideration for common stock equivalents. Diluted
EPS is computed by dividing the net income by the weighted-average number of common shares outstanding as well as common share
equivalents outstanding for the period determined using the treasury-stock method for stock options and warrants and the if-converted
method for convertible notes. The Company made an accounting policy election to use the if-converted method for convertible
securities that are eligible to receive common stock dividends, if declared. Diluted EPS reflect the potential dilution
that could occur based on the exercise of stock options or warrants or conversion of convertible securities using the if-converted
method.
The
following table presents a reconciliation of basic and diluted EPS for the nine and three months ended September 30, 2016 and
2015:
|
|
Nine Months Ended
September 30,
|
|
|
Three Months Ended
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Net income
|
|
$
|
2,977,791
|
|
|
$
|
18,681,506
|
|
|
$
|
536,839
|
|
|
$
|
3,266,591
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding – basic
|
|
|
8,310,198
|
|
|
|
8,308,019
|
|
|
|
8,310,198
|
|
|
|
8,308,404
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding – diluted
|
|
|
8,310,198
|
|
|
|
8,308,019
|
|
|
|
8,310,198
|
|
|
|
8,308,404
|
|
Earnings per share – basic
|
|
$
|
0.36
|
|
|
$
|
2.25
|
|
|
$
|
0.06
|
|
|
$
|
0.39
|
|
Earnings per share – diluted
|
|
$
|
0.36
|
|
|
$
|
2.25
|
|
|
$
|
0.06
|
|
|
$
|
0.39
|
|
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 uses 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 financial statements as substantially all of the Company’s operations are conducted in
one industry segment. All of the Company’s assets are located in the PRC.
New
Accounting Pronouncements
In
February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842). The guidance in ASU 2016-02 supersedes
the lease recognition requirements in ASC Topic 840, Leases (FAS 13). ASU 2016-02 requires an entity to recognize assets and liabilities
arising from a lease for both financing and operating leases, along with additional qualitative and quantitative disclosures.
ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently
evaluating the effect this standard will have on its Consolidated Financial Statements.
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 consolidated financial statements.
3.
RESTRICTED CASH
Restricted
cash is held by the banks as collateral to issue bank acceptances and bank loans. The Company endorses bank acceptances to
vendors as payment of its obligations. Most of the bank acceptances have maturities of less than six months. As of September
30, 2016 and December 31, 2015, the Company had restricted cash of $0 and $1.13 million.
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) Shenqiu Phase II (9.5-year term).
In addition, as of September 30, 2016, Erdos TCH leased power and steam generating systems from waste heat from metal refining
to Erdos (five systems) for a term of twenty years. The components of the net investment in sales-type leases as of September
30, 2016 and December 31, 2015 are as follows:
|
|
2016
|
|
|
2015
|
|
Total future minimum lease payments receivable
|
|
$
|
248,196,665
|
|
|
$
|
387,612,418
|
|
Less: executory cost
|
|
|
(70,089,703
|
)
|
|
|
(93,054,738
|
)
|
Less: unearned interest income
|
|
|
(61,430,134
|
)
|
|
|
(154,799,027
|
)
|
Investment in sales-type leases, net
|
|
|
116,676,828
|
|
|
|
139,758,653
|
|
Current portion
|
|
|
6,948,365
|
|
|
|
6,679,019
|
|
Noncurrent portion
|
|
$
|
109,728,463
|
|
|
$
|
133,079,634
|
|
As
of September 30, 2016, the future minimum rentals to be received on non-cancelable sales-type leases by years are as follows:
2017
|
|
$
|
25,907,888
|
|
2018
|
|
|
19,977,407
|
|
2019
|
|
|
20,284,586
|
|
2020
|
|
|
21,647,694
|
|
2021
|
|
|
23,317,982
|
|
Thereafter
|
|
|
137,061,108
|
|
Total
|
|
$
|
248,196,665
|
|
5. PREPAID
EXPENSES
Prepaid
expenses mainly consisted of prepayment for office rental and decorations, taxes, and consulting fees for the Company’s
HYREF fund completed in July 2013. Before the HYREF Fund released the money to Zhonghong, Xi’an TCH paid 2% of the funds
raised for Zhonghong, i.e. RMB 9.2 million ($1.5 million) to the Fund Management Company as a consulting fee and it shall pay
such 2% on the amount of funds actually contributed as an annual management fee on every 365-day anniversary thereafter until
Zhonghong fully repays the loan, and the HYREF Fund no longer has an ownership interest in Zhonghong. The Company had $1.15 million
and $0.83 million prepaid consulting expense as of September 30, 2016 and December 31, 2015, respectively. During the third quarter
of 2016, the Company prepaid RMB 9.2 million ($1.38 million) consulting fee. The Company had $0 and $0.30 million prepaid tax
as of September 30, 2016 and December 31, 2015.
