Registration of Securities (General Form) — Form 10 Filing Table of Contents
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10-12B — Registration of Securities (General Form)
(Exact
name of registrant as specified in its charter)
Nevada
(State or
other jurisdiction of incorporation or organization)
90-0093373
(I.R.S.
Employer Identification No.)
12/F,
Tower A
Chang
An International Building
No.
88 Nan Guan Zheng Jie
Xi
An City, Shan Xi Province
China
710068
(Address
of principal executive offices)
710068
(Zip
Code)
Registrant’s
telephone number, including area code: (011) (86-29) 8765-1097
Securities
to be registered pursuant to Section 12(b) of the Act:
Title
of each class
to be so registered
Name
of each exchange on which
each class is to be
registered
Common
stock, par value $0.001 per share
NASDAQ
Global Market
Securities
registered pursuant to Section 12(g) of the Act:
NONE
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,”“accelerated filer” and “small
reporting company” in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
o
(Do
not check if a smaller reporting company)
Smaller reporting company
x
CHINA
RECYCLING ENERGY CORPORATION
FORM
10
TABLE
OF CONTENTS
Item
1.
Business
1
Item
1A.
Risk
Factors
6
Item
2.
Financial
Information
9
Item
3.
Properties
20
Item
4.
Security
Ownership of Certain Beneficial Owners and Management
21
Item
5.
Directors
and Executive Officers
22
Item
6.
Executive
Compensation
23
Item
7.
Certain
Relationships and Related Transactions, and Director
Independence
25
Item
8.
Legal
Proceedings
25
Item
9.
Market
Price of and Dividends on the Registrant’s Common Equity and Related
Stockholder Matters
26
Item
10.
Recent
Sales of Unregistered Securities
26
Item
11.
Description
of Registrant’s Securities to be Registered
29
Item
12.
Indemnification
of Directors and Officers
29
Item
13.
Financial
Statements and Supplementary Data.
30
Item
14.
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
30
Item
15.
Financial
Statements and Exhibits
30
When we
use the terms ”we,””us,””our” and “the Company,” we mean China Recycling
Energy Corporation., a Nevada corporation, and its wholly-owned subsidiary,
Sifang Holdings Co., Ltd., and Sifang Holdings Co., Ltd.’s wholly-owned
subsidiary, Shanghai TCH Energy Technology Co., Ltd. and Shanghai TCH Energy
Technology Co., Ltd’s wholly-owned subsidiary, Xi’an TCH Energy Technology Co.,
Ltd. Prior to March 8, 2007, China Recycling Energy Corporation’s name was China
Digital Wireless, Inc.
ITEM
1. BUSINESS
General
We
currently engage in the recycling energy business, providing energy savings and
recycling products and services.
Overview
Business
History.
We
originally began operations as a Colorado corporation known as Boulder Brewing
Company, or Boulder Brewing. We were incorporated in Colorado on May 8, 1980 and
operated as a microbrewery of various beers. Boulder Brewing was unable to
become profitable within any segment of its core business, became illiquid, and
was forced to divest itself of all of its assets. Boulder Brewing became dormant
without any operations or assets in the second quarter of 1990.
In
September 2001, Boulder Brewing changed its state of incorporation from Colorado
to Nevada and changed its name to Boulder Acquisitions, Inc., or Boulder
Acquisitions. From the date of reincorporation until June 23, 2004, Boulder
Acquisitions had no material operations or assets.
On June23, 2004, we completed a stock exchange transaction with the shareholders of
Sifang Holdings Co., Ltd. (“Sifang Holdings”). The exchange was consummated
under Nevada and Cayman Islands law pursuant to the terms of a Securities
Exchange Agreement dated as of June 23, 2004 by and among Boulder Acquisitions,
Sifang Holdings and the shareholders of Sifang Holdings. Pursuant to the
Securities Exchange Agreement, we issued 13,782,636 shares of our common stock
to the shareholders of Sifang Holdings, representing approximately 89.7% of our
post-exchange issued and outstanding common stock, in exchange for 100% of the
outstanding capital stock of Sifang Holdings. We presently carry on the business
of Sifang Holdings’ wholly-owned subsidiary, Shanghai TCH Energy
Technology Co., Ltd. or Shanghai TCH, a corporation organized under the laws of
the People’s Republic of China (“PRC” or “China”).
Effective
August 6, 2004, we changed our name from Boulder Acquisitions, Inc. to
China Digital Wireless, Inc.
From
August 2004 to December 2006, we primarily engaged in the business of pager and
mobile phone distribution and provided value added information services to the
customers in the PRC. We gradually phased out and substantially
scaled down most of the business of mobile phone distribution and provision of
pager and mobile phone value-added information services, and on May 10, 2007,
the Company approved and announced that it completely ceased and discontinued
these businesses.
In
December 2006, we began to engage in business activities in the energy saving
and recycling industry, including purchasing certain equipment, devices,
hardware and software for the construction and installation of top gas recovery
turbine systems (“TRT”) and other renewable energy products. TRT is an
electricity generating system that utilizes the exhaust pressure and heat
produced in the blast furnace of steel mills to generate electricity. It has
commercial value for the steel mills by using waste heat and steam to produce
electricity for the operation of the mills.
On March8, 2007, we changed our name from China Digital Wireless, Inc. to China
Recycling Energy Corporation.
On April8, 2007, our Board of Directors approved and made effective a TRT Project
Joint-Operation Agreement (“Joint-Operation Agreement”) which was conditionally
entered on February 1, 2007 between Shanghai TCH and Xi’an Yingfeng Science and
Technology Co., Ltd.(“Yingfeng”). Yingfeng is a Chinese company that is located
in Xi’an, Shaanxi Province, China, which is engaged in the business of
designing, selling, installing, and operating TRT systems and other renewable
energy products.
Under the
Joint-Operation Agreement, Shanghai TCH and Yingfeng jointly pursued a top gas
recovery turbine project (“Project”) to design, construct, install and operate a
TRT system in Xingtai Iron and Steel Company, Ltd. (“Xingtai”). This project was
originally initiated by a Contract to Design and Construct TRT System (“Project
Contract”) entered by Yingfeng and Xingtai on September 26, 2006. Due to
Yingfeng’s lack of capital in pursuing this Project alone, Yingfeng sought
Shanghai TCH’s cooperation. After intensive and substantial inquiry and
assessment, Shanghai TCH agreed to pursue this project with Yingfeng as a joint
venture. Under the terms of the Joint-Operation Agreement, Shanghai TCH provided
various forms of investments and properties into the Project including cash,
hardware, software, equipments, major components and devices. In return,
Shanghai TCH obtained all the rights, titles, benefits and interests that
Yingfeng originally had under the Project Contract, including but not limited to
the cash payment made by Xingtai on regular basis and other property rights and
interests.
1
On
October 31, 2007, Shanghai TCH entered an asset-transfer agreement with Yingfeng
to transfer from Yingfeng to Shanghai TCH all electricity-generating related
assets owned by Yingfeng. As the result, the contractual relationships between
Shanghai TCH and Yingfeng under the TRT Project Joint-Operation Agreement
entered on April 8, 2007 were terminated.
In
November 2007, TCH signed a cooperative agreement with Shengwei Group for a
Cement Waste Heat Power Generator Project (“CHPG”). TCH will build two sets of
12MW pure low temperature cement waste heat power generator systems for
Shengwai’s two 2,500-tons-per-day cement manufacturing lines in Jin Yang and a
5,000-tons-per-day cement manufacturing line in Tong Chuan. Total
investment will be approximately $12,593,000 (RMB 93,000,000). At the
end of 2008, construction of the CHPG in Tong Chuan was completed at a total
cost of approximately $6,191,000 (RMB 43,000,000) and put into
operation. Under the original agreement, the ownership of the power
generator system would belong to Tong Chuan from the date the system is put into
service. TCH is responsible for the daily maintenance and repair of
the system, and charges Tong Chuan a monthly electricity fee based on the actual
power generated by the system at 0.4116 RMB per KWH for an operating period of
five years with the assurance from Tong Chuan of a properly functioning
5,000-tons-per-day cement manufacturing line and not less than 7,440 heat hours
per year for the electricity generator system. Shengwei Group
collateralized the cement manufacturing line in Tong Chuan to guarantee its
obligations to provide the minimum electricity income from the power generator
system under the agreement during the operating period. At the end of the five
year operating period, TCH will have no further obligations under the
cooperative agreement. On May 20, 2009, TCH entered into a
supplementary agreement with Shengwei Group to amend the timing for title
transfer until the end of the leasing term.
On
June 29, 2009, construction of the CHPG in Jin Yang was completed at a
total cost of approximately $7,318,000 (RMB 50,000,000) and put into
operation. TCH will charge Jin Yang a technical service fee of
$336,600 (RMB 2,300,000) monthly for sixty months. Jin Yang has the
right to purchase the ownership of the CHPG systems for $29,000 (RMB 200,000) at
the end of lease term. Jin Yang is required to provide assurance of properly
functioning 5,000-tons-per-day cement manufacturing lines and not less than
7,440 heat hours per year for the CHPG. Shengwei Group collateralized
the cement manufacturing lines in Jin Yang to guarantee its obligations to
provide the minimum electricity income from the power generator system under the
agreement during the operating period. Effective July 1, 2009, TCH
outsourced the operation and maintenance of the CHPG systems in Tong Chuan and
JinYang to a third party for total of $732,000 (RMB 5,000,000) per
year.
