The accompanying notes are an integral part
of these consolidated financial statements.
The accompanying notes are an integral part
of these consolidated financial statements.
The accompanying notes are an integral part
of these consolidated financial statements.
The accompanying notes are an integral part
of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017 AND 2016
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
China Recycling Energy
Corporation (the “Company” or “CREG”) was incorporated on May 8, 1980 as Boulder Brewing Company under
the laws of the State of Colorado. On September 6, 2001, the Company changed its state of incorporation to the Nevada. In 2004,
the Company changed its name from Boulder Brewing Company to China Digital Wireless, Inc. and on March 8, 2007, again changed its
name from China Digital Wireless, Inc. to its current name, China Recycling Energy Corporation. The Company, through its subsidiaries,
provides energy saving solutions and services, including selling and leasing energy saving systems and equipment to customers,
project investment, investment management, economic information consulting, technical services, financial leasing, purchase of
financial leasing assets, disposal and repair of financial leasing assets, consulting and ensuring of financial leasing transactions
in the Peoples Republic of China (“PRC”).
Erdos TCH – Joint Venture
On April 14, 2009,
the Company formed a joint venture (the “JV”) with Erdos Metallurgy Co., Ltd. (“Erdos”) to recycle waste
heat from Erdos’ metal refining plants to generate power and steam to be sold back to Erdos. The name of the JV was Inner
Mongolia Erdos TCH Energy Saving Development Co., Ltd. (“Erdos TCH”) with a term of 20 years. Total investment for
the project was estimated at $79 million (RMB 500 million) with an initial investment of $17.55 million (RMB 120 million). Erdos
contributed 7% of the total investment of the project, and Xi’an TCH Energy Technology Co., Ltd. (“Xi’an TCH”)
contributed 93%. According to the parties’ agreement on profit distribution, Xi’an TCH and Erdos will receive 80% and
20%, respectively, of the profit from the JV until Xi’an TCH receives the complete return of its investment. Xi’an
TCH and Erdos will then receive 60% and 40%, respectively, of the profit from the JV. On June 15, 2013, Xi’an TCH and Erdos
entered into a share transfer agreement, pursuant to which Erdos sold its 7% ownership interest in the JV to Xi’an TCH for
$1.29 million (RMB 8 million), plus certain accumulated profits as described below. Xi’an TCH paid the $1.29 million in July
2013 and, as a result, became the sole stockholder of the JV. In addition, Xi’an TCH paid Erdos accumulated profits from
inception up to June 30, 2013 in accordance with a supplementary agreement entered on August 6, 2013. In August 2013, Xi’an
TCH paid 20% of the accumulated profit (calculated under PRC GAAP) of $226,000 to Erdos. Erdos TCH currently has two power generation
systems in Phase I with a total of 18 MW power capacity, and three power generation systems in Phase II with a total of 27 MW power
capacity. On April 28, 2016, Erdos TCH and Erdos entered into a supplemental agreement, effective on May 1, 2016, whereby Erdos
TCH cancelled monthly minimum lease payments from Erdos, and charges Erdos based on actual electricity sold at RMB 0.30 / KWH.
The selling price of each KWH is determined annually based on prevailing market conditions.
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 12 MW BMPG systems to Pucheng at a minimum of $279,400 (RMB 1,900,000) per month for 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 12 MW BMPG systems with completion of system
transformation for RMB 100 million ($16.48 million) in the form of 8,766,547 shares of common stock of the Company at $1.87 per
share. These shares were issued to Pucheng on October 29, 2013. Also on September 11, 2013, Xi’an TCH entered into a BMPG
Project Lease Agreement with Pucheng (the “Pucheng Lease”). Under the Pucheng Lease, Xi’an TCH leases this same
set of 12 MW BMPG system to Pucheng, and combined this lease with the lease for the 12 MW BMPG station of Pucheng Phase I project,
under a single lease to Pucheng for RMB 3.8 million ($0.63 million) per month (the “Pucheng Phase II Project”). The
term for the combined lease is from September 2013 to June 2025. The lease agreement for the 12 MW station from Pucheng Phase I
project terminated upon the effective date of the Pucheng Lease. The ownership of two 12 MW BMPG systems will transfer to Pucheng
at no additional charge when the Pucheng Lease expires.
Shenqiu Yuneng Biomass Power Generation Projects
On May 25, 2011, Xi’an
TCH entered into a Letter of Intent with 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 the consideration was paid. On September 28, 2011, Xi’an
TCH and Shenqiu also entered into a BMPG Project Lease Agreement (the “2011 Shenqiu Lease”). Under the 2011 Shenqiu
Lease, Xi’an TCH agreed to lease a set of 12 MW BMPG systems to Shenqiu at a monthly rental rate of $286,000 (RMB 1,800,000)
for 11 years. Upon expiration of the 2011 Shenqiu Lease, ownership of this system will transfer from Xi’an TCH to Shenqiu
at no additional cost. In connection with the 2011 Shenqiu Lease, Shenqiu paid one month’s rent as a security deposit to
Xi’an TCH, in addition to providing personal guarantees.
On October 8, 2012,
Xi’an TCH entered into a Letter of Intent for technical reformation of Shenqiu Project Phase II with Shenqiu for technical
reformation to enlarge the capacity of the Shenqiu Project Phase I (the “Shenqiu Phase II Project”). The technical
reformation involved the construction of another 12 MW BMPG system. After the reformation, the generation capacity of the power
plant increased to 24 MW. The project commenced on October 25, 2012 and was completed during the first quarter of 2013. The total
cost of the project was $11.1 million (RMB 68 million). On March 30, 2013, Xi’an TCH and Shenqiu entered into a BMPG Project
Lease Agreement (the “2013 Shenqiu Lease”). Under the 2013 Shenqiu Lease, Xi’an TCH agreed to lease the second
set of 12 MW BMPG systems to Shenqiu for $239,000 (RMB 1.5 million) per month for 9.5 years. When the 2013 Shenqiu Lease expires,
ownership of this system will transfer from Xi’an TCH to Shenqiu at no additional cost.
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 Boli Yida 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 the 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 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
five 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 five 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 transfer from Xi’an TCH to Yida within three
business days after Xi’an TCH receives the full Transfer Price and the outstanding monthly leasing fees. In July 2016, the
Company received the full payment of the Transfer Price and title to the system was transferred at that time. The Company recorded
a $0.42 million loss from this transaction in 2016.
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 ($1.45 million).
Xi’an TCH made an initial capital contribution of RMB 4 million ($650,000) and has a 40% ownership interest in the Fund Management
Company. With respect to the Fund Management Company, voting rights and dividend rights are allocated 80% and 20% between HongyuanHuifu
and Xi’an TCH, respectively.
The Fund Management
Company is the general partner of Beijing Hongyuan Recycling Energy Investment Center, LLP (the “HYREF Fund”), a limited
liability partnership established on July 18, 2013 in Beijing. The Fund Management Company made an initial capital contribution
of RMB 5 million ($830,000) to the HYREF Fund. An initial total of RMB 460 million ($77 million) was fully subscribed by all partners
for the HYREF Fund. The HYREF Fund has three limited partners: (1) China Orient Asset Management Co., Ltd., which made an initial
capital contribution of RMB 280 million ($46.67 million) to the HYREF Fund and is a preferred limited partner; (2) HongyuanHuifu,
which made an initial capital contribution of RMB 100 million ($16.67 million) to the HYREF Fund and is an ordinary limited partner;
and (3) the Company’s wholly-owned subsidiary, Xi’an TCH, which made an initial capital contribution of RMB 75 million
($12.5 million) to the HYREF Fund and is a secondary limited partner. The term of the HYREF Fund’s partnership is six years
from the date of its establishment, expiring July 18, 2019. The term is four years from the date of contribution for the preferred
limited partner, and four years from the date of contribution for the ordinary limited partner. The total size of the HYREF Fund
is RMB 460 million ($76.66 million). The HYREF Fund was formed for the purpose of investing in Xi’an Zhonghong New Energy
Technology Co., Ltd., a 90% owned subsidiary of Xi’an TCH, for the construction of two coke dry quenching (“CDQ”)
WHPG stations with Jiangsu Tianyu Energy and Chemical Group Co., Ltd. (“Tianyu”) and one CDQ WHPG station with Boxing
County Chengli Gas Supply Co., Ltd. (“Chengli”).
Chengli Waste Heat Power Generation
Projects
On July 19, 2013, Xi’an
TCH formed a new company, “Xi’an Zhonghong New Energy Technology Co., Ltd.” (“Zhonghong”), with registered
capital of RMB 30 million ($4.85 million). Xi’an TCH paid RMB 27 million ($4.37 million) and owns 90% of Zhonghong. Zhonghong
is engaged to provide energy saving solution and services, including constructing, selling and leasing energy saving systems and
equipment to customers.