6. OTHER
RECEIVABLES
As
of September 30, 2016, other receivables mainly consisted of (i) advance to third parties of $0.35 million, bearing no interest,
payable upon demand; (ii) advances to employees of $0.03 million, bearing no interest, payable upon demand; and (iii) maintenance
cost and tax receivable of $0.49 million. As of December 31, 2015, other receivables mainly consisted of advance to third party
of $0.05 million, bearing no interest, payable upon demand; advance to employees of $0.04 million, bearing no interest, payable
upon demand; and maintenance cost and tax receivable of $0.47 million.
7.
LONG TERM INVESTMENT
On
June 25, 2013, Xi’an TCH with HongyuanHuifu Venture Capital Co. Ltd (“HongyuanHuifu”) jointly established Hongyuan
Recycling Energy Investment Management Beijing Co., Ltd (the “Fund Management Company”) with registered capital of
RMB 10 million ($1.6 million), to manage a fund that will be used for financing CDQ WHPG projects. Xi’an TCH made an initial
capital contribution of RMB 4 million ($0.65 million) and has a 40% ownership interest in the Fund Management Company. Voting
rights and dividend rights are allocated between HongyuanHuifu and Xi’an TCH at 80% and 20%, respectively. The Company accounted
for this investment using the equity method. The Company recorded $154,570 and $48,595 equity based investment income during the
nine and three months ended September 30, 2016; however, it was eliminated with the financial fee of Zhonghong for the Statement
of Income as 100% of Fund Management Company’s revenue is from Zhonghong’s financial fee and Zhonghong is 91.7% owned
by Xi’an TCH (see Note 12). Xi’an TCH paid a $1.6 million one-time commission (recorded as other expense) to the Fund
Management Company during 2013 for initiating and completing the Fund financing for the Company.
On
July 18, 2013, the HYREF Fund was established as a limited liability partnership in Beijing. Pursuant to the Partnership Agreement,
the HYREF Fund has a general partner, the Fund Management Company, which made an initial capital contribution of RMB 5 million
($0.83 million) to the HYREF Fund. The HYREF Fund has three limited partners: (1) China Orient Asset Management Co., Ltd., which
made an initial capital contribution of RMB 280 million ($46.67 million) and is a preferred limited partner, (2) HongyuanHuifu,
which made an initial capital contribution of RMB 100 million ($16.67 million) and is an ordinary limited partner and (3) the
Company’s wholly-owned subsidiary, Xian TCH, which made an initial capital contribution of RMB 75 million ($12.5 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 the preferred limited partner is three years from the date of its contribution and for the ordinary
limited partner is four years from the date of its contribution. Unless otherwise approved by the general partner (the Fund Management
Company), upon the expiration of their respective terms, each partner shall exit from the partnership automatically . The
total size of the HYREF Fund is RMB 460 million ($75.0 million), and the purpose of the HYREF Fund is to invest in Zhonghong for
constructing 3 new CDQ WHPG projects. Xi’an TCH owns 16.3% of the HYREF Fund. The Company accounted for this investment
using the cost method. The Company netted off the investment of RMB 75 million ($12.2 million) by Xi’an TCH with the entrusted
loan payable of the HYREF Fund by Xi’an TCH in the amount of $49.72 million.
8.
CONSTRUCTION IN PROGRESS
Construction
in progress was for constructing power generation systems. As of September 30, 2016 and December 31, 2015, the Company’s
construction in progress included:
|
|
2016
|
|
|
2015
|
|
Xuzhou Zhongtai
|
|
|
-
|
|
|
|
28,100,201
|
|
Xuzhou Huayu
|
|
|
29,633,538
|
|
|
|
29,752,270
|
|
Xuzhou Tian’an
|
|
|
28,469,454
|
|
|
|
26,909,193
|
|
Boxing County Chengli
|
|
|
30,900,260
|
|
|
|
30,760,404
|
|
Total
|
|
$
|
89,003,252
|
|
|
$
|
115,522,068
|
|
As
of September 30, 2016, the Company was committed to pay an additional (1) $7.49 million for Xuzhou Huayu project, (2) $8.65 million
for Xuzhou Tian’an project, and (3) $5.40 million for Boxing County Chengli project.