On April14, 2009, the Company incorporated a joint venture (“JV”) with Erdos Metallurgy
Co., Ltd. (“Erdos”) for recycling waste heat from Erdos 's metal
refining plants to generate power and steam, which will then be sold back to
Erdos. The name of the JV is Inner Mongolia Erdos TCH Energy Saving
Development Co., Ltd (“Erdos TCH”) with a term of 20 years, and the registered
capital of the JV is $2,635,000 (RMB 18,000,000). On September 30,2009, Xi’an TCH injected additional capital of $4.03 million (RMB 27,500,000).
Total investment for the project is estimated at approximately $74 million (RMB
500 million) with an initial investment of $8,773,000 (RMB
60,000,000). Erdos contributed 10% of the total investment of the
project, and Xi'an TCH contributed 90% of the total investment. Xi'an TCH and
Erdos will receive 80% and 20% of the profit allocation from the JV,
respectively, until Xi'an TCH has received a complete return on its
investment. Xi'an TCH and Erdos will then receive 60% and 40% of the
profit allocation from the JV, respectively. When the term of the JV expires,
Xi'an TCH will transfer its equity in the JV to Erdos at no additional
cost. By the end of 2009, the first power station unit was
completed.
During
2008, the Company also leased two energy recycling power generation equipment
systems under one-year, non-cancellable leases with the rents paid in full,
which the Company was able to sublease for higher rental income under one-year,
non-cancellable leases. The Company did not renew its lease when it expired in
April 2009, and as a result, the sublessee was unable to renew its lease with
the Company.
On
September 30, 2009, Xi’an TCH delivered to Shenmu County Juijiang Trading Co.,
Ltd. (“Shenmu”) a set of 18 megawatt capacity Waste Gas Power Generation
(“WGPG”) power generating systems pursuant to a Cooperative Contract on
Coke-oven Gas Power Generation Project (including its Supplementary Agreement)
and a Gas Supply Contract for Coke-oven Gas Power Generation
Project. The contracts are for 10 years and provide that Xi’an TCH
will recycle coke furnace gas from the coke-oven plant of Shenmu to generate
power, which will then be supplied back to Shenmu. Shenmu agrees to
supply Xi’an TCH the coke-oven gas free of charge. Under the
contracts, Shenmu will pay to the Company“energy-saving service fees” of
approximately $473,000 per month for the life of the contracts, as well as such
additional amount as may result from the supply of power to Shenmu in excess of
10.80 million kilowatt hours per month at the rate of 0.30 yuan (approximately
$0.04) per kilowatt hour. The Company is responsible for operating
the systems and will do so through an unrelated third party at a cost of
approximately $438,000 per year. Shenmu guarantees that monthly gas supply will
not be lower than 21.6 million standard cubic meters, delivered monthly. If gas
supply is lower than that, Shenmu agrees to pay Xi’an TCH an energy-saving
service fee, of up to 10.80 million kilowatt-hours a month, the amount of which
would result in “energy-saving service fees” of approximately $473,000 per
month. Xi’an TCH maintains the ownership of the project throughout the term of
the contracts, including the already completed investment, design, equipment,
construction and installation as well as the operation and maintenance of the
project. Xi’an TCH agrees to pay to Shenmu 50,000 yuan (about $7,300)
a year to use the land for the power station. At the end of the
10-year term, ownership of the systems transfers to Shenmu at no additional
charge. Shenmu agrees to provide a lien on its production line to
guarantee its performance under the contracts. Three individuals
provide an unlimited joint liability guarantee to Xi’an TCH for Shenmu’s
performance under the Contracts and the Yulin Huiyuan Group provides a guarantee
to Xi’an TCH for Shenmu’s performance under the contracts.
2
Starting
in November 2008, the Chinese government announced a series of economic stimulus
plans aimed at bolstering its weakening economy – a sweeping move to help fight
the effects of the global slowdown. In the announcements, China estimated it
would spend $586 billion over the next two years – roughly seven percent of its
gross domestic product each year – to construct new railways, subways and
airports and to rebuild communities devastated by an earthquake in the southwest
China in May 2008. The economic stimulus package is the largest effort ever
undertaken by the Chinese government. The government said that the stimulus
would cover ten areas, including low-income housing, electricity, water, rural
infrastructure and projects aiming at environmental protection and technological
innovation.
Our
current business is primarily conducted through our wholly-owned subsidiary,
Sifang Holdings and its wholly-owned subsidiaries, Shanghai TCH and Shanghai
TCH’s wholly-subsidiaries, Xi’an TCH Energy Technology Company, Ltd (“Xi’an
TCH”), Xingtai Huaxin Energy Tech Co., Ltd. (“Huaxin”), Xi’an TCH’s 90% owned
subsidiary Erdos TCH, and Sifang Holding’s subsidiary, Huahong New Energy
Technology Co., Ltd. (“Huahong”). Shanghai TCH was established as a
foreign investment enterprise in Shanghai under the laws of the PRC on May 25,2004, with registered capital of $7.2 million. Xi’an TCH was
established as a foreign investment enterprise in Xi’an, Shannxi Province under
the laws of the PRC on December 14, 2007. Huaxin was incorporated in Xingtai,
PRC in November, 2007. Erdos TCH was incorporated in April
2009. Huahong was registered in 2009.
Market
A.
Description
of the TRT (Blast Furnace Top-Gas Recovery Turbine Unit)
Market
Energy is
a major strategic issue affecting the development of the Chinese economy. The
Chinese government has committed to adjusting the economic structure and
changing the mode of economic growth in order to encourage the use of more
advanced and more environment-friendly technologies. Also, the Chinese
government has been promoting the development of a recycling economy and the
circulated use of resources by encouraging enterprises to engage in the
energy-recycling industry. Various government issued documents indicate the
government’s plan to promote the use of energy saving and recycling equipment
and systems.
The 2007
Report of China’s Iron & Steel Association predicted that 200 TRT
systems or plants will be installed in China from 2008 to 2010. The total amount
of investment is expected to reach RMB 5 billion (averaging RMB 2.5 million each
year), with an electricity-generation up to 11.2 billion KWH per
year.
TRT
projects are one of our core businesses and we have an excellent team
specialized in development, installation, production and operation of TRT
systems and equipment. Also, we have rich marketing experience in this field and
have become a leader in TRT market.
We
invested and built 3 TRT projects in 2007 (one for Shanxi Changzhi Steel Group,
and two for Hebei Xingtai Steel Group). In addition, we have one project
currently under construction and scheduled to be built up in 2010 for Zhonggang
Binhai.
B.
Description
of CHPG (Cement Low Temperature Heat Power Generation)
Market
Cement
waste heat power generation, or CHPG, is power generation by recovering cement
residual heat without additional fuel, to be built on NSP (New Suspension
Pre-heater Dry Process) cement clinker production lines.
1.
State of the market:
The
cement industry experienced substantial growth in China during past years
according to a February 2009 article of China’s Securities News . China’s
total investment in the cement industry reached RMB 105 billion ($15 billion) in
2008, a 60% increase from 2007. Of the RMB 105 billion ($15 billion)
investment, 65 percent was spent on building up NSP cement clinker production
lines, a 10% increase from 2007. It is estimated that the percentage of NSP
production lines of the total will rise to 70% by the end of 2009. There are
three main reasons for such strong demand of CHPG systems.
First,
during the period of the Chinese government’s 10th Five-Year Plan, the output of
NSP production lines reached 40% of the total cement output. The 11th
Five-Year plan has continued to promote the NSP production line as a primary
goal for the cement industry. This government promotion provides a good
foundation for CHPG.
Second,
with the development of China’s national economy, demand on electricity and coal
has been increasing, and the price for such materials has been rising. This
exerts a negative effect on cement enterprises. As the price of power and coal
reached the majority of the production cost and substantially exceeded the cost
of raw materials, companies are motivated to utilize CHPG in order to reduce
production cost.
3
Third, at
the end of the 10th Five-Year Plan and the start of the 11th Five-Year Plan, the
Chinese government called for an energy saving campaign and issued a Medium and Long-Term Plan on Special
Energy-Saving which indicated that CHPG should be widely used, and
specified that 30 CHPG systems be established annually on cement producing lines
with an output of 2000 tons daily. The 11th Five-Year Plan provides policy
support for development of CHPG.
2.
Market
prospects
The rapid
development of CHPG creates a good opportunity for the development, marketing
and sales of cement residual heat boilers. In 2006, eight Chinese state
ministries jointly issued Views on Adjustment of Structure of
Cement Industry that pointed out that by the year 2010, the percentage of
the NSP production lines equipped with CHPG should reach 40% and the total
output of cement will reach between 1.4 billion-1.5 billion tons up from 1.24
billion tons in 2006. According to regulations on Chinese saving-energy
industry, in the future, the NSP production will gradually replace shaft kiln
cement. The 2007 Report of China’s Cement Association estimated that there
will be a demand for more than 400 CHPG systems beyond 2010.