On July 24, 2013, Zhonghong entered into
a Cooperative Agreement of CDQ and CDQ WHPG Project with Boxing County Chengli Gas Supply Co., Ltd. (“Chengli”). The
parties entered into a supplement agreement on July 26, 2013. Pursuant to these agreements, Zhonghong will design, build and maintain
a 25 MW CDQ system and a CDQ WHPG system to supply power to Chengli, and Chengli will pay energy saving fees (the “Chengli
Project”). Chengli will contract the operation of the system to a third-party contractor that is mutually agreed to by Zhonghong.
In addition, Chengli will provide the land for the CDQ system and CDQ WHPG system at no cost to Zhonghong. The term of the Agreements
is for 20 years. The watt hours generated by the Chengli Project will be charged at RMB 0.42 ($0.068) per kilowatt hour (excluding
tax). The operating time shall be based upon an average 8,000 hours annually. If the operating time is less than 8,000 hours per
year due to a reason attributable to Chengli, then time charged shall be 8,000 hours a year, and if it is less than 8,000 hours
due to a reason attributable to Zhonghong, then it shall be charged at actual operating hours. The construction of the Chengli
Project was completed in the second quarter of 2015 and the project successfully completed commissioning tests in the first quarter
of 2017. The Chengli Project is now operational, but will not begin operations until the Company receives the required power generating
license, which the Company anticipates receiving in the second quarter of 2018. When operations begin, Chengli shall ensure its
coking production line works properly and that working hours for the CDQ system are at least 8,000 hours per year, and Zhonghong
shall ensure that working hours for the CDQ WHPG system are at least 7,200 hours per year.
On July 22, 2013, Zhonghong
entered into an Engineering, Procurement and Construction (“EPC”) General Contractor Agreement for the Boxing County
Chengli Gas Supply Co., Ltd. CDQ Power Generation Project (the “Chengli Project”) with Xi’an Huaxin New Energy
Co., Ltd. (“Huaxin”). Zhonghong, as the owner of the Chengli Project, contracted EPC services for a CDQ system and
a 25 MW CDQ WHPG system for Chengli from Huaxin. Huaxin shall provide construction, equipment procurement, transportation, installation
and adjustment, test run, construction engineering management and other necessary services to complete the Huaxin Project and ensure
the CDQ system and CDQ WHPG system for Chengli meet the inspection and acceptance requirements and work normally. The Chengli Project
is a turn-key project where Huaxin is responsible for monitoring the quality, safety, duration and cost of the Chengli Project.
The total contract price is RMB 200 million ($33.34 million), which includes all the materials, equipment, labor, transportation,
electricity, water, waste disposal, machinery and safety costs.
Tianyu Waste Heat Power Generation Project
On July 19, 2013,
Zhonghong entered into a Cooperative Agreement (the “Tianyu Agreement”) for Energy Management of CDQ and CDQ WHPG
Project with Jiangsu Tianyu Energy and Chemical Group Co., Ltd. (“Tianyu”). Pursuant to the Tianyu Agreement,
Zhonghong will design, build, operate and maintain two sets of 25 MW CDQ systems and CDQ WHPG systems for two subsidiaries of
Tianyu – Xuzhou Tian’an Chemical Co., Ltd. (“Xuzhou Tian’an”) and Xuzhou Huayu Coking Co., Ltd.
(“Xuzhou Huayu”) – to be located at Xuzhou Tian’an and Xuzhou Huayu’s respective locations (the
“Tianyu Project”). Upon completion of the Tianyu Project, Zhonghong will charge Tianyu an energy saving fee of
RMB 0.534 ($0.087) per kilowatt hour (excluding tax). The operating time will be based upon an average 8,000 hours annually
for each of Xuzhou Tian’an and Xuzhou Huayu. If the operating time is less than 8,000 hours per year due to a reason
attributable to Tianyu, then time charged will be 8,000 hours a year. Because of the control of the overcapacity and
pollution of the iron and steel and related industries, the government has imposed production limitations for the
energy-intensive enterprises with heavy pollution, including Xuzhou Tian’an. Xuzhou Tian’an has slowed the
construction process for its dry quenching production line which caused the delay of our project. The term of the Tianyu
Agreement is 20 years. The construction of the Xuzhou Tian’an Project is anticipated to be completed by the third
quarter of 2018. 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 the power generated by the CDQ WHPG systems. The Xuzhou Huayu Project is currently
on hold due to a conflict between Xuzhou Huayu Coking Co., Ltd. and local residents on certain pollution-related issues. The
local government has acted in its capacity to coordinate the resolution of this issue. The local residents were requested
to move from the hygienic buffer zone of the project location with compensatory payments from the government. Xuzhou Huayu
was required to stop production and implement technical innovations to mitigate pollution discharge including sewage
treatment, dust collection, noise control, and recycling of coal gas. Currently, some local residents have moved. Xuzhou
Huayu has completed the implementation of the technical innovations of sewage treatment, dust collection, and noise control,
and the Company is waiting for local governmental agencies to approve these technical innovations so that we can resume
construction. We expect to complete the recycling of coal gas in the second quarter of 2018. Once Huayu obtains the
government’s acceptance and approval of the technical innovations, the project will resume.
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 fee at RMB 0.534 ($0.089) per kilowatt hour (KWH) (including
value added tax) for the power generated from the system. For the second 10 years, Zhongtai shall pay an energy saving fee at RMB
0.402 ($0.067) per KWH (including value added tax). During the term of the contract the energy saving fee shall be adjusted at
the same percentage as the change of local grid electricity price. Zhongtai shall also pay an energy saving fee for the steam supplied
by Xi’an TCH at RMB 100 ($16.67) per ton (including value added tax). Zhongtai and its parent company will provide guarantees
to ensure Zhongtai will fulfill its obligations under the Agreement. Upon the completion of the term, Xi’an TCH will transfer
the systems to Zhongtai at RMB 1 ($0.16). Zhongtai shall provide waste heat to the systems for no less than 8,000 hours per year
and waste gas volume no less than 150,000 Normal Meter Cubed (Nm3) per hour with a temperature no less than 950°C. If these
requirements are not met, the term of the Agreement will be extended accordingly. If Zhongtai wants to terminate the Zhongtai Agreement
early, it shall provide Xi’an TCH a 60 day notice and pay the termination fee and compensation for the damages to Xi’an
TCH according to the following formula: (1) if it is less than five years into the term when Zhongtai requests termination, Zhongtai
shall pay: Xi’an TCH’s total investment amount plus Xi’an TCH’s annual investment return times five years
minus the years in which the system has already operated; or 2) if it is more than five years into the term when Zhongtai requests
the termination, Zhongtai shall pay: Xi’an TCH’s total investment amount minus total amortization cost (the amortization
period is 10 years).
In March 2016, Xi’an
TCH entered into a Transfer Agreement of CDQ and a CDQ WHPG system with Zhongtai and Xi’an Huaxin (the “Transfer Agreement”).
Under the Transfer Agreement, Xi’an TCH agreed to transfer to Zhongtai all of the assets associated with the CDQ Waste Heat
Power Generation Project (the “Project”), which is under construction pursuant to the Zhongtai Agreement. Additionally,
Xi’an TCH agreed to transfer to Zhongtai the Engineering, Procurement and Construction (“EPC”) Contract for the
CDQ Waste Heat Power Generation Project which Xi’an TCH had entered into with Xi’an Huaxin in connection with the Project.
Xi’an Huaxin will continue to construct and complete the Project and Xi’an TCH agreed to transfer all its rights and
obligation under the EPC Contract to Zhongtai. As consideration for the transfer of the Project, Zhongtai agreed to pay to Xi’an
TCH an aggregate transfer price of RMB 167,360,000 ($25.77 million) including payments of: (i) RMB 152,360,000 ($23.46 million)
for the construction of the Project; and (ii) RMB 15,000,000 ($2.31 million) as payment for partial loan interest accrued during
the construction period. Those amounts have been, or will be, paid by Zhongtai to Xi’an TCH according to the following schedule:
(a) RMB 50,000,000 ($7.70 million) was paid within 20 business days after the Transfer Agreement was signed; (b) RMB 30,000,000
($4.32 million) was 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”)
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, 2017, Xi’an TCH had received the first payment of $7.70 million and the second payment of $4.32 million. The Company
recorded a $2.82 million loss from this transaction in 2016. As of the date of this report, the Company has not yet received the
remaining payment of RMB 87,360,000 ($13.45 million). However, the Company received a repayment commitment letter from Zhongtai
on February 23, 2018, in which Zhongtai committed to pay the remaining payment of RMB 87,360,000 ($13.45 million) no later than
the end of July 2018.