9. TAXES
PAYABLE
Taxes
payable consisted of the following as of September 30, 2016 and December 31, 2015:
|
|
2016
|
|
|
2015
|
|
Income
|
|
$
|
165,396
|
|
|
$
|
405,431
|
|
Business
|
|
|
-
|
|
|
|
249,141
|
|
VAT
|
|
|
638,899
|
|
|
|
369,595
|
|
Other
|
|
|
50,134
|
|
|
|
34,250
|
|
Total
|
|
$
|
854,429
|
|
|
$
|
1,058,417
|
|
10. ACCRUED
LIABILITIES AND OTHER PAYABLES
Accrued
liabilities and other payables consisted of the following as of September 30, 2016 and December 31, 2015:
|
|
2016
|
|
|
2015
|
|
Employee
training, labor union expenditure and social insurance payable
|
|
$
|
729,244
|
|
|
$
|
749,930
|
|
Consulting,
auditing, and legal expenses
|
|
|
1,841,927
|
|
|
|
1,342,395
|
|
Accrued
payroll and welfare
|
|
|
271,522
|
|
|
|
278,819
|
|
Accrued
interest expense
|
|
|
1,182
|
|
|
|
682,949
|
|
Other
|
|
|
6,777
|
|
|
|
145,302
|
|
Total
|
|
$
|
2,850,652
|
|
|
$
|
3,199,395
|
|
11. DEFERRED
TAX LIABILITY, NET
Deferred
tax asset resulted from accrued employee social insurance that can be deducted for tax purposes in the future, and the difference
between tax and accounting basis of cost of fixed assets which was capitalized for tax purposes and expensed as part of cost of
systems in accordance with US GAAP. Deferred tax liability arose from the difference between tax and accounting basis of net investment
in sales-type leases.
As
of September 30, 2016 and December 31, 2015, deferred tax liability consisted of the following:
|
|
2016
|
|
|
2015
|
|
Deferred tax asset — current (accrual of employee social insurance)
|
|
$
|
159,431
|
|
|
$
|
98,372
|
|
Deferred tax liability — current (net investment in sales-type
leases)
|
|
|
(1,249,121
|
)
|
|
|
(1,636,477
|
)
|
Deferred tax liability, net of deferred tax asset – current
|
|
$
|
(1,089,690
|
)
|
|
$
|
(1,538,105
|
)
|
|
|
|
|
|
|
|
|
|
Deferred tax asset — noncurrent (depreciation of fixed assets)
|
|
$
|
18,621,095
|
|
|
$
|
22,498,560
|
|
Deferred tax liability — noncurrent (net investment in sales-type
leases)
|
|
|
(27,432,116
|
)
|
|
|
(33,269,908
|
)
|
Deferred tax liability, net of deferred tax asset – noncurrent
|
|
$
|
(8,811,021
|
)
|
|
$
|
(10,771,348
|
)
|
12.
LOANS PAYABLE
Entrusted
Loan Payable
The
HYREF Fund (Beijing Hongyuan Recycling Energy Investment Center, LLP) established in July 2013 with total fund size of RMB 460
million ($75.0 million) invests in Xi’an Zhonghong for Zhonghong’s three new CDQ WHPG projects. The HYREF Fund invested
RMB 3 million ($0.5 million) as an equity investment and RMB 457 million ($74.5 million) as a debt investment in Xi’an Zhonghong;
in return for such investments, the HYREF Fund will receive an interest payment 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 to a bank account at the Supervising Bank (the Industrial Bank Xi’an
Branch) and is jointly supervised by Zhonghong and the Fund Management Company. Project spending shall be verified by the Fund
Management Company to confirm that it is in accordance with the project schedule before the funds are released. All the operating
accounts of Zhonghong have been opened with the branches of the Supervising Bank and the Supervising Bank has the right to monitor
all bank accounts opened by Zhonghong. The entrusted bank will charge 0.1% of loan amount as service fee and will not take any
lending risk. The loan was collateralized by the accounts receivable and the fixed assets of Shenqiu Phase I and II power generation
systems, the accounts receivable and fixed assets of Zhonghong’s three CDQ WHPG systems, and a 27 million RMB capital contribution
made by Xi’an TCH. Repayment of the loan (principal and interest) was also jointly and severally guaranteed by Xi’an
TCH and the Chairman and CEO of the Company. In the fourth quarter of 2015, three power stations of Erdos TCH were pledged to
Industrial Bank as an additional guarantee for the loan lent to Zhonghong’s three CDQ WHPG systems.