We
invested and have built two CHPG systems. One (Tongchuan) was
completed at the end of 2008 and the other (Jinyang) was completed at the end of
June 2009.
C.
Description of WGPG (Waste Gas
Power Generation)
During
the process of industrial production, some by-products, such as blast furnace
gas, coke furnace gas, oil gas, and others are created with certain high
intensive thermal energy. The waste gas can be collected and used as a fuel by
gas turbine system to generate power energy.
Gas
turbines are a set of hi-tech equipment and devices that is very crucial to the
energy development strategy of China. Gas turbine, which uses flammable gas as
fuel and combines with recycling power generating technology, has many
merits. These include high efficiency power generation, low
investment, short construction periods, small land usage, water savings,
environment protection and more. The market prospect of the gas
turbine industry is largely promising. A Bohai security analysis
report in 2008 indicated that “during Tenth Five-year Plan Period, the total
volume of Chinese gas power generating was almost 10 million KW and it will
reach to 20 million KW by 2010, and 60 million KW by 2020. The total
investment amount will be USD 27 billion.” The natural gas power plants being or
to be built, representing about 6% of the total equipment capability of China,
most of which are newly constructed projects, provide huge market potential for
gas turbine.
Through
years of research, development and experimental applications, this gas-to-energy
system has started to be applied into some high energy intensive industrial
plants, such as in the course of the iron-smelting in metallurgy
plants. Metallurgical enterprises, as the biggest industrial energy
user in China, consume 13%-15% of national electricity. Electricity
consumed by the iron-smelting industry accounts for 40% of that consumed by
metallurgical enterprises. If all top furnaces in the iron-smelting
industry are equipped with gas recovery systems, electricity consumption may be
decreased by 30-45%. Furthermore, environmental pollution will be
efficiently reduced while energy efficiency is improved in those heavy
industries.
We
invested and built up one WGPG facility for a coking plant (Shenmu) during the
third quarter of 2009. We are currently working with Erdos Metallurgy
to build up a cluster of WGPG systems. At the end of 2009, a first
power generation unit was completed and another unit is currently under
construction..
D.
Suppliers
1. Through
its business subsidiaries in China, the company believes it maintains good
relationships with TRT, CHPG and WGPG equipment suppliers, and these
relationships help provide cost-effective equipment purchasing for its intended
projects and ensure the timely completion of these projects.
2. The
Company has established business relationships with its suppliers, including
Hangzhou Boiler Plant, Beijing Zhongdian Electric Machinery, Chengdu Engine
Group, Shanghai Electric Group, China Aviation Gas Turbine Co. Ltd and Xuji
Electric. Therefore, we believe that we now have strong support in
equipment supply and installation, and in research and development of
technologies.
E.
Main
Customers
Our
customers are mainly large-size domestic enterprises involving high
energy-consuming businesses producing iron and steel, cement, coking, and
metallurgy. As stated below, due to the continued expansion of the
Chinese markets and administrative support for energy-recycling by the Chinese
government, our market to provide TRT, CHPG and WGPG projects continues to
expand.
4
F.
Demand
for Recycled Energy
The
following table is the funds invested, or expected to be invested, in
environmental protection industry by the Chinese government (in billion
RMB).
Eighth Five-
Year Plan
(1991-1995)
Ninth Five-
Year Plan
(1996-2000)
Tenth Five-
Year Plan
(2001-2005)
Eleventh Five-
Year Plan
(2006-2010)
Total
Investment Amount
(in
billion RMB)
131
450
750
1,350
(proj.)
Percentage
of PRC’s GDP
0.73
%
1.3
%
1.5
%
1.5
%
Source:
11th
Five-Year Plan of the China National Environmental Protection
Plans.
Currently,
recycled energy accounts for less than 1% of China’s total energy consumption.
As a result, due to environmental protection pressure and improvement of
infrastructure in western China, recycled energy, as a special and stable energy
resource, can be expected to grow in China.
G.
Intellectual
Property Rights
The
company has applied for a service mark “TCH” in China, which will be used in all
of our business operations.
H.
Research
and Development
In 2009,
2008 and 2007, we invested about $198,000, $120,000 and $100,000, respectively,
in research and development.
I.
Government
and Environmental Management
System
We own
all licenses that the Chinese governments require for all aspect of our
operations.
J.
Competition
The
Company faces limited domestic competition. Currently, most TRT, CHPG and WGPG
systems are purchased, constructed and operated by the steel, cement, coking and
metallurgy companies, themselves, rather than outsourced to a
third-party. Our main competitors as third-party providers are state
owned research institutes or their wholly owned construction companies. The
reasons for low competition are high entry barriers in technology, experience,
investment capital, and credibility, as well customer relationships. We believe
that we offer advantages over our competitors in several ways:
1. Our
management team has over 20 years of industry experience and
expertise;
2. We
have the capabilities to provide TRT, CHPG and WGPG systems, while our
competitors usually concentrate on one type or another;
3. We
have the capabilities and experience in undertaking large scale projects;
and
4. We
provide BOT or capital lease services to the customers, while our
competitors usually use an EPC (engineering, procurement and construction) or
turnkey contract model.
All of
our personnel are employed full-time and none of them are represented under
collective bargaining agreements. We consider our relations with our employees
to be good.
L.
Costs
and effects of compliance with environmental
laws
There
were many new laws, regulations, rules and notices regarding the environment and
energy production adopted, promulgated and put into force during past years.
The Chinese government is putting more stringent requirements and urgency
on reducing pollution and emissions and improving energy efficiency nationwide.
Our products are designed and constructed to comply with the environmental laws
and regulations of China. As our systems allow our customers to use
waste heat and gases to create energy, we help reduce the overall environmental
impact of our customers. Since our business focuses on recycling
energy, the effect of the strengthening of environmental laws in China may be to
increase demand for the products and services we offer and others like
them.
ITEM
1A. RISK FACTORS
Risks
Related to our Common Stock
The
market price for our common stock may be volatile.
The
market price for our common stock is highly volatile and subject to wide
fluctuations in response to factors including the following:
·
actual or anticipated
fluctuations in our quarterly operating
results,
·
announcements of new services by
us or our competitors,
·
changes in financial estimates by
securities analysts,
·
conditions in the energy
recycling and saving services
market,
·
changes in the economic
performance or market valuations of other companies involved in the same
industry,
·
announcements by our competitors
of significant acquisitions, strategic partnerships, joint ventures or
capital commitments,
In
addition, the securities markets from time to time experience significant price
and volume fluctuations that are not related to the operating performance of
particular companies. These market fluctuations may also materially and
adversely affect the market price of our common stock.
Shareholders
could experience substantial dilution.
We may
issue additional shares of our capital stock to raise additional cash for
working capital. If we issue additional shares of our capital stock, our
shareholders will experience dilution in their respective percentage ownership
in the company.
We
have no present intention to pay dividends.
We have
not paid dividends or made other cash distributions on our common stock during
any of the past three years, and we do not expect to declare or pay any
dividends in the foreseeable future. We intend to retain any future earnings for
working capital and to finance current operations and expansion of our
business.
6
A
large portion of our common stock is controlled by a small number of
shareholders.
A large
portion of our common stock is held by a small number of shareholders. As a
result, these shareholders are able to influence the outcome of shareholder
votes on various matters, including the election of directors and extraordinary
corporate transactions including business combinations. In addition,
the occurrence of sales of a large number of shares of our common stock, or the
perception that these sales could occur, may affect our stock price and could
impair our ability to obtain capital through an offering of equity securities.
Furthermore, the current ratios of ownership of our common stock reduce the
public float and liquidity of our common stock which can in turn affect the
market price of our common stock.
We
may be subject to “penny stock” regulations.
The
Securities and Exchange Commission, or SEC, has adopted rules that regulate
broker-dealer practices in connection with transactions in “penny stocks.” Penny
stocks generally are equity securities with a price of less than $5.00 (other
than securities registered on certain national securities exchanges, provided
that current price and volume information with respect to transactions in such
securities is provided by the exchange or system). Penny stock rules require a
broker-dealer, prior to a transaction in a penny stock not otherwise exempt from
those rules, to deliver a standardized risk disclosure document prepared by the
SEC, which specifies information about penny stocks and the nature and
significance of risks of the penny stock market. A broker-dealer must also
provide the customer with bid and offer quotations for the penny stock, the
compensation of the broker-dealer, and our sales person in the transaction, and
monthly account statements indicating the market value of each penny stock held
in the customer’s account. In addition, the penny stock rules require that,
prior to a transaction in a penny stock not otherwise exempt from those rules,
the broker-dealer must make a special written determination that the penny stock
is a suitable investment for the purchaser and receive the purchaser’s written
agreement to the transaction. These disclosure requirements may have the effect
of reducing the trading activity in the secondary market for stock that becomes
subject to those penny stock rules. These additional sales practice and
disclosure requirements could impede the sale of our securities. Whenever any of
our securities become subject to the penny stock rules, holders of those
securities may have difficulty in selling those securities.