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 pay an energy saving 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 fee at RMB 0.582 ($0.095) per KWH (including tax) for the power
generated from the system. For the second 10 years, Rongfeng shall pay an energy saving fee at RMB 0.432 ($0.071) per KWH (including
tax). During the term of the contract the energy saving fee shall be adjusted at the same percentage as the change of local grid
electricity price. 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), over several installments. 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. The Company recorded a $3.78 million loss from this transaction in 2015. The Company
received full payment of $25.45 million in 2016.
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), which must be contributed before October 1, 2028. Zhongxun is 100% owned
by Xi’an TCH and will be mainly engaged in project investment, investment management, economic information consulting, and
technical services. Zhongxun has not yet commenced operations as of the date of this report.
Formation of Yinghua
On
February 11, 2015, the Company incorporated a new subsidiary, Shanghai Yinghua Financial Leasing Co., Ltd (“Yinghua”)
with registered capital of $30,000,000, to be paid within 10 years from the date the business license is issued. Yinghua is 100%
owned by the Company and will be mainly engaged in financial leasing, purchase of financial leasing assets, disposal and repair
of financial leasing assets, consulting and ensuring of financial leasing transactions, and related factoring business. Yinghua
has not yet commenced operations as of the date of this report.
Summary of Sales-Type Lease at December
31, 2017
Status at December
31, 2017
As of December 31,
2017, 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 December 31,
2017, Erdos TCH leased power and steam generating systems for recycling waste heat from metal refining to Erdos (five systems)
for a term of 20 years.
Asset Repurchase
Agreement
During the years ended
December 31, 2017 and 2016, the Company entered into the following Asset Repurchase Agreements:
In March 2016, Xi’an
TCH entered into a Transfer Agreement of CDQ and a CDQ WHPG system with Zhongtai and Xi’an Huaxin (the “Transfer Agreement”).
Under the Transfer Agreement, Xi’an TCH agreed to transfer to Zhongtai all of the assets associated with the CDQ Waste Heat
Power Generation Project (the “Project”), which is under construction pursuant to the Zhongtai Agreement. Additionally,
Xi’an TCH agreed to transfer to Zhongtai the Engineering, Procurement and Construction (“EPC”) Contract for the
CDQ Waste Heat Power Generation Project which Xi’an TCH had entered into with Xi’an Huaxin in connection with the Project.
Xi’an Huaxin will continue to construct and complete the Project and Xi’an TCH agreed to transfer all its rights and
obligation under the “EPC” Contract to Zhongtai. As consideration for the transfer of the Project, Zhongtai agreed
to pay to Xi’an TCH an aggregate transfer price of RMB 167,360,000 ($25.77 million) including payments of: (i) RMB 152,360,000
($23.46 million) for the construction of the Project; and (ii) RMB 15,000,000 ($2.31 million) as payment for partial loan interest
accrued during the construction period. Those amounts have been, or will be, paid by Zhongtai to Xi’an TCH according to the
following schedule: (a) RMB 50,000,000 ($7.70 million) was paid within 20 business days after the Transfer Agreement was signed;
(b) RMB 30,000,000 ($4.32 million) was 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, 2017, Xi’an TCH had received the first payment of $7.70 million and the second
payment of $4.32 million. The Company recorded a $2.82 million loss from this transaction in 2016. As of this report date, the
Company has not yet received the remaining payment of RMB 87,360,000 ($13.45 million) due to the tight cash flow of Zhongtai; the
Company received a repayment commitment letter from Zhongtai in February 23, 2018, in which Zhongtai committed to pay the remaining
payment of RMB 87,360,000 ($13.45 million) no later than the end of July 2018.
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 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. In July 2016,
the Company had received the full payment of the Transfer Price and title to the system was transferred at that time. The Company
recorded a $0.42 million loss from this transaction in 2016.
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 the Company effected 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”).
The Company 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 financial statements
included herein were prepared by the Company, pursuant to the rules and regulations of the Securities and Exchange Commission
(“SEC”). The information furnished herein reflects all adjustments (consisting of normal recurring accruals and
adjustments) that are, in the opinion of management, necessary to fairly present the operating results for the respective periods.
Certain information and footnote disclosures normally present in annual financial statements prepared in accordance with accounting
principles generally accepted in the United States of America (“US GAAP”) were omitted pursuant to such rules and regulations.
Basis of Consolidation
The consolidated financial
statements (“CFS”) include the accounts of CREG and its subsidiaries, Shanghai Yinghua Financial Leasing Co., Ltd.
(“Yinghua”) and Sifang Holdings, Sifang Holdings’ wholly owned subsidiaries, Huahong New Energy Technology Co., Ltd. (“Huahong”)
and Shanghai TCH, Shanghai TCH’s wholly-owned subsidiary, Xi’an TCH Energy Tech Co., Ltd. (“Xi’an TCH”)
and Xi’an TCH’s subsidiaries, Erdos TCH Energy Saving Development Co., Ltd (“Erdos TCH”), 100% owned by
Xi’an TCH (See note 1), Zhonghong, 90% owned by Xi’an TCH, and Zhongxun, 100% owned by Xi’an TCH. Substantially
all the Company’s revenues are derived from the operations of Shanghai TCH and its subsidiaries, which represent substantially
all the Company’s consolidated assets and liabilities as December 31, 2017 and 2016, respectively. All significant inter-company
accounts and transactions were eliminated in consolidation.
Use of Estimates
In preparing these
CFS in accordance with US GAAP, management makes estimates and assumptions that affect the reported amounts of assets and liabilities
in the balance sheets as well as revenues and expenses during the period reported. Actual results may differ from these estimates.
Revenue Recognition
Sales-type Leasing and Related Revenue
Recognition
The Company constructs and leases waste
energy recycling power generating projects to its customers. The Company typically transfers ownership of the waste energy recycling
power generating projects to its customers at the end of the lease. The investment in these projects is recorded as investment
in sales-type leases in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) Topic 840
, “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 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 December 31,
2017, the Company had accounts receivable of $13,369,655 (from the sales of CDQ and a CDQ WHPG system to Zhongtai). As of December
31, 2016, the Company had accounts receivable of $12,593,340 (from the sales of CDQ and a CDQ WHPG system to Zhongtai).
Interest Receivable on Sales Type Leases
As of December 31,
2017, the interest receivable on sales type leases was $9,869,357, mainly from recognized but not yet collected interest income
for the Pucheng and Shenqiu systems. As of December 31, 2016, the interest receivable on sales type leases was $4,621,491.
The Company maintains
reserves for potential credit losses on receivables. Management reviews the composition of receivables and analyzes historical
bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns
to evaluate the adequacy of these reserves. As of December 31, 2017, the Company had bad debt allowance for net investment receivable
of $1,802,822 for Pucheng and Shenqiu systems.
Concentration of Credit Risk
Cash includes cash
on hand and demand deposits in accounts maintained within China. Balances at financial institutions within China are not covered
by insurance. The Company has not experienced any losses in such accounts.
Certain other financial
instruments, which subject the Company to concentration of credit risk, consist of accounts and other receivables. The Company
does not require collateral or other security to support these receivables. The Company conducts periodic reviews of its customers’
financial condition and customer payment practices to minimize collection risk on accounts receivable.
The operations of the
Company are located in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be
influenced by the political, economic and legal environments in the PRC.
Property and Equipment
Property and equipment
are stated at cost, net of accumulated depreciation. Expenditures for maintenance and repairs are expensed as incurred; additions,
renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and
accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation
of property and equipment is provided using the straight-line method over the estimated lives as follows:
Building
|
|
20 years
|
Vehicles
|
|
2 - 5 years
|
Office and Other Equipment
|
|
2 - 5 years
|
Software
|
|
2 - 3 years
|
Impairment of Long-lived Assets
In accordance with FASB ASC Topic 360,
“Property,
Plant, and Equipment
,” the Company reviews its long-lived assets, including property and equipment, for impairment whenever
events or changes in circumstances indicate that the carrying amounts of the assets may not be fully recoverable. If the total
expected undiscounted future net cash flows is less than the carrying amount of the asset, a loss is recognized for the difference
between the fair value and carrying amount of the asset. The total undiscounted future net cash flow (total future payment receivable)
is less than net investment in sales-type leases for Erdos Phase II, the 2nd system at December 31,2017 and 2016; accordingly,
the Company recorded an asset impairment loss of $38,859 and $242,305 for the years ended December 31, 2017 and 2016, respectively.