The
loan agreement provides that Zhonghong shall also maintain a certain capital level in its account with the Supervising Bank to
make sure it has sufficient funds to make interest payments when they are due:
|
●
|
During
the first three years from the first release of the loan, the balance in its account shall be no less than RMB 7.14 million
($1.19 million) on the 20th day of the second month of each quarter and no less than RMB 14.28 million ($2.38 million) on
the 14th day of the last month of each quarter;
|
|
|
|
|
●
|
During
the fourth year from the first release of the loan, the balance in its account shall be no less than RMB 1.92 million ($0.32
million) on the 20th day of the second month of each quarter and no less than RMB 3.85 million ($0.64 million) on the 14th
day of the last month of each quarter; and
|
|
|
|
|
●
|
During
the fifth year from the first release of the loan, the balance in its account shall be no less than RMB 96,300 ($16,050) on
the 20th day of the second month of each quarter and no less than RMB 192,500 ($32,080) on the 14th day of the last month
of each quarter.
|
The
term of this loan is for 60 months from July 31, 2013 to July 30, 2018. On August 6, 2016, Zhonghong shall repay principal in
the amount of RMB 280 million ($42.22 million); on August 6, 2017, it shall repay principal of RMB 100 million ($16.27 million)
and on July 30, 2018, it shall repay the remainder of RMB 77 million ($12.52 million). The interest rate is 12.5% per year. 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 requirement, there is a
verbal agreement from the HYREF Fund that for the purpose of the efficient utilization of working capital, Zhonghong does not
have to maintain a minimum funding level in its designated account with the Supervising Bank. As of September 30, 2016, the entrusted
loan payable had an outstanding balance of $60.95 million, of which, $11.23 million was from the investment of Xi’an TCH;
accordingly, the Company netted off the loan payable of $11.23 million with the long-term investment to the HYREF Fund made by
Xi’an TCH. For the nine months ended September 30, 2016, the Company recorded interest expense of $3.67 million on this
loan and capitalized $2.67 million interest to construction in progress. For the nine months ended September 30, 2015, the Company
recorded interest expense of $369,681 and on this loan and capitalized $6.64 million interest to construction in progress.
As
of the date of this report, the Company paid RMB 50 million ($7.54 million) of the RMB 280 million ($42.22 million), and on August
5, 2016, the Company entered 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.
Bank
Loan – Bank of Xi’an
On
June 26, 2015, Xi’an TCH entered into a loan agreement with Bank of Xi’an, whereby Bank of Xi’an agreed to loan
$6.29 million (RMB 40 million) to Xi’an TCH for one year with maturity on June 25, 2016. The monthly interest rate of the
loan is 0.595%. Under the terms of the loan, Xi’an TCH is required to make monthly interest payments and the principal is
to be repaid at maturity. The loan is guaranteed by a third party guarantee company and the Chairman and CEO of the Company. The
Company paid a third party $149,341 (RMB 950,000) as a re-guarantee service fee. As of September 30, 2016, this loan was paid
in full.
Bank
Loan – Bank of Chongqing
On
April 11, 2014, Xi’an TCH entered into a loan agreement with Bank of Chongqing - Xi’an Branch, whereby Bank of Chongqing
agreed to loan $8.13 million (RMB 50 million) to Xi’an TCH for three years with maturity on April 10, 2017. The annual interest
rate of the loan is 9.225%. Under the terms of the loan, Xi’an TCH was required to make monthly interest payments and, to
make a principal payment of $0.81 million (RMB 5 million) on the 24
th
month after receiving the loan and of the
remaining $7.32 million (RMB 45 million) on the loan maturity date. The loan was guaranteed by a third party guarantee company
and the Chairman and CEO of the Company. The company paid a third party $155,280 (RMB 950,000) as a re-guarantee service fee.
In addition, Xi’an TCH pledged its collection right for Tangshan Rongfeng and Xuzhou Zhongtai projects to Bank of Chongqing
after the two projects were completed and put into operation, to ensure the repayment of loan. As of September 30, 2016, this
loan had an outstanding balance of $0.75 million and was classified as a current liability.