Risks
Related to Our Business Operations
We
depend on the waste energy of our customers to generate
electricity.
We
acquire waste pressure, heat and gases from steelworks, cement, coking or
metallurgy plants and use these to generate power. Therefore, our power
generating capacity depends on the availability of an adequate supply of our
“raw materials” from our customers. If we do not have enough supply, power
generated for those customers will be impeded. Since our contracts are often
structured so that we receive compensation based on the amount of energy we
supply, a reduction in production may cause problems for our revenues and
results of operations.
The
global financial crisis intensified in 2009 and will adversely affect our
revenues.
Although
the Chinese government has indicated it will focus on keeping its economy on
track, it is difficult to insulate any economy from the global financial crisis
and economic downturn that intensified worldwide during 2009. After five years
of growth in excess of 10 percent, the Chinese economy is beginning to weaken.
Growth in exports and investment is slowing, consumer confidence is waning and
stock and property markets are severely depressed. At a time when major
infrastructure projects are being put off around the world, there are obvious
slowdowns in China’s major industries, like iron and steel, construction and
energy. Our customers in such industries may face more challenges and
hardships than before and tend to take more conservative positions in their
business and investment, including the purchase of TRT, CHPG or WGPG
systems.
Our
insurance may not cover all liabilities and damages.
Our
industry can be dangerous and hazardous. The insurance we carry might not be
enough to cover all the liabilities and damages that may be caused by potential
accidents.
A
downturn in the Chinese economy may slow down our growth and
profitability.
The
growth of the Chinese economy has been uneven across geographic regions and
economic sectors. There can be no assurance that growth of the Chinese economy
will be steady or that any downturn will not have a negative effect on our
business. Our profitability, will decrease if less energy is consumed due to a
downturn in the Chinese economy.
Our
heavy reliance on the experience and expertise of our management may cause
adverse impacts on us if management member departs.
We depend
on key personnel for the success of our business. Our business may be severely
disrupted if we lose the services of our key executives and employees or fail to
add new senior and middle managers to our management.
7
Our
future success is heavily dependent upon the continued service of our key
executives. We also rely on a number of key technology staff for the operation
of our company. Our future success is also dependent upon our ability to attract
and retain qualified senior and middle managers to our management team. If one
or more of our current or future key executives or employees are unable or
unwilling to continue in their present positions, we may not be able to easily
replace them, and our business may be severely disrupted. In addition, if any of
these key executives or employees joins a competitor or forms a competing
company, we could lose customers and suppliers and incur additional expenses to
recruit and train personnel. We do not maintain key-man life insurance for any
of our key executives.
We
may need more capital for the operation and failure to raise the capital we need
may delay the development plan and reduce the profits.
If we
don’t have adequate income or our capital can’t meet the requirement for
expansion of operations, we will need to seek financing to continue our business
development. If we fail to acquire adequate financial resources at acceptable
terms, we might have to postpone our proposed business development plans and
reduce projections of our future incomes.
Risks
Related to the People’s Republic of China
China’s
economic policy may affect our business.
All of
our assets are in China, and all of our revenue comes from business in China.
Therefore, our business and prospects are tied to China’s economic, political
and legal development.
China’s
economy had been changed from planned economy into market economy. In recent
years, the government has taken many measures to strengthen market forces to
reduce state-owned assets and set up joint ventures. However, a great portion of
Chinese assets, still remains controlled by the government. In addition, the
government plays a great role in industrial development. The great level of
interference of government in the business and industrial development might have
an adverse impact on us because we are not part of the state-owned business, and
our relationship with the governmental authorities might not be as strong as
those state-owned enterprises.
China’s
regulation of foreign currency exchange and cash out-flow may prevent us from
remitting profits and dividends to the United States.
China has
adopted complicated rules that govern foreign currency exchange and cash
out-flow. Although we believe we meet the requirements of those rules, we may
not be able to remit all of our profits to the United States and distribute
dividends to our shareholders if those rules are substantially changed to
restrict the cash out-flow. Foreign currency exchange rate changes
might also have negative impact on our financial performance.
We
may face the hindrance of China’s bureaucratic system.
Foreign
companies face the political, economic and legal risks when developing business
in China. China’s bureaucratic system might hinder investment from foreign
countries.
The
legal system in China has some uncertainties, which may affect the
implementation of laws.
The legal
system in China is a system of civil laws, based on provisions and written
codes, therefore precedents and cases are not binding on the future decisions of
the courts. Only after 1979 did the Chinese government begin to promulgate a
comprehensive system of laws that regulate economic affairs in general and
encourage foreign investment in China. Although the influence of the
law has been increasing, in certain rural areas the legal system and its
enforcement are not well implemented. In addition, there have been
constant changes and amendments of laws and regulations over the past 30 years
in order to keep up with the rapidly changing society and economy in China.
Because government agencies and courts provide interpretations of laws and
regulations and decide contractual disputes and issues, their inexperience on
new business and new polices or regulations in certain less developed areas
causes uncertainty and may affect our business. In some
provincial areas, the government agencies and the courts are protectionist and
may not fully enforce contractual rights against local parties. In
certain areas, the intellectual property and trade secret protections are not as
effective as those in the other areas in China or in the U.S. in
general. Consequently, we cannot clearly foresee the future direction
of Chinese legislative activities on foreign invested business and effectiveness
on enforcement of laws and regulations in the less developed areas in China. The
uncertainties, including new laws and regulations and changes of existing laws,
as well judicial interpretation by inexperienced officials in the agencies and
courts in certain areas, may cause possible problems to foreign
investors.
8
Where
You Can Find More Information
We file
annual, quarterly and special reports, proxy statements and other information
with the SEC. Our SEC filings are available to the public over the Internet at
the SEC’s web site at http://www.sec.gov. You may also read and copy any
document we file at the SEC’s Public Reference Room at 100 F Street,
NE, Washington, DC 20549. You may obtain information on the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-0330.
ITEM
2. FINANCIAL INFORMATION.
Note
Regarding Forward-Looking Statements
This
registration statement on Form 10 and other reports filed by the Company from
time to time with the SEC (collectively the “Filings”) contain or may contain
forward-looking statements and information that are based upon beliefs of, and
information currently available to, Company’s management as well as estimates
and assumptions made by Company’s management. Readers are cautioned not to place
undue reliance on these forward-looking statements, which are only predictions
and speak only as of the date hereof. When used in the filings, the words
“anticipate”, “believe”, “estimate”, “expect”, “future”, “intend”, “plan”, or
the negative of these terms and similar expressions as they relate to Company or
Company’s management identify forward-looking statements. Such statements
reflect the current view of Company with respect to future events and are
subject to risks, uncertainties, assumptions, and other factors (including the
risks contained in Item 1A. “Risk Factors” and the section “results of
operations” below), and any businesses that Company may acquire.
Should one or more of these risks or uncertainties materialize, or should the
underlying assumptions prove incorrect, actual results may differ significantly
from those anticipated, believed, estimated, expected, intended, or
planned.
Although
the Company believes that the expectations reflected in the forward-looking
statements are based on reasonable assumptions, the Company cannot guarantee
future results, levels of activity, performance, or achievements. Except as
required by applicable law, including the securities laws of the United States,
the Company does not intend to update any of the forward-looking
statements to conform these statements to actual results. Readers are urged to
carefully review and consider the various disclosures made throughout the
entirety of this registration statement, which attempt to advise interested
parties of the risks and factors that may affect our business, financial
condition, results of operations, and prospects.
Our
financial statements are prepared in US Dollars and in accordance with
accounting principles generally accepted in the United States. See “Foreign
Currency Translation and Comprehensive Income (Loss)” below for information
concerning the exchange rates at which Renminbi (“RMB”) were translated into US
Dollars (“USD”) at various pertinent dates and for pertinent
periods.
OVERVIEW
OF BUSINESS BACKGROUND
China
Recycling Energy Corporation (the “Company” or “CREG”) (formerly China Digital
Wireless, Inc.) was incorporated on May 8, 1980, under the laws of the State of
Colorado. On September 6, 2001, the Company re-domiciled its state of
incorporation from Colorado to Nevada. The Company, through its subsidiary
Shanghai TCH Energy Technology Co., Ltd. (“TCH”), is in the business of selling
and leasing energy saving equipment. The businesses of mobile phone distribution
and provision of pager and mobile phone value-added information services were
discontinued in 2007. On March 8, 2007, the Company changed its name to “China
Recycling Energy Corporation”.