Notes Payable – Banker’s Acceptances
The Company endorses
banker’s acceptances that are issued from a bank to vendors as payment for its obligations. Most of the banker’s acceptances
have maturity dates of less than six months following their issuance.
Cost of Sales
Cost of sales consists
primarily of the direct material of the power generating system and expenses incurred directly for project construction for sales-type
leasing and sales tax and additions for contingent rental income.
Income Taxes
Income taxes are accounted
for using an asset and liability method. Under this method, deferred income taxes are recognized for the tax consequences in future
years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based
on enacted tax laws and statutory tax rates, applicable to the periods in which the differences are expected to affect taxable
income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
The Company follows
ASC Topic 740, which prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. ASC Topic 740 also provides guidance on recognition of income tax assets and liabilities,
classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with
tax positions, accounting for income taxes in interim periods, and income tax disclosures.
Under the provisions
of ASC Topic 740, when tax returns are filed, it is highly certain that some positions taken would be sustained upon examination
by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the
position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period
during which, based on all available evidence, management believes it is more likely than not that the position will be sustained
upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated
with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount
of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The
portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as
a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that
would be payable to the taxing authorities upon examination.
CREG
is subject to U.S. corporate income taxes on its taxable income at a rate of up to 21% for taxable years beginning after December 31,
2017 and U.S. corporate income tax on its taxable income of up to 35% for prior tax years. On December 22, 2017, the Tax Cut and
Jobs Act (“Tax Act”) was signed into law. The Tax Act introduced a broad range of tax reform measures that significantly
change the federal income tax laws. The provisions of the Tax Act that may have significant impact on the Company include the permanent
reduction of the corporate income tax rate from 35% to 21% effective for tax years including or commencing on January 1, 2018,
one-time transition tax on post-1986 foreign unremitted earnings, provision for Global Intangible Low Tax Income (“GILTI”),
deduction for Foreign Derived Intangible Income (“FDII”), repeal of corporate alternative minimum tax, limitation of
various business deductions, and modification of the maximum deduction of net operating loss with no carryback but indefinite carryforward
provision. Many provisions in the Tax Act are generally effective in tax years beginning after December 31, 2017. Taxpayers may
elect to pay the one-time transition tax over eight years, or in a single lump-sum payment.
To
the extent that portions of its U.S. taxable income, such as Subpart F income or GILTI, are determined to be from sources outside
of the U.S., subject to certain limitations, the Company may be able to claim foreign tax credits to offset its U.S. income tax
liabilities. Any remaining liabilities are accrued in the Company’s consolidated statements of comprehensive income and estimated
tax payments are made when required by U.S. law.
Noncontrolling Interests
The Company follows FASB ASC Topic 810,
“Consolidation,”
which
established new standards governing the accounting for and reporting of noncontrolling interests (“NCIs”) in partially
owned consolidated subsidiaries and the loss of control of subsidiaries. Certain provisions of this standard indicate, among other
things, that NCIs (previously referred to as minority interests) be treated as a separate component of equity, not as a liability
(as was previously the case), that increases and decreases in the parent’s ownership interest that leave control intact be
treated as equity transactions rather than as step acquisitions or dilution gains or losses, and that losses of a partially-owned
consolidated subsidiary be allocated to NCIs even when such allocation might result in a deficit balance.
The net income (loss)
attributed to NCIs was separately designated in the accompanying statements of income and comprehensive income (loss). Losses attributable
to NCIs in a subsidiary may exceed an NCI’s interests in the subsidiary’s equity. The excess attributable to NCIs is
attributed to those interests. NCIs shall continue to be attributed their share of losses even if that attribution results in a
deficit NCI balance.
Statement of Cash Flows
In accordance with
FASB ASC Topic 230,
“Statement of Cash Flows,”
cash flows from the Company’s operations are
calculated based upon the local currencies. As a result, amounts related to assets and liabilities reported on the statement of
cash flows may not necessarily agree with changes in the corresponding balances on the balance sheet.
Fair Value of Financial Instruments
For certain of the
Company’s financial instruments, including cash and equivalents, restricted cash, accounts receivable, other receivables,
accounts payable, accrued liabilities and short-term debts, the carrying amounts approximate their fair values due to their short
maturities. Receivables on sales-type leases are based on interest rates implicit in the lease.
FASB ASC Topic 820,
“Fair
Value Measurements and Disclosures,”
requires disclosure of the fair value (“FV”) of financial instruments
held by the Company. FASB ASC Topic 825,
“Financial Instruments,”
defines FV, and establishes a three-level
valuation hierarchy for disclosures of FV measurement that enhances disclosure requirements for FV measures. The carrying amounts
reported in the consolidated balance sheets for receivables and current liabilities each qualify as financial instruments and are
a reasonable estimate of their FV because of the short period of time between the origination of such instruments and their expected
realization and their current market rate of interest. The three levels of valuation hierarchy are defined as follows:
|
●
|
Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
|
|
|
|
|
●
|
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
|
|
|
|
|
●
|
Level 3 inputs to the valuation methodology are unobservable and significant to FV measurement.
|
The Company analyzes
all financial instruments with features of both liabilities and equity under ASC 480,
“Distinguishing Liabilities
from Equity,”
and ASC 815,
“Derivatives and Hedging.”
The following are the
considerations with respect to disclosures of FV of long-term debt obligations:
As of December 31,
2017, the Company did not have any long-term debt obligations. As of December 31, 2016, the Company’s long-term debt obligations
consisted of the Zhonghong entrusted loan and interest payable on entrusted loans of $48.08 million (Note 12).
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, 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 December 31,
2017 and 2016, 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 year ended December 31, 2017 and 2016:
|
|
Years Ended
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Net income (loss)
|
|
$
|
(8,998,259
|
)
|
|
$
|
1,827,171
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding – basic
|
|
|
8,310,198
|
|
|
|
8,310,198
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Options granted
|
|
|
155
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding – diluted
|
|
|
8,310,353
|
|
|
|
8,310,198
|
|
Earnings (loss) per share – basic
|
|
$
|
(1.08
|
)
|
|
$
|
0.22
|
|
Earnings (loss) per share – diluted
|
|
$
|
(1.08
|
)
|
|
$
|
0.22
|
|
Foreign Currency Translation and Comprehensive
Income (Loss)
The Company’s functional currency
is the Renminbi (“RMB”). For financial reporting purposes, RMB were translated into United States Dollars (“USD”
or “$”) as the reporting currency. Assets and liabilities are translated at the exchange rate in effect at the balance
sheet date. Revenues and expenses are translated at the average rate of exchange prevailing during the reporting period. Translation
adjustments arising from the use of different exchange rates from period to period are included as a component of stockholders’
equity as “Accumulated other comprehensive income.” Gains and losses resulting from foreign currency transactions are
included in income. There was no significant fluctuation in the exchange rate for the conversion of RMB to USD after the balance
sheet date.
The Company follows
FASB ASC Topic 220,
“Comprehensive Income.”
Comprehensive income is comprised of net income and all
changes to the statements of stockholders’ equity, except those due to investments by stockholders, changes in paid-in capital
and distributions to stockholders.
Segment Reporting
FASB ASC Topic 280,
“Segment
Reporting,”
requires use of the “management approach” model for segment reporting. The management approach
model is based on the way a company’s management organizes segments within the company for making operating decisions and
assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure,
or any other manner in which management disaggregates a company. FASB ASC Topic 280 has no effect on the Company’s CFS as
substantially all of the Company’s operations are conducted in one industry segment. All of the Company’s assets are
located in the PRC.
New Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with Customers
. ASU 2014-09 is a comprehensive revenue recognition standard that will supersede
nearly all existing revenue recognition guidance under current U.S. GAAP and replace it with a principle-based approach for determining
revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or
services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing
and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments
and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for interim and annual
periods beginning after December 15, 2017. Early adoption is permitted only in annual reporting periods beginning
after December 15, 2016, including interim periods therein. Entities will be able to transition to the standard either retrospectively
or as a cumulative-effect adjustment as of the date of adoption. The Company does not believe the adoption of this ASU will
have a significant impact on its CFS.
In February 2016, the
FASB issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842). The guidance in ASU 2016-02 supersedes
the lease recognition requirements in ASC Topic 840, Leases (FAS 13). ASU 2016-02 requires an entity to recognize assets and liabilities
arising from a lease for both financing and operating leases, along with additional qualitative and quantitative disclosures. ASU
2016-02 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently
evaluating the effect this standard will have on its CFS.
In August 2016, the
FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 clarifies the presentation
and classification of certain cash receipts and cash payments in the statement of cash flows. This ASU is effective for public
business entities for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is
permitted. The Company does not anticipate that the adoption of this ASU will have a significant impact on its CFS.