Trust
Loan - Zhongrong International Trust - Xuzhou Zhongtai and Tangshan Rongfeng
On
February 17, 2014, Xi’an TCH entered into a trust loan agreement with Zhongrong International Trust Co., Ltd (“ZRIT”),
for Xi’an TCH to borrow RMB 150 million ($24.5 million) for the CDQ system and the CDQ WHPG Project with Xuzhou Zhongtai
Energy Technology Co., Ltd. (the “Zhongtai Project”). ZRIT set up a Zhongrong-Green Recycling Energy Collective Capital
Trust Plan No. 1 (the “Trust Plan No. 1”) to raise money and loan the proceeds to Xi’an TCH for the Zhongtai
Project (the “Zhongtai Loan”). The Zhongtai Loan was secured by the pledge of CDQ equipment and power generation system
of the Zhongtai Project, by personal guarantee of the Chairman and CEO of the Company, and by a corporate guarantee of Xuzhou
Zhongtai Energy Technology Co., Ltd. and its affiliated companies. As of September 30, 2016, this loan was paid in full.
On
February 17, 2014, Xi’an TCH entered into another trust loan agreement with ZRIT, for Xi’an TCH to borrow RMB 135
million ($22.1 million) for the CDQ system and the CDQ WHPG Project with Tangshan Rongfeng Iron & Steel Co., Ltd. (the “Rongfeng
Project”). ZRIT will set up a Zhongrong-Green Recycling Energy Collective Capital Trust Plan No. 2 (the “Trust Plan
No. 2”) to raise money and loan the proceeds to Xi’an TCH for the Rongfeng Project (the “Rongfeng Loan”).
The Rongfeng Loan is secured by the pledge of CDQ equipment and power generation system of the Rongfeng Project, by a personal
guarantee of the Chairman and CEO of the Company, and by a corporate guarantee of Tangshan Rongfeng Iron & Steel Co., Ltd.
and its parent company. On December 21, 2015, Xi’an TCH paid in full the loan for the Rongfeng Project upon the transfer
of the CDQ and a CDQ WHPG system to Rongfeng.
Summary
As
of September 30, 2016, the future minimum repayment of all the loans including the entrusted loan to be made by years is as follows:
2017
|
|
$
|
50,166,223
|
|
2018
|
|
|
299,500
|
|
Total
|
|
$
|
50,465,723
|
|
13.
LONG TERM PAYABLE – FINANCING AGREEMENT FOR SALE LEASE-BACK TRANSACTION
On
June 28, 2011, Xi’an TCH entered into a Financing Agreement (the “Cinda Agreement”) with Cinda Financial, an
affiliate of China Cinda (HK) Asset Management Co., Ltd, a company organized under the laws of the Hong Kong Special Administrative
Region of China (“Cinda HK”).
Under
the Cinda Agreement, Xi’an TCH transferred its ownership of (i) a set of 7MW steam turbine WHPG systems and (ii) four
furnaces and ancillary apparatus ((i) and (ii) collectively, the “Assets”) to Cinda Financial for $6.72
million (RMB 42.50 million), and Cinda Financial leased the Assets to Xi’an TCH for five years for $8.15 million (RMB 51.54
million) based on the transfer cost and benchmark interest rate for five year loans by People’s Bank of China (“PBOC”)
(then 6.65%) plus 15% of that rate (7.6475%). The interest rate will increase if the five-year benchmark interest rate of PBOC
increases but will remain the same if the benchmark rate decreases in the future. Xi’an TCH shall make pro rata quarterly
payments to Cinda Financial for the leasing fees. Upon the completion of the lease term and full payment of all leasing fees and
other fees, Xi’an TCH exercised its option to pay $676 (RMB 4,250) to acquire the Assets from Cinda Financial. The quarterly
minimum leasing payment to Cinda Financial is $412,855 (RMB 2.59 million).
In
addition to the leasing fees and payment to acquire the Assets, Xi’an TCH prepaid a one-time non-refundable leasing service
charge of $405,696 (RMB 2.55 million) and a refundable security deposit of $338,079 (RMB 2.13 million) to Cinda Financial. The
prepaid leasing service fee is to be: amortized over five years. For the nine months ended September 30, 2016 and 2015, $0 was
amortized, respectively. In accordance with ASC 840-10-25-4, because we retain substantially all of the benefits and risks relating
to the property, this transaction was a financing and was recorded as such.