On June23, 2004, the Company entered into a stock exchange agreement with Sifang
Holdings Co. Ltd. (“Sifang Holdings”) and certain shareholders. Pursuant to the
stock exchange agreement, the Company issued 13,782,636 shares of its common
stock in exchange for a 100% equity interest in Sifang Holdings, making Sifang
Holdings a wholly owned subsidiary of the Company. Sifang Holdings was
established under the laws of the Cayman Islands on February 9, 2004 for the
purpose of holding a 100% equity interest in TCH. TCH was established
as a foreign investment enterprise in Shanghai under the laws of the PRC on May25, 2004. Beginning January 2007, the Company gradually phased out and
substantially scaled down most of its business of mobile phone distribution and
provision of pager and mobile phone value-added information services. In the
first and second quarters of 2007, the Company did not engage in any substantial
transactions or activity in connection with these businesses. On May 10, 2007,
the Company discontinued the businesses related to mobile phones and pagers.
These businesses are reflected in continuing operations for all periods
presented based on the criteria for discontinued operations prescribed by
Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for
the Impairment or Disposal of Long-Lived Assets”.
On
February 1, 2007, the Company’s subsidiary, TCH entered into two TRT Project
joint-operation agreements with Xi’an Yingfeng Science and Technology Co., Ltd.
(“Yingfeng”). Yingfeng is a joint stock company registered in Xi’an, Shaanxi
Province, the PRC, and engages in the business of designing, installing, and
operating TRT systems and sales of other renewable energy products. TRT is an
electricity generating system that utilizes the exhaust pressure and heat
produced in the blast furnace of a steel mill to generate electricity. In
October 2007, the Company terminated both joint-operation agreements with
Yingfeng and became fully entitled to the rights, titles, benefits and interests
in the TRT Projects.
On
September 21, 2007, the Company’s subsidiary, TCH changed its name from Shanghai
TCH Data Technology Co., Ltd to “Shanghai TCH Energy Technology Co.,
Ltd.”
9
In
November 2007, TCH signed a cooperative agreement with Shengwei Group for a
Cement Waste Heat Power Generator Project (“CHPG”). TCH will build two sets of
12MW pure low temperature cement waste heat power generator systems for
Shengwai’s two 2,500-tons-per-day cement manufacturing lines in Jin Yang and a
5,000-tons-per-day cement manufacturing line in Tong Chuan. Total
investment will be approximately $12,593,000 (RMB 93,000,000). At the
end of 2008, construction of the CHPG in Tong Chuan was completed at a total
cost of approximately $6,191,000 (RMB 43,000,000) and put into
operation. Under the original agreement, the ownership of the power
generator system would belong to Tong Chuan from the date the system is put into
service. TCH is responsible for the daily maintenance and repair of
the system, and charges Tong Chuan a monthly electricity fee based on the actual
power generated by the system at 0.4116 RMB per KWH for an operating period of
five years with the assurance from Tong Chuan of a properly functioning
5,000-tons-per-day cement manufacturing line and not less than 7,440 heat hours
per year for the electricity generator system. Shengwei Group
collateralized the cement manufacturing line in Tong Chuan to guarantee its
obligations to provide the minimum electricity income from the power generator
system under the agreement during the operating period. At the end of the five
year operating period, TCH will have no further obligations under the
cooperative agreement. On May 20, 2009, TCH entered into a
supplementary agreement with Shengwei Group to amend the timing for title
transfer until the end of the leasing term.
On
June 29, 2009, construction of the CHPG in Jin Yang was completed at a
total cost of approximately $7,318,000 (RMB 50,000,000) and put into
operation. TCH will charge Jin Yang a technical service fee of
$336,600 (RMB 2,300,000) monthly for sixty months. Jin Yang has the
right to purchase the ownership of the CHPG systems for $29,000 (RMB 200,000) at
the end of lease term. Jin Yang is required to provide assurance of properly
functioning 5,000-tons-per-day cement manufacturing lines and not less than
7,440 heat hours per year for the CHPG. Shengwei Group collateralized
the cement manufacturing lines in Jin Yang to guarantee its obligations to
provide the minimum electricity income from the power generator system under the
agreement during the operating period. Effective July 1, 2009, TCH
outsourced the operation and maintenance of the CHPG systems in Tong Chuan and
JinYang to a third party for total of $732,000 (RMB 5,000,000) per
year.
On April14, 2009, the Company incorporated a joint venture (“JV”) with Erdos Metallurgy
Co., Ltd. (“Erdos”) for recycling waste heat from Erdos 's metal
refining plants to generate power and steam, which will then be sold back to
Erdos. The name of the JV is Inner Mongolia Erdos TCH Energy Saving
Development Co., Ltd (“Erdos TCH”) with a term of 20 years, and the registered
capital of the JV is $2,635,000 (RMB 18,000,000). On September 30,2009, Xi’an TCH injected additional capital of $4.03 million (RMB 27,500,000).
Total investment for the project is estimated at approximately $74 million (RMB
500 million) with an initial investment of $8,773,000 (RMB
60,000,000). Erdos contributed 10% of the total investment of the
project, and Xi'an TCH contributed 90% of the total investment. Xi'an TCH and
Erdos will receive 80% and 20% of the profit allocation from the JV,
respectively, until Xi'an TCH has received a complete return on its
investment. Xi'an TCH and Erdos will then receive 60% and 40% of the
profit allocation from the JV, respectively. When the term of the JV expires,
Xi'an TCH will transfer its equity in the JV to Erdos at no additional
cost. By the end of 2009, the first power station unit was
completed.
During
2008, the Company also leased two energy recycling power generation equipment
systems under one-year, non-cancellable leases with the rents paid in full,
which the Company was able to sublease for higher rental income under one-year,
non-cancellable leases. The Company did not renew its lease when it expired in
April 2009, and as a result, the sublessee was unable to renew its lease with
the Company.
On
September 30, 2009, Xi’an TCH delivered to Shenmu County Juijiang Trading Co.,
Ltd. (“Shenmu”) a set of 18 megawatt capacity Waste Gas Power Generation
(“WGPG”) power generating systems pursuant to a Cooperative Contract on
Coke-oven Gas Power Generation Project (including its Supplementary Agreement)
and a Gas Supply Contract for Coke-oven Gas Power Generation
Project. The contracts are for 10 years and provide that Xi’an TCH
will recycle coke furnace gas from the coke-oven plant of Shenmu to generate
power, which will then be supplied back to Shenmu. Shenmu agrees to
supply Xi’an TCH the coke-oven gas free of charge. Under the
contracts, Shenmu will pay to the Company“energy-saving service fees” of
approximately $473,000 per month for the life of the contracts, as well as such
additional amount as may result from the supply of power to Shenmu in excess of
10.80 million kilowatt hours per month at the rate of 0.30 yuan (approximately
$0.04) per kilowatt hour. The Company is responsible for operating
the systems and will do so through an unrelated third party at a cost of
approximately $438,000 per year. Shenmu guarantees that monthly gas supply will
not be lower than 21.6 million standard cubic meters, delivered monthly. If gas
supply is lower than that, Shenmu agrees to pay Xi’an TCH an energy-saving
service fee, of up to 10.80 million kilowatt-hours a month, the amount of which
would result in “energy-saving service fees” of approximately $473,000 per
month. Xi’an TCH maintains the ownership of the project throughout the term of
the contracts, including the already completed investment, design, equipment,
construction and installation as well as the operation and maintenance of the
project. Xi’an TCH agrees to pay to Shenmu 50,000 yuan (about $7,300)
a year to use the land for the power station. At the end of the
10-year term, ownership of the systems transfers to Shenmu at no additional
charge. Shenmu agrees to provide a lien on its production line to
guarantee its performance under the contracts. Three individuals
provide an unlimited joint liability guarantee to Xi’an TCH for Shenmu’s
performance under the Contracts and the Yulin Huiyuan Group provides a guarantee
to Xi’an TCH for Shenmu’s performance under the contracts.
Starting
in November 2008, the Chinese government announced a series of economic stimulus
plans aimed at bolstering its weakening economy – a sweeping move to help fight
the effects of the global slowdown. In the announcements, China estimated it
would spend $586 billion over the next two years – roughly seven percent of its
gross domestic product each year – to construct new railways, subways and
airports and to rebuild communities devastated by an earthquake in the southwest
China in May 2008. The economic stimulus package is the largest effort ever
undertaken by the Chinese government. The government said that the stimulus
would cover ten areas, including low-income housing, electricity, water, rural
infrastructure and projects aiming at environmental protection and technological
innovation.
10
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
Our
management’s discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements as well as the reported net sales and expenses
during the reporting periods. On an ongoing basis, we evaluate our estimates and
assumptions. We base our estimates on historical experience and on various other
factors that we believe are reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying value of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or
conditions.
While our
significant accounting policies are more fully described in Note 2 to our
consolidated financial statements, we believe that the following accounting
policies are the most critical to aid you in fully understanding and evaluating
this management discussion and analysis.
Basis
of presentation
These
accompanying consolidated financial statements have been prepared in accordance
with generally accepted accounting principles in the United States of America
(“GAAP”) and pursuant to the rules and regulations of the SEC for annual
financial statements.