In October 2016, the
FASB issued ASU No. 2016-16—Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. This ASU improves
the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. For public business entities,
the amendments in this update are effective for annual reporting periods beginning after December 15, 2017, including interim reporting
periods within those annual reporting periods. Early adoption is permitted. The Company does not anticipate that the adoption of
this ASU will have a significant impact on its CFS.
In November 2016, the
FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The guidance requires that a statement
of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted
cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents
should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown
on the statement of cash flows. The standard is effective for fiscal years beginning after December 15, 2017, and interim
periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The standard should be
applied using a retrospective transition method to each period presented. The Company does not anticipate that the adoption of
this ASU will have a significant impact on its CFS.
In January 2017, the FASB issued ASU No. 2017-01,
Business Combinations (Topic 805): Clarifying the Definition of a Business, which clarifies the definition of a business with
the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions
or disposals of assets or businesses. The standard is effective for fiscal years beginning after December 15, 2017, including
interim periods within those fiscal years. Early adoption is permitted. The standard should be applied prospectively on or after
the effective date. The Company will evaluate the impact of adopting this standard prospectively upon any transactions of acquisitions
or disposals of assets or businesses.
In January 2017, the
FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. The guidance removes Step 2 of the goodwill impairment test,
which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s
carrying value exceeds its FV, not to exceed the carrying amount of goodwill. The guidance should be adopted on a prospective basis
for the annual or any interim goodwill impairment tests beginning after December 15, 2019. Early adoption is permitted for
interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating
the impact of adopting this standard on its CFS.
Other recent accounting
pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants,
and the SEC did not or are not believed by management to have a material impact on the Company’s present or future CFS.
Reclassification
In November 2015, the
FASB issued ASU No. 2015-17 on the balance sheet classification of deferred taxes, which would require that deferred tax assets
and liabilities be classified as non-current in the balance sheet. Current GAAP requires the presentation of deferred tax assets
and liabilities as either current or non-current in the balance sheet. This ASU is effective for annual reporting periods beginning
after December 15, 2016, including interim reporting periods within those annual reporting periods. Earlier adoption is permitted.
The guidance may be applied either prospectively or retrospectively. The Company adopted this ASU as of December 31, 2016 on a
retrospective basis and reclassified current deferred tax liability (net) to the noncurrent deferred tax liability (net) in the
consolidated balance sheet as of December 31, 2016. The reclassification had no effect on reported revenues, operating income,
or cash flows for the periods presented.
3. NOTES RECEIVABLE – BANK ACCEPTANCE
As of December 31,
2017 and 2016, the Company had outstanding notes receivable on-hand of $979,462 and $0, respectively, representing the bank acceptance
that were issued by the suppliers to Erdos TCH and the payments were honored by the bank. Erdos TCH may hold the bank acceptance
until the maturity for the full payment, or get cashed from the bank at a discount at an earlier date prior to maturity, or transfer
the bank acceptance to its vendors in lieu of payment. As of December 31, 2017, Erdos TCH had $1.41 million bank acceptance that
was transferred to one of its suppliers but haven’t matured; If the honored bank refuse to redeem the bank acceptance, then Erdos
TCH would be obligated to redeem these bank acceptance.
4. INVESTMENT IN SALES-TYPE LEASES,
NET
Under sales-type leases,
Xi’an TCH leases the following systems: (i) BMPG systems to Pucheng Phase I and II (15 and 11 year terms, respectively);
(ii) BMPG systems to Shenqiu Phase I (11-year term); and (iii) Shenqiu Phase II (9.5-year term). In addition, as of December 31,
2017, 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 December 31, 2017 and 2016 are as follows:
|
|
2017
|
|
|
2016
|
|
Total future minimum lease payments receivable
|
|
$
|
222,132,929
|
|
|
$
|
217,470,913
|
|
Less: executory cost
|
|
|
(67,212,769
|
)
|
|
|
(66,444,519
|
)
|
Less: unearned interest
|
|
|
(29,542,876
|
)
|
|
|
(35,312,473
|
)
|
Less: realized interest income but not yet received
|
|
|
(9,869,358
|
)
|
|
|
(4,621,490
|
)
|
Less: allowance for net investment receivable
|
|
|
(1,802,822
|
)
|
|
|
|
|
Investment in sales-type leases, net
|
|
|
113,705,104
|
|
|
|
111,092,431
|
|
Current portion
|
|
|
13,076,516
|
|
|
|
9,385,453
|
|
Noncurrent portion
|
|
$
|
100,628,588
|
|
|
$
|
101,706,978
|
|
As of December 31,
2017, the future minimum rentals to be received on non-cancelable sales-type leases by years are as follows:
2018
|
|
$
|
39,761,386
|
|
2019
|
|
|
20,102,514
|
|
2020
|
|
|
21,795,120
|
|
2021
|
|
|
21,002,447
|
|
2022
|
|
|
21,939,921
|
|
Thereafter
|
|
|
97,531,541
|
|
Total
|
|
$
|
222,132,929
|
|
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 $0.71 million and $0.65 million prepaid
consulting expense as of December 31, 2017 and 2016, respectively. The Company had $34,026 and $32,050 prepaid tax as of December
31, 2017 and 2016.
6. OTHER RECEIVABLES
As of December 31,
2017, other receivables mainly consisted of (i) advances to third parties of $7,652, bearing no interest, payable upon demand;
and (ii) maintenance cost and tax receivable of $3.06 million. As of December 31, 2016, other receivables mainly consisted of
an advance to a third party of $0.53 million, bearing no interest, payable upon demand; and advances to employees of $0.02 million,
bearing no interest, payable upon demand.
7. LONG TERM INVESTMENT
On June 25, 2013, Xi’an
TCH with HongyuanHuifu Venture Capital Co. Ltd (“HongyuanHuifu”) jointly established 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 $176,481 and $258,817 equity based investment loss during the years ended December 31,
2017 and 2016, respectively.
On July 18, 2013, the
HYREF Fund was established as a limited liability partnership in Beijing. Pursuant to the Partnership Agreement, the HYREF Fund
has a general partner, the Fund Management Company, which made an initial capital contribution of RMB 5 million ($0.83 million)
to the HYREF Fund. The HYREF Fund has three limited partners: (1) China Orient Asset Management Co., Ltd., which made an initial
capital contribution of RMB 280 million ($46.67 million) and is a preferred limited partner, (2) HongyuanHuifu, which made an initial
capital contribution of RMB 100 million ($16.67 million) and is an ordinary limited partner and (3) the Company’s wholly-owned
subsidiary, Xian TCH, which made an initial capital contribution of RMB 75 million ($10.81 million) and is a secondary limited
partner. The term of the HYREF Fund’s partnership is six years from the date of its establishment, July 18, 2013. The current
term for (x) the preferred limited partner is four years from the date of its contribution and (y) the ordinary limited partner
is four years from the date of its contribution. Unless otherwise approved by the general partner (the Fund Management Company),
upon the expiration of their respective terms, each partner shall exit from the partnership automatically. The total size of the
HYREF Fund is RMB 460 million ($75.0 million), and the purpose of the HYREF Fund is to invest in Zhonghong for constructing 3 new
CDQ WHPG projects. Xi’an TCH owns 16.3% of the HYREF Fund. The Company accounted for this investment using the cost method.
The Company netted off the investment of RMB 75 million ($10.81 million) by Xi’an TCH with the entrusted loan payable of
the HYREF Fund.
8. CONSTRUCTION IN PROGRESS
Construction in progress
was for constructing power generation systems. As of December 31, 2017 and 2016, the Company’s construction in progress included:
|
|
2017
|
|
|
2016
|
|
Xuzhou Huayu
|
|
$
|
24,976,178
|
|
|
$
|
23,525,925
|
|
Xuzhou Tian’an
|
|
|
37,814,637
|
|
|
|
32,471,977
|
|
Boxing County Chengli
|
|
|
32,375,158
|
|
|
|
30,495,280
|
|
Total
|
|
$
|
95,165,973
|
|
|
$
|
86,493,182
|
|
As of December 31,
2017, the Company was committed to pay an additional (1) $12.24 million for the Xuzhou Huayu project, (2) $4.25 million for the
Xuzhou Tian’an project, and (3) $4.72 million for Boxing County Chengli project. The Boxing County Chengli project has finished
construction, but is waiting for government approval before beginning operations.