As
of December 31, 2014, the prepaid leasing service fee was fully amortized as a result of the Early Repayment Agreement entered
by Xi’an TCH and Cinda Financial on December 22, 2014. Under the Repayment Agreement, Xi’an TCH paid the principal
and interest in the amount of RMB 2.55 million ($0.42 million) in the first quarter of 2015 as well as the remaining principal
of RMB 12.14 million ($1.97 million) before March 28, 2015 (the “Total Repayment Price”). Cinda Financial returned
the deposit of RMB 2,125,000 ($0.35 million) to Xi’an TCH within three days after Xi’an TCH paid the Total Repayment
Price. Upon the effective date of the Repayment Agreement, the Financial Leasing Agreement was terminated. The Company made repayment
in full during the first quarter of 2015.
14.
REFUNDABLE DEPOSIT FROM CUSTOMERS FOR SYSTEMS LEASING
The
refundable deposit was mainly for Pucheng, Shenqiu and Yida systems. As of September 30, 2016 and December 31, 2015, the balance
of refundable deposit from customers for systems leasing was $1,063,224 for Pucheng and Shengqiu systems, and $1,555,378 for Pucheng,
Shenqiu and Yida systems, respectively.
15.
RELATED PARTY TRANSACTIONS
On
March 1, 2014, Xi’an TCH entered a loan agreement with a major stockholder and the Company’s Chairman and CEO, pursuant
to which the Chairman and CEO of the Company will loan the Company, from time to time, up to RMB 80 million ($13 million) for
the Company’s operating needs. The loans bear no interest, have a one-year term, and the Company can repay the principal
in installments. As of September 30, 2016, the Company had borrowed $0 from the Chairman and CEO of the Company, but had $44,059
in advances from the Company’s management, which bear no interest, and are payable upon demand. As of December 31, 2015,
the Company had borrowed $0 from the Chairman and CEO of the Company, but had $44,059 in advances from the Company’s management,
which bear no interest, and are payable upon demand.
During
the nine months ended September 30, 2016, the Company recognized RMB 21.79 million ($3.27 million) interest income for the sales-type
lease of Pucheng BMPG systems from Pucheng Xin Heng Yuan Biomass Power Generation Corporation, whose major stockholder became
a stockholder of CREG through the issuance of the Company’s common stock to this stockholder in consideration for the transfer
of the old system to CREG for BMPG system transformation.
During
the nine months ended September 30, 2016, prior to repurchase date, the Company recognized RMB 13.83 million ($2.09 million) interest
income for the sales-type lease of Yida WGPG system from Qitaihe City Boli Yida Coal Selection Co., Ltd., whose major stockholder
became a stockholder of CREG through the issuance of the Company’s common stock to this stockholder in consideration for
the transfer of the old system to CREG for WGPG system transformation.
16. NONCONTROLLING
INTEREST
On
July 15, 2013, Xi’an TCH and HYREF Fund jointly established Xi’an Zhonghong New Energy Technology (“Zhonghong”)
with registered capital of RMB 30 million ($4.88 million), to manage new projects. Xi’an TCH paid RMB 27 million ($4.37
million). Xi’an TCH owns 90% of Zhonghong while HYREF Fund owns 10% of Zhonghong as non-controlling interest of Zhonghong.
In
addition, the HYREF Fund was 16.3% owned by Xi’an TCH and 1.1% owned by the Fund Management Company, and the Fund Management
Company was 40% owned by Xi’an TCH as described in Note 7, which resulted in an additional indirect ownership of Xi’an
TCH in Zhonghong of 1.7%; accordingly, the ultimate non-controlling interest (HYREF Fund) in Zhonghong became 8.3%. During the
nine months ended September 30, 2016 and 2015, the Company had losses of $227,126 and $23,024 that were attributable to the noncontrolling
interest, respectively. During the three months ended September 30, 2016 and 2015, the Company had losses of $79,921 and $6,907
that were attributable to noncontrolling interest, respectively.
17. INCOME
TAX
The
Company’s Chinese subsidiaries are governed by the Income Tax Law of the PRC concerning privately-run enterprises, which
are generally subject to tax at 25% on income reported in the statutory financial statements after appropriate tax adjustments.
Under the Chinese tax law, the tax treatment of finance and sales-type leases is similar to US GAAP. However, the local
tax bureau continues to treat CREG sales-type leases as operating leases. Accordingly, the Company recorded deferred income
taxes.