Basis
of consolidation
The
consolidated financial statements include the accounts of CREG and, its
subsidiaries, Sifang Holdings, TCH, and TCH’s subsidiaries Xi’an TCH Energy Tech
Co., Ltd. (“Xi’an TCH”) and Xingtai Huaxin Energy Tech Co., Ltd. (“Huaxin”), and
Xi’an TCH’s 90% owned subsidiary Erdos TCH , and Sifang Holding’s subsidiary,
Huahong New Energy Technology Co., Ltd. (“Huahong”). Xi’an TCH, Huaxin, Erdos
TCH and Huahong engage in the same business as TCH. Substantially all of the
Company’s revenues are derived from the operations of TCH and its subsidiaries,
which represent substantially all of the Company’s consolidated assets and
liabilities as of September 30, 2009 and December 31, 2008, respectively. All
significant inter-company accounts and transactions were eliminated in
consolidation.
Use
of estimates
In
preparing these consolidated financial statements, management makes estimates
and assumptions that affect the reported amounts of assets and liabilities in
the balance sheets and revenues and expenses during the year reported. Actual
results may differ from these estimates.
Accounts
receivable and concentration of credit risk
Accounts
receivable are recorded at the invoiced amounts and do not bear interest. The
Company extends unsecured credit to its customers in the ordinary course of
business but mitigates the associated risks by performing credit checks and
actively pursuing past due accounts. An allowance for doubtful accounts is
established and determined based on managements’ assessment of known
requirements, aging of receivables, payment history, the customer’s current
credit worthiness and the economic environment.
Financial
instruments that potentially subject the Company to credit risk primarily are
accounts receivable, receivables on sales-type leases and other receivables. The
Company does not require collateral or other security to support these
receivables. The Company conducts periodic reviews of its clients’ 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, as well as by the
general state of the PRC economy.
Inventory
Inventory
is valued at the lower of cost or market. Cost of work in progress and finished
goods comprises direct material cost, direct production cost and an allocated
portion of production overheads.
11
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 ranging from 5 to 20 years as
follows:
Building
20
years
Vehicle
2 -
5 years
Office
and Other Equipment
2 -
5 years
Software
2 -
3 years
Sales-type
leasing and related revenue recognition
The
Company leases TRT, CHPG and WGPG systems to its customers. The Company usually
transfers all benefits, risks and ownership of the TRT, CHPG or WGPG system to
its customers at the end of each lease term. The Company’s investment
in these projects is recorded as investment in sales-type leases in accordance
with SFAS No. 13, “Accounting for Leases” (codified in FASB ASC Topic 840) and
its various amendments and interpretations. The Company manufactures and
constructs the TRT , CHPG and WGPG systems and power generating system, and
finances its customers for the price of the systems. The sales and
cost of goods sold are recognized at the point of sale or inception of the
lease. The investment in sales-type leases consists of the sum of the total
minimum lease payments receivable less unearned interest income and estimated
executory cost. Unearned interest income is amortized to income over the lease
term in order to produce a constant periodic rate of return on the net
investment in the lease.
Foreign
Currency Translation and Comprehensive Income (Loss)
The
Company’s functional currency is the Renminbi (“RMB”). For financial
reporting purposes, RMB has been translated into United States dollars (“USD”)
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 has been no
significant fluctuation in exchange rate for the conversion of RMB to USD after
the balance sheet date.
The
Company uses SFAS 130 “Reporting Comprehensive Income” (codified in FASB ASC
Topic 220). Comprehensive income is comprised of net income and all changes to
the statements of stockholders’ equity, except those due to investments by
stockholders, changes in paid-in capital and distributions to
stockholders.
NEW
ACCOUNTING PRONOUNCEMENTS
On July1, 2009, the Company adopted Accounting Standards Update (“ASU”) No.
2009-01, “Topic 105 - Generally Accepted Accounting Principles - amendments
based on Statement of Financial Accounting Standards No. 168 , “The FASB
Accounting Standards Codification™ and the Hierarchy of Generally Accepted
Accounting Principles” (“ASU No. 2009-01”). ASU No. 2009-01
re-defines authoritative GAAP for nongovernmental entities to be only comprised
of the FASB Accounting Standards Codification™ (“Codification”) and, for SEC
registrants, guidance issued by the SEC. The Codification is a
reorganization and compilation of all then-existing authoritative GAAP for
nongovernmental entities, except for guidance issued by the SEC. The
Codification is amended to effect non-SEC changes to authoritative
GAAP. Adoption of ASU No. 2009-01 only changed the referencing
convention of GAAP in Notes to the Consolidated Financial
Statements.
In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No.
46(R)” (“SFAS 167”), codified as FASB ASC Topic 810-10, which modifies how a
company determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be consolidated. SFAS 167
clarifies that the determination of whether a company is required to consolidate
an entity is based on, among other things, an entity’s purpose and design and a
company’s ability to direct the activities of the entity that most significantly
impact the entity’s economic performance. SFAS 167 requires an ongoing
reassessment of whether a company is the primary beneficiary of a variable
interest entity. SFAS 167 also requires additional disclosures about a company’s
involvement in variable interest entities and any significant changes in risk
exposure due to that involvement. SFAS 167 is effective for fiscal years
beginning after November 15, 2009. The Company does not believe the adoption of
SFAS 167 will have an impact on its financial condition, results of operations
or cash flows.
In June
2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial
Assets — an amendment of FASB Statement No. 140” (“SFAS 166”), codified as FASB
Topic ASC 860, which requires entities to provide more information regarding
sales of securitized financial assets and similar transactions, particularly if
the entity has continuing exposure to the risks related to transferred financial
assets. SFAS 166 eliminates the concept of a “qualifying special-purpose
entity,” changes the requirements for derecognizing financial assets and
requires additional disclosures. SFAS 166 is effective for fiscal years
beginning after November 15, 2009. The Company does not believe the adoption of
SFAS 166 will have an impact on its financial condition, results of operations
or cash flows.
12
In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”) codified in
FASB ASC Topic 855-10-05, which provides guidance to establish general standards
of accounting for and disclosures of events that occur after the balance sheet
date but before financial statements are issued or are available to be issued.
SFAS 165 also requires entities to disclose the date through which subsequent
events were evaluated as well as the rationale for why that date was selected.
SFAS 165 is effective for interim and annual periods ending after June 15, 2009,
and accordingly, the Company adopted this pronouncement during the second
quarter of 2009. SFAS 165 requires that public entities evaluate subsequent
events through the date that the financial statements are issued. The Company
has evaluated subsequent events through November 9, 2009.
In April
2009, the FASB issued FSP No. SFAS 107-1 and APB 28-1, “Interim Disclosures
about Fair Value of Financial Instruments,” which is codified in FASB ASC Topic
825-10-50. This FSP essentially expands the disclosure about fair value of
financial instruments that were previously required only annually to also be
required for interim period reporting. In addition, the FSP requires certain
additional disclosures regarding the methods and significant assumptions used to
estimate the fair value of financial instruments. These additional disclosures
are required beginning with the quarter ending June 30, 2009.
In
April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition
and Presentation of Other-Than-Temporary Impairments,” which is codified in FASB
ASC Topic 320-10. This FSP modifies the requirements for recognizing
other-than-temporarily impaired debt securities and changes the existing
impairment model for such securities. The FSP also requires additional
disclosures for both annual and interim periods with respect to both debt and
equity securities. Under the FSP, impairment of debt securities will be
considered other-than-temporary if an entity (1) intends to sell the security,
(2) more likely than not will be required to sell the security before recovering
its cost, or (3) does not expect to recover the security’s entire amortized cost
basis (even if the entity does not intend to sell). The FSP further indicates
that, depending on which of the above factor(s) causes the impairment to be
considered other-than-temporary, (1) the entire shortfall of the security’s fair
value versus its amortized cost basis or (2) only the credit loss portion would
be recognized in earnings while the remaining shortfall (if any) would be
recorded in other comprehensive income. FSP 115-2 requires entities to initially
apply the provisions of the standard to previously other-than-temporarily
impaired debt securities existing as of the date of initial adoption by making a
cumulative-effect adjustment to the opening balance of retained earnings in the
period of adoption. The cumulative-effect adjustment potentially reclassifies
the noncredit portion of a previously other-than-temporarily impaired debt
security held as of the date of initial adoption from retained earnings to
accumulate other comprehensive income. The Company adopted FSP No. SFAS 115-2
and SFAS 124-2 beginning April 1, 2009. This FSP had no material impact on the
Company’s financial position, results of operations or cash flows.
In April
2009, the Financial Accounting Standards Board (“FASB”) issued FSP
No. SFAS 157-4, “Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly” (“FSP No. SFAS 157-4”). FSP
No. SFAS 157-4, which is codified in FASB ASC Topics 820-10-35-51 and
820-10-50-2, provides additional guidance for estimating fair value and
emphasizes that even if there has been a significant decrease in the volume and
level of activity for the asset or liability and regardless of the valuation
technique(s) used, the objective of a fair value measurement remains the same.
The Company adopted FSP No. SFAS 157-4 beginning April 1, 2009.
This FSP had no material impact on the Company’s financial position, results of
operations or cash flows.