9. TAXES PAYABLE
Taxes payable consisted
of the following as of December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
Income - current
|
|
$
|
1,097,768
|
|
|
$
|
773,397
|
|
VAT
|
|
|
1,145,363
|
|
|
|
366,230
|
|
Other
|
|
|
180,649
|
|
|
|
63,050
|
|
Total - current
|
|
|
2,423,780
|
|
|
|
1,202,677
|
|
Income - noncurrent
|
|
$
|
6,998,625
|
|
|
$
|
-
|
|
Income tax payable
consisted approximately $7.60 million tax expense ($0.61 million current and $6.99 million noncurrent) from recording the estimated
one-time transition tax on post-1986 foreign unremitted earnings under the Tax Cut and Jobs Act signed on December 22, 2017. An
election is available for the US shareholder of foreign company to pay the tax liability in installments over a period of eight
years with 8% of net tax liability in the first five years, 15% in the sixth year, 20% in the seventh year, and 25% in the eighth
year.
10. ACCRUED LIABILITIES AND OTHER PAYABLES
Accrued liabilities
and other payables consisted of the following as of December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
Employee training, labor union expenditure and social insurance payable
|
|
$
|
852,316
|
|
|
$
|
760,021
|
|
Consulting, auditing, and legal expenses
|
|
|
480,057
|
|
|
|
468,393
|
|
Accrued payroll and welfare
|
|
|
261,793
|
|
|
|
322,605
|
|
Accrued interest
|
|
|
-
|
|
|
|
1,569
|
|
Other
|
|
|
24,150
|
|
|
|
43,992
|
|
Total
|
|
$
|
1,618,316
|
|
|
$
|
1,596,580
|
|
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 December 31,
2017 and 2016, deferred tax liability consisted of the following:
|
|
2017
|
|
|
2016
|
|
Deferred tax asset — current (accrual of employee social insurance)
|
|
$
|
189,617
|
|
|
$
|
167,980
|
|
Deferred tax liability — current (net investment in sales-type leases)
|
|
|
(1,828,246
|
)
|
|
|
(1,586,058
|
)
|
Deferred tax liability, net of current deferred tax asset
|
|
$
|
(1,638,629
|
)
|
|
$
|
(1,418,078
|
)
|
|
|
|
|
|
|
|
|
|
Deferred tax asset — noncurrent (depreciation of fixed assets)
|
|
$
|
17,709,919
|
|
|
$
|
17,943,843
|
|
Deferred tax asset — noncurrent (asset impairment loss)
|
|
|
450,706
|
|
|
|
-
|
|
Deferred tax liability — noncurrent (net investment in sales-type leases)
|
|
|
(25,157,147
|
)
|
|
|
(25,426,744
|
)
|
Deferred tax liability, net of noncurrent deferred tax asset
|
|
$
|
(6,996,522
|
)
|
|
$
|
(7,482,901
|
)
|
|
|
|
|
|
|
|
|
|
Total Deferred tax liability, noncurrent per ASU 2015-17
|
|
$
|
(8,635,151
|
)
|
|
$
|
8,900,979
|
|
12. LOANS PAYABLE
Entrusted Loan Payable
The HYREF Fund (Beijing
Hongyuan Recycling Energy Investment Center, LLP) established in July 2013 with total fund size of RMB 460 million ($75.0 million)
invests in Xi’an Zhonghong for Zhonghong’s three new CDQ WHPG projects. The HYREF Fund invested RMB 3 million ($0.5
million) as an equity investment and RMB 457 million ($74.5 million) as a debt investment in Xi’an Zhonghong; in return for
such investments, the HYREF Fund will receive interest from Zhonghong for the HYREF Fund’s debt investment. The RMB 457 million
($74.5 million) was released to Zhonghong through an entrusted bank, which is also the supervising bank for the use of the loan.
The loan was deposited in a bank account at the Supervising Bank (the Industrial Bank Xi’an Branch) and is jointly supervised
by Zhonghong and the Fund Management Company. Project spending shall be verified by the Fund Management Company to confirm that
it is in accordance with the project schedule before the funds are released. All the operating accounts of Zhonghong have been
opened with the branches of the Supervising Bank and the Supervising Bank has the right to monitor all bank accounts opened by
Zhonghong. The entrusted bank will charge 0.1% of loan amount as service fee and will not take any lending risk. The loan was collateralized
by the accounts receivable and the fixed assets of Shenqiu Phase I and II power generation systems, the accounts receivable and
fixed assets of Zhonghong’s three CDQ WHPG systems, and a 27 million RMB capital contribution made by Xi’an TCH. Repayment
of the loan (principal and interest) was also jointly and severally guaranteed by Xi’an TCH and the Chairman and CEO of the
Company. In the fourth quarter of 2015, three power stations of Erdos TCH were pledged to Industrial Bank as an additional guarantee
for the loan lent to Zhonghong’s three CDQ WHPG systems. In 2016, two additional power stations of Erdos TCH and Pucheng
Phase I and II systems were pledged to Industrial Bank as an additional guarantee along with Xi’an TCH’s equity in
Zhonghong.
The loan agreement
provides that Zhonghong shall also maintain a certain capital level in its account with the Supervising Bank to make sure it has
sufficient funds to make interest payments when they are due:
|
●
|
During the first three years from the first release of the loan, the balance in its account shall be no less than RMB 7.14 million ($1.19 million) on the 20th day of the second month of each quarter and no less than RMB 14.28 million ($2.38 million) on the 14th day of the last month of each quarter;
|
|
●
|
During the fourth year from the first release of the loan, the balance in its account shall be no less than RMB 1.92 million ($0.32 million) on the 20th day of the second month of each quarter and no less than RMB 3.85 million ($0.64 million) on the 14th day of the last month of each quarter; and
|
|
|
|
|
●
|
During the fifth year from the first release of the loan, the balance in its account shall be no less than RMB 96,300 ($16,050) on the 20th day of the second month of each quarter and no less than RMB 192,500 ($32,080) on the 14th day of the last month of each quarter.
|
The term of this loan is for 60 months
from July 31, 2013 to July 30, 2018. On August 6, 2016, Zhonghong was to repay principal of RMB 280 million ($42.22 million); on
August 6, 2017, Zhonghong was supposed to repay principal of RMB 100 million ($16.27 million) and on July 30, 2018, Zhonghong shall
repay the remainder of RMB 77 million ($12.52 million). The interest rate is 12.5%. During the term, Zhonghong shall maintain a
minimal funding level and capital level in its designated account with the Supervising Bank to make sure it has sufficient funds
to make principal payments when they are due. Notwithstanding the requirements, the HYREF Fund and Supervising Bank have verbally
notified Zhonghong from the beginning that unlikely they will enforce these requirements for the purpose of the efficient utilization
of working capital. As of December 31, 2017, the entrusted loan payable had an outstanding balance of $62.29 million, of which,
$11.47 million was from the investment of Xi’an TCH; accordingly, the Company netted the loan payable of $11.47 million with
the long-term investment to the HYREF Fund made by Xi’an TCH. For the years ended December 31, 2017 and 2016, the Company
recorded interest expense of $4.41 million and $5.57 million on this loan, respectively; and capitalized $3.34 million and $2.75
million interest to construction in progress, respectively. The Company had fully paid RMB 50 million ($7.54 million) of the RMB
280 million ($42.22 million), and on August 5, 2016, the Company entered into a supplemental agreement with the lender to extend
the due date of the remaining RMB 230 million ($34.68 million) of the original RMB 280 million ($45.54 million) to August 6, 2017.
During the year ended December 31, 2017, the Company negotiated with the lender again for further extending the remaining loan
balance of RMB 230 million ($34.68 million), RMB 100 million ($16.27 million), and RMB 77 million ($12.52 million) (which included
investment from Xi’an TCH of RMB 75 million and was netted off with the entrusted loan payable of the HYREF Fund in the balance
sheet). The lender has tentatively agreed to extend the remaining loan balance for another two years until August 2019 with an
adjusted annual interest rate of 9%, subject to the final approval from its headquarters. The related extension documents are currently
going through the lender’s internal approval procedure.
Due to the slow progress
of the construction of the three CDQ WHPG projects, the Company applied for a lower interest rate from the lender in January 2017,
and the lender tentatively agreed to lower the interest rate to 9% in December 2017 subject to the approval from its headquarters.
The Company planned to repay the interest once the lender’s internal approval procedure is officially completed. As of December
31, 2017, the interest payable for this loan was $8.13 million.
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 loaned $6.29 million (RMB 40 million) to
Xi’an TCH for one year due June 25, 2016. The monthly interest on the loan was 0.595%. Under the terms of the loan, Xi’an
TCH was required to make monthly interest payments and the principal was to be repaid at maturity. The loan was 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. This loan was repaid in full in 2016.