The
Company’s subsidiaries generate all of their net income from their PRC operations. Yinghua and Shanghai TCH’s effective
income tax rate for 2016 and 2015 was 25%. During 2013, Xi’an TCH was re-approved for high tech enterprise status and enjoyed
15% preferential income tax rate for three years effective January 1, 2013 through December 31, 2015, and is subject to 25% income
tax rate in 2016 unless the renewal of preferential income tax rate is approved by the tax authority. Huahong, Zhonghong and Erdos
TCH’s effective income tax rate for 2016 and 2015 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 consolidated financial statements
do not present any income tax provisions related to Cayman Islands tax jurisdiction where Sifang Holding is domiciled.
The
US parent company, China Recycling Energy Corporation, is taxed in the US and, as of September 30, 2016, had net operating loss
(“NOL”) carry forwards for income taxes of $14.03 million, which may be available to reduce future years’
taxable income as NOLs can be carried forward up to 20 years from the year the loss is incurred. Our management believes the realization
of benefits from these losses may be uncertain due to the US parent company’s continuing operating losses. Accordingly,
a 100% deferred tax asset valuation allowance was provided.
The
following table reconciles the US statutory rates to the Company’s effective tax rate for the nine and three months ended
September 30, 2016 and 2015, respectively:
|
|
Nine Months
|
|
|
Three Months
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
U.S. statutory rates
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
Tax rate difference – current provision
|
|
|
(11.1
|
)%
|
|
|
(9.3
|
)%
|
|
|
(12.2
|
)%
|
|
|
(9.3
|
)%
|
Effective tax holiday
|
|
|
-
|
%
|
|
|
(7.9
|
)%
|
|
|
-
|
%
|
|
|
(6.4
|
)%
|
Other
|
|
|
4.6
|
%
|
|
|
(3.6
|
)%
|
|
|
14.9
|
%
|
|
|
-
|
%
|
Prior periods income tax adjustment per income tax return filed
|
|
|
(1.0
|
)%
|
|
|
-
|
%
|
|
|
(3.2
|
)%
|
|
|
-
|
%
|
Valuation allowance on PRC NOL
|
|
|
(80.0
|
)%
|
|
|
-
|
%
|
|
|
(19.9
|
)%
|
|
|
-
|
%
|
Valuation allowance on US NOL
|
|
|
7.9
|
%
|
|
|
1.0
|
%
|
|
|
5.9
|
%
|
|
|
1.3
|
%
|
Tax per financial statements
|
|
|
(45.6
|
)%
|
|
|
14.2
|
%
|
|
|
19.5
|
%
|
|
|
19.6
|
%
|
The
provision for income taxes expense for the nine and three months ended September 30, 2016 and 2015 consisted of the following:
|
|
Nine Months
|
|
|
Three Months
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Income tax expense – current
|
|
$
|
1,211,424
|
|
|
$
|
4,466,774
|
|
|
$
|
305,516
|
|
|
$
|
730,828
|
|
Income tax expense (benefit) - deferred
|
|
|
(2,073,235
|
)
|
|
|
(1,370,648
|
)
|
|
|
(194,559
|
)
|
|
|
65,835
|
)
|
Total income tax expense (benefit)
|
|
$
|
(861,811
|
)
|
|
$
|
3,096,126
|
|
|
$
|
110,957
|
|
|
$
|
796,663
|
|
18. STOCK-BASED
COMPENSATION PLAN
Options
to Employees
The
Company recorded no compensation expense for stock options to employees during each of the nine and three months ended September
30, 2016 and 2015.
On
June 19, 2015, the stockholders of the Company approved the China Recycling Energy Corporation Omnibus Equity Plan (the “Equity
Plan”) at its annual meeting. The total aggregate shares of common stock authorized for issuance during the term of the
Equity Plan is limited to 12,462,605 shares (prior to the 10:1 reverse split). The Equity Plan was effective immediately upon
the adoption by our Board of Directors on April 24, 2015, subject to stockholder approval, and will terminate on the earliest
to occur of (i) the 10th anniversary of the Equity Plan’s effective date, or (ii) the date on which all shares available
for issuance under the Equity Plan shall have been issued as fully-vested shares. No share or option grants have been made to
employees under the Equity Plan as of September 30, 2016.
Options
to Independent Directors
On
March 31, 2015, the Board appointed Mr. Cangsang Huang as a member of the Company’s Board of Directors to fill a vacancy.