The
following table sets forth the results of our operations for the periods
indicated as a percentage of net sales:
2009
2008 (Restated)
Nine Months Ended September 30
$
% of Sales
$
% of Sales
Sales
$
33,885,889
100
%
$
6,876,223
100
%
Sales
of Products
27,938,697
82
%
—
—
Rental
income
5,946,892
18
%
6,876,223
100
%
Cost
of sales
(25,645,744
)
76
%
(4,810,011)
70
%
Cost
of products
(21,497,172
)
77
%
—
—
Rental
expense
(4,148,572
)
70
%
(4,810,011)
70
%
Gross
profit
8,239,845
24
%
2,066,212
30
%
Interest
income on sales-type lease
4,117,305
12
%
1,716,544
25
%
Total
operating income
12,357,150
36
%
3,782,756
55
%
Total
Operating expenses
(2,730,971
)
8
%
(2,543,563
)
37
%
Income
from operation
9,626,179
28
%
1,239,193
18
%
Total
non-operating expenses
(362,405
)
(1
)%
(4,789,154
)
(70
)%
Income
(loss) before income tax
9,263,774
27
%
(3,549,961
)
(51.6
)%
Income
tax expense
1,166,684
(4
)%
796,458
(11.6
)%
Net
income (loss) attributable to noncontrolling interest
(10,898
)
(0.03
)%
83
-
Net
income (loss)
$
8,107,987
24
%
$
(4,346,502
)
(63
)%
SALES. Net sales for the
nine months ended September 30, 2009 were approximately $33.89 million while our
net sales for the nine months ended September 30, 2008 were $6.88 million, an
increase in revenues of approximately $27.01 million. The increase was due to
selling of one energy saving system (Jin Yang CHPG system) through sales-type
leases at the end of June of 2009, and one Shenmu WGPG system through sales-type
lease at the end of September of 2009, in addition to two TRT systems that were
sold under sales-type leases in 2007 and one energy saving system (CHPG system)
sold under sales-type leases at the end of 2008. During the nine months ended
September 30, 2009, we recorded $9.51 million revenue from sales of the Jin Yang
CHPG system, $18.43 million revenue from sales of the shenmu WGPG system, and
rental income of approximately $5.95 million from leasing our two power
generating systems through an operating lease. The operating lease term ended in
April of 2009. There were no sales other than operating leasing
activities of $6.88 million in the same period of 2008. Sales and cost of sales
are recorded at the time of leases; the interest income from the sales-type
leases is our other major revenue source in addition to sales
revenue.
COST OF SALES. Cost of
sales for the nine months ended September 30, 2009 was approximately $25.65
million while our cost of sales for the same period in 2008 was $4.81 million,
an increase of approximately $20.84 million. The increase was mainly due to the
cost of sale for sales-type leases of the Jin Yang CHPG system and Shenmu WGPG
system.
GROSS PROFIT. Gross profit
was approximately $8.24 million for the nine months ended September 30, 2009 as
compared to $2.07 million for the same period in 2008, representing a gross
margin of approximately 24% and 30% for the nine months ended September 30, 2009
and 2008, respectively. The increase in gross profit was mainly from the profit
from the sales-type lease of the Jin Yang CHPG system and Shenmu WGPG system
both with gross profit margin of about 23%, our operating lease business in
connection with leasing out two energy recycling power generation equipment
systems since April of 2008 with a profit margin of about 30%, which ended in
April 2009.
OPERATING INCOME. Operating
income was approximately $12.36 million for the nine months ended September 30,2009 while our operating income for the same period in 2008 was approximately
$3.78 million, an increase of approximately $8.57 million. The growth in
operating income was mainly due to (i) the increase in interest income from
selling and leasing our energy saving systems through sales-type leases, and
(ii) commencing our operating lease business since the second quarter of 2008.
Interest income on sales-type leases for the nine months ended September 30,2009 was approximately $4.11 million, an approximately $2.4 million
increase from approximately $1.72 million for the same period in 2008, this
increase was mainly due to increased interest income on CHPG
systems.
OPERATING
EXPENSES. Operating expenses consisted of selling, general and
administrative expenses totaling approximately $2.73 million for the nine months
ended September 30, 2009 as compared to approximately $2.54 million for the same
period in 2008, a increase of approximately $187,408 or 7.37%. This slight
increase was mainly due to increased expenses in connection with our sales of
two energy recycling systems through sales-type lease in 2009 .
14
NET INCOME. Our net
income for the nine months ended September 30, 2009 was approximately $8.11
million as compared to an approximately $4.35 million net loss for the same
period in 2008, an increase of approximately $12.44 million. This increase in
net income was mainly due to the rental income commenced since the second
quarter of 2008 and additional interest income from sales-type leases of the
CHPG system, as well as the sales of two energy recycling systems through
sales-type leases in 2009. While in the same period of 2008, we have
recorded a $4.68 million one-time expense for the unamortized portion of the
beneficial conversion feature of our first $5 million convertible
note.
The
following table sets forth the results of our operations for the periods
indicated as a percentage of net sales:
2009
2008 (Restated)
Three Months Ended September 30
$
% of Sales
$
% of Sales
Sales
$
18,425,620
100
%
$
4,259,807
100
%
Sales
of Products
18,425,620
100
%
—
—
Rental
income
—
0
%
4,259,807
100
%
Cost
of sales
(14,179,421
)
77
%
(2,977,402
)
70
%
Cost
of products
(14,179,421
)
77
%
—
—
Rental
expense
—
0
%
(2,977,402
)
70
%
Gross
profit
4,246,199
23
%
1,282,405
30
%
Interest
income on sales-type lease
1,783,833
10
%
576,817
14
%
Total
operating income
6,030,032
33
%
1,859,222
44
%
Total
Operating expenses
(1,375,230
)
7
%
(1,039,784
)
24
%
Income
from operation
4,654,802
26
%
819,438
20
%
Total
non-operating income (expenses)
76,516
0.4
%
(59,774
)
(1.4
)%
Income
before income tax
4,731,318
26
%
759,664
18
%
Income
tax expense
941,962
(5
)%
427,960
(10
)%
Net
income (loss) attributable to noncontrolling interest
(7,740
)
(0.04
)%
27
0
%
Net
income
$
3,797,095
21
%
$
331,677
8
%
SALES. Net sales for the
third quarter of 2009 were approximately $18.43 million while our net sales for
the third quarter of 2008 were $4.26 million, an increase in revenues of
approximately $14.17 million. We sold one power generating system (Shenmu)
through a sales-type lease at the end of September. The increase in sales
in the third quarter of 2009 is attributed to the sales recognized for the
Shenmu power generating system compared to the same period of 2008 in which only
leasing activities occurred. The leasing of two energy recycling power
generation equipment systems under one-year, non-cancellable leases with the
rents paid by the Company in full to generate a rental income commenced since
the second quarter of 2008 and ended in April of 2009. We recorded sales of the
Shenmu WGPG system of $18.43 million; compared to the same period in 2008 was
4.26 million for rental income only. Sales and cost of sales are recorded at the
time of leases; the interest income from the sales-type leases is our other
major revenue source in addition to sales revenue.
COST OF SALES. Cost of
sales for the third quarter of 2009 was approximately $14.18 million while our
cost of sales for the same period in 2008 was $2.98 million, an increase of
approximately 11.2 million. During the third quarter of 2009,
the Shenmu WGPG system transaction occurred and has been accounted
for as a sales-type lease with a cost of $14.18 million.
GROSS PROFIT. Gross profit
was approximately $4.25 million for the third quarter of 2009 as compared to
$1.28 million for the same period in 2008, representing a gross margin of
approximately 23% and 30% for the third quarter of 2009 and 2008, respectively.
The increase in gross profit was mainly from the profit from the sales-type
lease of the Shenmu WGPG system, which had a gross profit margin of about
23%.
OPERATING INCOME. Operating
income was approximately $6.03 million for the third quarter of 2009 while our
operating income for the same period in 2008 was approximately $1.86 million, an
increase of approximately $4.17 million. The growth in operating income was
mainly due to the sale of the Shenmu WGPG system and an increase in interest
income from selling and leasing our energy saving systems through sales-type
leases. Interest income on sales-type leases for the third quarter of 2009 was
approximately $1.78 million, an approximately $1.21 million increase from
approximately $0.58 million for the same period in 2008; this increase was
mainly due to increased interest income on CHPG
systems.
OPERATING
EXPENSES. Operating expenses consisted of selling, general and
administrative expenses totaling approximately $1.38 million for the third
quarter of 2009 as compared to approximately $1.04 million for the same period
in 2008, an increase of approximately $335,446 or 32%. This increase was mainly
due to the increased cost associated with servicing higher
sales.
15
NET INCOME. Our net
income for the third quarter of 2009 was approximately $3.80 million as compared
to an approximately $0.33 million for the same period in 2008, an increase of
approximately $3.47 million. This increase in net income was mainly due to the
sale of Shenmu WGPG system in the third quarter of 2009 and increased interest
income from sales-type leases of the CHPG systems.