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
loaned $8.13 million (RMB 50 million) to Xi’an TCH for three years with maturity on April 10, 2017. The annual
interest on the loan was 9.225%. Under the terms of the loan, Xi’an TCH was 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. This loan
was repaid in full on April 10, 2017.
Summary
As of December 31,
2017, the future minimum repayment of all the loans including the entrusted loan to be made by years is as follows:
2018
|
|
$
|
50,825,375
|
|
Total
|
|
$
|
50,825,375
|
|
13. REFUNDABLE DEPOSIT FROM CUSTOMERS
FOR SYSTEMS LEASING
As of December 31,
2017 and 2016, the balance of refundable deposit from customers for systems leasing for Pucheng and Shengqiu was $1,086,591 and
$1,023,497, respectively.
14. RELATED PARTY TRANSACTIONS
As of December 31, 2017 and 2016, the Company
had $43,623 and $44,059 in advances from the Company’s management, which bear no interest, are unsecured, and are payable
upon demand.
During the year ended
December 31, 2017, the Company recognized RMB 26.44 million ($3.92 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 the
Company through the issuance of the Company’s common stock to this stockholder in consideration for the transfer of the old
system to the Company for BMPG system transformation. The Company recognized RMB 28.47 million ($4.29 million) interest income
for the sales-type lease of Pucheng BMPG systems during year ended December 31, 2016. On November 29, 2017, Pucheng’s
major shareholder disposed of his stock, and Pucheng was no longer a related party of Xi’an TCH. Interest income from Pucheng project
for the period from January 1, 2017 to November 29, 2017 was RMB 24.31 million ($3.60 millon).
During the year ended
December 31, 2016, prior to the repurchase date of June 22, 2016, 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 the Company through the issuance of the Company’s common stock to this stockholder in consideration
for the transfer of the WGPG system to the Company in 2014.
15. NONCONTROLLING INTEREST
On July 15, 2013, Xi’an
TCH and HYREF Fund jointly established Xi’an Zhonghong New Energy Technology (“Zhonghong”) with registered capital
of RMB 30 million ($4.88 million), to manage new projects. Xi’an TCH paid RMB 27 million ($4.37 million) as its contribution
of the registered capital to Zhonghong. Xi’an TCH owns 90% of Zhonghong while HYREF Fund owns 10% of Zhonghong as a non-controlling
interest of Zhonghong.
In addition, the HYREF
Fund was 16.3% owned by Xi’an TCH and 1.1% owned by the Fund Management Company, and the Fund Management Company was 40%
owned by Xi’an TCH as described in Note 7, which resulted in an additional indirect ownership of Xi’an TCH in Zhonghong
of 1.7%; accordingly, the ultimate non-controlling interest (HYREF Fund) in Zhonghong became 8.3%. During the years ended December
31, 2017 and 2016, the Company had losses of $327,147 and $347,136 that were attributable to noncontrolling interest, respectively.
16. INCOME TAX
The Company’s Chinese subsidiaries
are governed by the Income Tax Law of the PRC concerning privately-run enterprises, which are generally subject to tax at 25% on
income reported in the statutory financial statements after appropriate tax adjustments. Under the Chinese tax law, the tax treatment
of finance and sales-type leases is similar to US GAAP. However, the local tax bureau continues to treat CREG sales-type leases
as operating leases. Accordingly, the Company recorded deferred income taxes.
The Company’s
subsidiaries generate all of their income from their PRC operations. Yinghua and Shanghai TCH’s effective income tax rate
for 2017 and 2016 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 2017
and 2016 due to the renewal of preferential income tax rate was not approved by the tax authority. Huahong, Zhonghong and Erdos
TCH’s effective income tax rate for 2017 and 2016 was 25%. Yinghua, Shanghai TCH, Xi’an TCH, Huahong, Zhonghong and
Erdos TCH file separate income tax returns.
There is no income tax for companies domiciled
in the Cayman Islands. Accordingly, the Company’s CFS do not present any income tax provisions related to Cayman Islands
tax jurisdiction, where Sifang Holding is domiciled.
The US parent company,
China Recycling Energy Corporation, is taxed in the US and, as of December 31, 2017, had net operating loss (“NOL”)
carry forwards for income taxes of $14.32 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 years ended December 31, 2017 and 2016, respectively:
|
|
2017
|
|
|
2016
|
|
U.S.
statutory rates
|
|
|
(34.0
|
)%
|
|
|
34.0
|
%
|
Tax
rate difference – current provision
|
|
|
7.3
|
%
|
|
|
(16.9
|
)%
|
Other
|
|
|
(-
|
)%
|
|
|
0.7
|
%
|
Tax
rate change for future deferred tax items
|
|
|
11.2
|
%
|
|
|
(10.1
|
)%
|
Prior
periods income tax adjustment per income tax return filed
|
|
|
(1.5
|
)%
|
|
|
(2.8
|
)%
|
Section
965 one-time transition tax
|
|
|
747.3
|
%
|
|
|
|
|
Permanent
differences
|
|
|
0.4
|
%
|
|
|
(165.9
|
)%
|
Valuation
allowance on PRC NOL
|
|
|
84.2
|
%
|
|
|
0.1
|
%
|
Valuation
allowance on US NOL
|
|
|
6.0
|
%
|
|
|
30.0
|
%
|
Tax
(benefit) per financial statements
|
|
|
820.9
|
%
|
|
|
(130.9
|
)%
|
The provision for income
taxes expense for years ended December 31, 2017 and 2016 consisted of the following:
|
|
2017
|
|
|
2016
|
|
Income tax expense – current
|
|
$
|
9,101,025
|
|
|
$
|
1,899,005
|
|
Income tax benefit – deferred
|
|
|
(788,276
|
)
|
|
|
(2,737,993
|
)
|
Total income tax expense (benefit)
|
|
$
|
8,312,749
|
|
|
$
|
(838,988
|
)
|
On
December 22, 2017, the Tax Cut and Jobs Act (“Tax Act”) was signed into law in the United States. The Tax Act introduced
a broad range of tax reform measures that significantly change the federal income tax laws. The provisions of the Tax Act that
may have significant impact on the Company include the permanent reduction of the corporate income tax rate from 35% to 21% effective
for tax years including or commencing on January 1, 2018, a one-time transition tax on post-1986 foreign unremitted earnings, the
provision for Global Intangible Low Tax Income (“GILTI”), the deduction for Foreign Derived Intangible Income (“FDII”),
the repeal of corporate alternative minimum tax, the limitation of various business deductions, and the modification of the maximum
deduction of net operating loss with no carryback but indefinite carryforward provision. Many provisions in the Tax Act are generally
effective in tax years beginning after December 31, 2017.
At
December 31, 2017, the Company reflected the provisional income tax effects of the Tax Act under Accounting Standards Codification
Topic 740, Income Taxes. The Company has recorded a provisional tax expense in the Statement of Operations of approximately $8.31
million, comprised of approximately $7.61 million tax expense from recording the estimated one-time transition tax on post-1986
foreign unremitted earnings.
The Company continues
to examine the impact of certain provisions of the Tax Act that will become applicable in calendar year 2018 related to Base Erosion
and Anti Abuse Tax (“BEAT”), GILTI, deduction for FDII, and other provisions that could affect its effective tax rate
in the future. The Company will record the income tax effects of GILTI and other provisions of the Tax Act as incurred beginning
in calendar year 2018. Also, because there may be additional state income tax implications, the Company will continue to monitor
changes in state and local tax laws to determine if state and local taxing authorities intend to conform or deviate from changes
to U.S. federal tax legislation as a result of the Tax Act. The prospects of supplemental legislation or regulatory processes to
address questions that arise because of the Tax Act, or evolving technical interpretations of the tax law, may cause the final
impact from the Tax Act to differ from the provisionally recorded amounts. The Company expects to complete its analysis within
the measurement period allowed by Staff Accounting Bulletin (“SAB”) No.118, no later than the fourth quarter of calendar
year 2018.
China maintains a “closed” capital
account, meaning companies, banks, and individuals cannot move money in or out of the country except in accordance with strict
rules. The People’s Bank of China (PBOC) and State Administration of Foreign Exchange (SAFE) regulate the flow of foreign
exchange in and out of the country. For inward or outward foreign currency transactions, the Company needs to make a timely declaration
to the bank with sufficient supporting documents to declare the nature of the business transaction.
Consolidated
foreign pretax earnings (loss) approximated $(0.83) million loss and $1.21 million income for the years ended December 31, 2017
and 2016, respectively. Pretax earnings of a foreign subsidiary are subject to US taxation when repatriated. Undistributed earnings
of the Company’s foreign subsidiaries amounted to approximately $99.37 million as of December 31, 2017, of which all was subject
to the one-time transition tax on foreign unremitted earnings required by the Tax Act or has otherwise been previously subject
to U.S. tax. Those earnings are considered to be permanently reinvested and accordingly, no deferred tax expense is recorded for
U.S. federal and state income tax or applicable withholding taxes.