Mr. Huang will serve until his successor has been duly elected and qualified. In connection with the appointment, the Board authorized
the Company to provide Mr. Huang with (i) compensation in the amount of $2,000 per month and (ii) the grant of an option to purchase
40,000 shares of the Company’s Common Stock, par value $0.001, at an exercise price equal of $1.02 per share, which was
equal to the closing price per share of the Company’s Common Stock on March 31, 2015. Such options were only valid and exercisable
upon stockholder approval. The options to Mr. Huang were not voted upon at the Company’s annual stockholder’s meeting
on June 19, 2015 and were cancelled automatically. However, the Company’s Omnibus Equity Plan (“Plan”) adopted
by the Board on April 24, 2015 for providing equity awards to employees, directors and consultants was approved at the annual
stockholder’s meeting; accordingly, the Compensation Committee of the Board of Directors approved a grant of 40,000 options
(prior to the 10:1 stock split) to Mr. Huang at an exercise price of $1.02 per share under the Plan which vested immediately on
the date of grant, which was on October 10, 2015. The options may be exercised within five years of the date of the grant.
The
following table summarizes option activity with respect to the independent directors, the number of options reflected 10:1
reverse split effective on May 25, 2016:
|
|
Number of
Shares
|
|
|
Average Exercise Price per Share
|
|
|
Weighted
Average
Remaining
Contractual
Term in Years
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at January 1, 2015
|
|
|
8,000
|
|
|
$
|
38.3
|
|
|
|
0.31
|
|
Exercisable at January 1, 2015
|
|
|
8,000
|
|
|
|
38.3
|
|
|
|
0.31
|
|
Granted
|
|
|
4,000
|
|
|
|
10.2
|
|
|
|
4.77
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
8,000
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding at December 31, 2015
|
|
|
4,000
|
|
|
|
10.2
|
|
|
|
4.77
|
|
Exercisable at December 31, 2015
|
|
|
4,000
|
|
|
|
10.2
|
|
|
|
4.77
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding at September 30, 2016
|
|
|
4,000
|
|
|
|
10.2
|
|
|
|
4.02
|
|
Exercisable at September 30, 2016
|
|
|
4,000
|
|
|
$
|
10.2
|
|
|
|
4.02
|
|
19. CONTINGENCIES
The
Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with
companies in North America and Western Europe. These include risks associated with, among others, the political, economic and
legal environments and foreign currency exchange. The Company’s results may be adversely affected by changes in governmental
policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates
and methods of taxation, among other things.
The
Company’s sales, purchases and expense transactions are denominated in RMB and all of the Company’s assets and liabilities
are also denominated in RMB. The RMB is not freely convertible into foreign currencies under the current law. In China, foreign
exchange transactions are required by law to be transacted only by authorized financial institutions. Remittances in currencies
other than RMB may require certain supporting documentation in order to make the remittance.
The
Company sells electricity to its customers and receives commercial notes (bank acceptance) from them in lieu of payments for accounts
receivable. The Company discounts the commercial notes with the bank or endorses the commercial notes to vendors for payment of
their own obligations or to get cash from third parties. Most of the commercial notes have a maturity of less than six (6) months.
As of September 30, 2016 and December 31, 2015, Xi’an TCH had outstanding notes receivable of $0.
20. COMMITMENTS
Lease
Commitment
On
March 4, 2014, Xi’an TCH’s office lease expired and Xi’an TCH renewed this lease for an additional two years;
the monthly rental payment is $20,140. The lease for the office in Xi’an was renewed for an additional two years starting
on March 5, 2016 with a monthly rental payment of $21,804 but payable quarterly in advance. In addition, on September 16, 2013,
Xi’an TCH leased an office in Beijing for a term of two-years and three-months, expiring on December 31, 2015, with a monthly
rental payment of $12,110. The lease for the office in Beijing was not renewed at expiration. For the nine months ended September
30, 2016 and 2015, the rental expense of Xi’an TCH was $183,843 and $300,923, respectively. For the three months ended
September 30, 2016 and 2015, the rental expense of Xi’an TCH was $57,459 and $100,906, respectively.
Future
minimum annual rental payments required under operating leases as of September 30, 2016 were as below (by year):
2017
|
|
$
|
256,313
|
|
2018
|
|
$
|
128,156
|
|
Total
|
|
$
|
384,469
|
|
Construction
Commitment
Refer
to Note 1 for additional details related to lease commitments with Chengli, Tianyu (and its subsidiaries Xuzhou Tian’an
and Xuzhou Huayu), and Zhongtai and Note 8 for commitments on construction in progress.
21. SUBSEQUENT
EVENTS
The
Company has evaluated subsequent events that occurred subsequent to September 30, 2016, and through the date the consolidated
financial statements were issued as of the date of the report. Management has concluded that no subsequent events required disclosure
in these financial statements.