17. STOCK-BASED COMPENSATION PLAN
Options to Employees
On June 19, 2015, the
stockholders of the Company approved the China Recycling Energy Corporation Omnibus Equity Plan (the “Plan”) at its
annual meeting. The total shares of common stock authorized for issuance during the term of the Plan is 12,462,605 (prior to the
10:1 Reverse Stock Split). The Plan was effective immediately upon the adoption by our Board of Directors on April 24, 2015, subject
to stockholder approval, and will terminate on the earliest to occur of (i) the 10th anniversary of the Plan’s effective
date, or (ii) the date on which all shares available for issuance under the Plan shall have been issued as fully-vested shares.
The stockholders approved the Plan at its annual meeting on June 19, 2015.
On April 27, 2017,
the Board approved the grant to the Company’s CFO of an option to purchase 5,000 shares of the Company’s common stock
at an exercise price of $1.61 per share, with a term of 10 years. The option vested immediately upon the grant.
The FV of the stock option granted is estimated
on the date of the grant using the Black-Scholes option pricing model (“BSOPM”). The BSOPM has assumptions for risk
free interest rates, dividends, stock volatility and expected life of an option grant. The risk-free interest rate is based upon
market yields for United States Treasury debt securities at a maturity near the term remaining on the option. Dividend rates are
based on the Company’s dividend history. The stock volatility factor is based on the historical volatility of the Company’s
stock price. The expected life of an option grant is based on management’s estimate as no options have been exercised in
the Plan to date. The FV of the option granted to employees is recognized as compensation expense over the vesting period of the
stock option award. The FV of the options was calculated using the following assumptions, estimated life of ten years, volatility
of 124%, risk free interest rate of 2.30%, and dividend yield of 0%. The FV of the 5,000 stock options was $7,647 at the grant
date.
Options to Independent Directors
On March 31, 2015,
the Board appointed Mr. Cangsang Huang as a member of the Company’s Board of Directors to fill a vacancy. In connection with
the appointment, the Board authorized the Company to provide Mr. Huang with (i) compensation of $2,000 per month and (ii) the grant
of an option to purchase 40,000 shares of the Company’s Common Stock, par value $0.001, at an exercise price of $1.02 per
share (prior to the 10:1 Reverse Stock Split effective May 25, 2016), which was equal to the closing price per share of the Company’s
Common Stock on March 31, 2015. Such options were only valid and exercisable upon stockholder approval. The options to Mr. Huang
were not voted upon at the Company’s annual stockholder’s meeting on June 19, 2015 and were cancelled automatically.
However, the Company’s Plan adopted by the Board on April 24, 2015 for providing equity awards to employees, directors and
consultants was approved at the annual stockholder’s meeting; accordingly, the Compensation Committee of the Board of Directors
approved a grant of 40,000 options (prior to the 10:1 Reverse Stock Split) to Mr. Huang at an exercise price of $1.02 per share
under the Plan, which vested immediately on the date of grant, which was on October 10, 2015. The options may be exercised within
five years of the date of the grant. The FV of the options was calculated using the following assumptions, estimated life of five
years, volatility of 82%, risk free interest rate of 1.37%, and dividend yield of 0%. The FV of the 40,000 stock options was $26,528
at the grant date.
The Company recorded
$7,647 and $0 compensation expense for stock options to employees during years ended December 31, 2017 and 2016.
The following table
summarizes option activity with respect to employees and independent directors, the number of options reflects the 10:1 Reverse
Stock Split effective May 25, 2016:
|
|
Number of
Shares
|
|
|
Average Exercise Price per Share
|
|
|
Weighted
Average
Remaining
Contractual
Term in Years
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at January 1, 2016
|
|
|
4,000
|
|
|
$
|
10.2
|
|
|
|
4.77
|
|
Exercisable at January 1, 2016
|
|
|
4,000
|
|
|
|
10.2
|
|
|
|
4.77
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding at December 31, 2016
|
|
|
4,000
|
|
|
|
10.2
|
|
|
|
3.77
|
|
Exercisable at December 31, 2016
|
|
|
4,000
|
|
|
|
10.2
|
|
|
|
3.77
|
|
Granted
|
|
|
5,000
|
|
|
|
1.6
|
|
|
|
10
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding at December 31, 2017
|
|
|
9,000
|
|
|
|
5.4
|
|
|
|
6.41
|
|
Exercisable at December 31, 2017
|
|
|
9,000
|
|
|
$
|
5.4
|
|
|
|
6.41
|
|
18. STATUTORY RESERVES
Pursuant to the corporate
law of the PRC effective January 1, 2006, the Company is only required to maintain one statutory reserve by appropriating from
its after-tax profit before declaration or payment of dividends. The statutory reserve represents restricted retained earnings.
Surplus Reserve Fund
The Company’s
Chinese subsidiaries are required to transfer 10% of their net income, as determined under PRC accounting rules and regulations,
to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital.
The surplus reserve
fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be
utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to
their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance
after such issue is not less than 25% of the registered capital.
The maximum statutory
reserve amount has not been reached for any subsidiary. The table below discloses the statutory reserve amount in the currency
type registered for each Chinese subsidiary as of December 31, 2017.
Name of Chinese
Subsidiaries
|
|
Registered Capital
|
|
|
Maximum Statutory
Reserve Amount
|
|
|
Statutory reserve at
December 31, 2017
|
|
|
|
|
|
|
|
|
|
Shanghai TCH
|
|
$
|
29,800,000
|
|
|
$
|
14,900,000
|
|
|
¥ 6,564,303 ($1,003,859)
|
|
|
|
|
|
|
|
|
|
|
|
Xi’an TCH
|
|
¥
|
202,000,000
|
|
|
¥
|
101,000,000
|
|
|
¥ 69,359,820 ($10,606,984)
|
|
|
|
|
|
|
|
|
|
|
|
Erdos TCH
|
|
¥
|
120,000,000
|
|
|
¥
|
60,000,000
|
|
|
¥ 20,418,368 ($3,122,518)
|
|
|
|
|
|
|
|
|
|
|
|
Xi’an Zhonghong
|
|
¥
|
30,000,000
|
|
|
¥
|
15,000,000
|
|
|
Did not accrue yet due to accumulated deficit
|
|
|
|
|
|
|
|
|
|
|
|
Shaanxi Huahong
|
|
$
|
2,500,300
|
|
|
$
|
1,250,150
|
|
|
Did not accrue yet due to accumulated deficit
|
|
|
|
|
|
|
|
|
|
|
|
Zhongxun
|
|
¥
|
35,000,000
|
|
|
¥
|
17,500,000
|
|
|
Did not accrue yet due to accumulated deficit
|
Common Welfare Fund
The common welfare
fund is a voluntary fund to which the Company can transfer 5% to 10% of its net income. This fund can only be utilized on capital
items for the collective benefit of the Company’s employees, such as construction of dormitories, cafeteria facilities, and
other staff welfare facilities. This fund is non-distributable other than upon liquidation. The Company does not participate in
this fund
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 December 31, 2017, the Company
had outstanding notes receivable of $979,462, and endorsed notes receivable to vendors of $1.41 million; at December 31, 2016,
the Company had outstanding and endorsed 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 two years; the monthly rental payment is $20,140. The
lease for the office in Xi’an was renewed for another two years starting on March 5, 2016 with a monthly rental payment of
$21,804 but payable quarterly in advance. However, the Company decided not to lease Xi’an TCH’s office after October
15, 2017. The landlord provided 45 days to the Company for moving without charging rent after October 15, 2017. There was no penalty
for not complying with the lease agreement since the Company used to prepay three-month rent in advance.
On November 20, 2017,
Xi’an TCH entered a lease agreement for its office use for a lease term from December 1, 2017 through November 30, 2020.
The monthly rent is RMB 36,536 ($5,600) with quarterly payment in advance. The annual rental payment is $67,200, $67,200 and $61,600
for the years ending December 31, 2018, 2019 and 2020.
For the years ended December 31, 2017 and
2016, the rental expense of Xi’an TCH was $197,143 and $245,699, respectively.
Construction Commitment
Refer to Note 1 for
additional details related to lease commitments with Chengli, and Tianyu (and its subsidiaries Xuzhou Tian’an and Xuzhou
Huayu), Note 8 for commitments on construction in progress.
21. SUBSEQUENT EVENTS
The Company has evaluated
subsequent events that occurred subsequent to December 31, 2017, 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.