The
following table sets forth the results of our operations for the periods
indicated as a percentage of net sales:
2008 (Restated)
2007
Years Ended December 31
$
% of Sales
$
% of Sales
Sales
$
19,217,663
100
%
$
9,302,347
100
%
Sales
of products
8,048,956
42
%
9,302,347
100
%
Rental
income
11,168,707
58
%
-
-
Cost
of sales
(14,001,736
)
73
%
(7,033,400
)
76
%
Cost
of products
(6,191,505
)
32
%
(7,033,400
)
76
%
Rental
expense
(7,810,231
)
41
%
-
-
Gross
profit
5,215,927
27
%
2,268,947
24
%
Interest
income on sales-type lease
2,285,582
12
%
1,015,712
11
%
Total
operating income
7,501,509
39
%
3,284,659
35
%
Total
operating expenses
(3,354,028
)
17
%
(542,434
)
6
%
Income
from operation
4,147,481
22
%
2,742,225
29.5
%
Total
non-operating expenses
(4,734,308
)
(25
)%
(425,964
)
(4.6
)%
Income
(loss) before income tax
(586,827
)
(3
)%
2,316,261
25
%
Income
tax expense
(1,632,754
)
9
%
(466,647
)
5
%
Minority
interest
(83
)
-
-
Income
from operations of discontinued component
-
28,699
0.3
%
Net
income (loss)
$
(2,219,664
)
(12
)%
$
1,878,313
20
%
SALES. Net sales for 2008
were approximately $19.22 million while our net sales for 2007 were
approximately $9.30 million, an increase in revenues of approximately $9.92
million. The increase was due to the change in our business during 2007. We
discontinued our mobile phone business and commenced selling, manufacturing and
constructing energy saving systems during 2007. We sell our energy saving
systems through sales-type leases. Sales and cost of sales are recorded at the
time of leases; the interest income from the sales-type leases are our major
revenue source in addition to sales revenue. We sold two TRT systems through
sales-type leasing during 2007 with sales recorded for approximately $9.30
million and interest income of approximately $1.02 million, while in 2008, we
sold one CHPG system through sales-type leasing with sales of approximately
$8.05 million in addition to total interest income of approximately $2.29
million from sales-type leases. We also recorded rental income of
approximately $11.17 million from leasing our two power generating systems in
2008.
COST OF SALES. Cost of sales
for 2008 was approximately $14 million while our cost of sales for 2007 was
approximately $7.03 million, an increase of approximately $6.97 million. The
increase in cost of sales is attributed to changing our business type from a
mobile phone business to manufacturing, selling, constructing and leasing the
energy saving systems in 2007. Our cost of sales consisted of the cost of the
energy saving systems for sales-type leases, and cost of the operating lease as
we leased two power generating systems under one-year, non-cancellable leases
with options to renew at a favorable price during 2008, which we subleased for
higher monthly rental income under one-year, non-cancellable lease.
GROSS PROFIT . Gross profit
was approximately $5.22 million for 2008 as compared to approximately $2.27
million for 2007, representing gross margins of approximately 27% and 24% for
2008 and 2007, respectively. The increase in our gross profit was mainly due to
changes of our business from a mobile phone business to manufacturing, selling,
constructing and leasing energy saving systems. We sold two TRT systems through
sales-type leasing with gross margin of approximately 24% during 2007, while
during 2008, we sold one CHPG system through sales type leasing with gross
profit margin of approximately 74%, and commenced operating lease business for
leasing out two energy recycling power generation equipment systems at a profit
margin of approximately 30%.
OPERATING INCOME . Operating
income was approximately $7.50 million for 2008 while our operating income for
2007 was approximately $3.28 million, an increase of approximately $4.22
million. The growth in operating income was mainly due to (i) changing our
business type, (ii) selling and leasing our energy saving systems through
sales-type leasing and (iii) commencing operating lease business in 2008. A new
sales-type lease for power generated system was commenced in 2008 in addition to
our two TRT systems which were sold under sales-type leases in 2007. The
sales-type lease brings us additional interest income. Interest income on
sales-type lease for 2008 was approximately $2.29 million, an approximately
$1.27 million increase from approximately $1.02 million for 2007.
OPERATING EXPENSES. Operating
expenses consisted of selling, general and administrative expenses totaling
approximately $3.35 million for 2008 as compared to approximately $0.54 million
for 2007, an increase of approximately $2.81 million or 518%. This increase was
mainly due to the compensation expense of approximately $1.44 million related to
the fair value of the stock options to employees, and increased payroll,
marketing and traveling expense due to the expansion of our
business.
16
NET INCOME. Our net loss for
2008 was approximately $2.22 million as compared to approximately $1.88 million
net income for 2007, a decrease of $4.1 million. This decrease in net income was
mainly due to interest expense on our amortized beneficial conversion feature
for the convertible note of approximately $4.68 million and compensation expense
of the fair value of stock options of approximately $1.44 million for 2008. The
convertible note that was issued on November 16, 2007 was repaid on June 25,2008. The vested and non-vested employee stock options that were
granted on November 13, 2007, were forfeited and cancelled on June 25,2008. We subsequently reissued the same number of stock options on
August 4, 2008; this reissuance was accounted for as a modification of the
original options.
As of
September 30, 2009, the Company had cash and cash equivalents of $5,683,300. At
September 30, 2009, other current assets were approximately $12.54 million and
current liabilities were approximately $21.08 million. Working
capital amounted to negative $2.86 million at September 30, 2009. The ratio
of current assets to current liabilities was 0.86:1 at the nine months ended
September 30, 2009.
The
following is a summary of cash provided by or used in each of the indicated
types of activities during nine months ended September 30, 2009 and
2008:
2009
2008
(Restated)
Cash
provided by (used in):
Operating
Activities
$
12,387,226
$
(4,456,661
)
Investing
Activities
(22,164,713
)
(10,189,521
)
Financing
Activities
8,190,797
14,387,174
Net cash
flow provided by operating activities was approximately $12.39 million
during the nine months ended September 30, 2009, as compared to
approximately $4.46 million used in the same period of 2008. The increase in net
cash inflow was mainly due to the increase in net income as well as a decrease
in our advances to suppliers and prepaid expenses.
Net cash
flow used in investing activities was approximately $22.16 million in the nine
months ended September 30, 2009, as compared to approximately $10.19 million
used in the same period of 2008. The increase of net cash flow used in investing
activities was mainly due to our investment of $9.48 million in the systems that
are the subject of the sales-type leases of the Jingyang CHPG and the Shenmu
WGPG projects and an $8.25 million payment for construction in progress of
Erdos and Zhonggang Binhai projects, as well as restricted cash of $4.39 million
in the bank as collateral for the same amount of bank acceptance.
Net cash
flow provided by financing activities was $8.19 million for the nine months
ended September 30, 2009 as compared to net cash provided by financing
activities of $14.39 million for the same period in 2008. The $8.19 million cash
inflow from financing activities mainly consisted of common stock issued for $2
million, convertible note issued for $3 million, and short term bank loan of
$2.92 million, while in the same period of 2008 we received $14 million from the
issuance of common stock and convertible notes.
We
believe we have sufficient cash resources to continue our current business
through June 2010 due to stable interest revenue from our operating
activities. As of September 30, 2009, we have five sale-type leases
to generate our cash inflows, two TRT systems, two CHPG systems and one WGPG
systems. We believe we have sufficient cash resources to cover our anticipated
capital expenditures for the remainder of 2009.
We do not
believe that inflation has had a significant negative impact on our results of
operations during 2009.
As of
December 31, 2008, the Company had cash and cash equivalents of $7,267,344. At
December 31, 2008, other current assets were approximately $16.54 million and
current liabilities were approximately $11.69 million, working capital amounted
to $12.12 million at December 31, 2008. The ratio of current assets to current
liabilities was 2.04:1 at the year ended December 31, 2008.
The
following is a summary of cash provided by or used in each of the indicated
types of activities during 2008 and 2007:
2008 (Restated)
2007
Cash
provided by (used in):
Operating
Activities
$
1,958,334
$
4,997,455
Investing
Activities
(10,896,198
)
(8,640,969
)
Financing
Activities
13,957,150
5,068,583
17
Net cash
flow provided in operating activities was approximately $1.96 million
during 2008, as compared to approximately $5 million provided in same period of
2007. The decrease in net cash provided in operating activities was mainly due
to the prepaid equipment rents of approximately $3.79 million as well as
decrease in our accounts payable.
Net cash
flow used in investing activities was approximately $10.90 million for 2008, as
compared to approximately $8.64 million net cash used in investing activities
for 2007. The increase of net cash flow used in investing activities was mainly
due to the acquisition of equipment of $115,000 and payment for construction in
progress of approximately $3.72 million for constructing a power generating
system. We will use the BOT (build, operate, transfer) model to build and
operate a system and charge the user of this system monthly electricity fees
based on the actual power generated by the systems.
Net cash
flow provided by financing activities was approximately $13.96 million for 2008
as compared to net cash provided by financing activities of $5.07 million for
2007. The increase of net cash flow provided by financing activities was mainly
due to the issuance of common stock to an accredited investor for $5 million,
issuance of a convertible note to the same investor for $5 million, and issuance
of common stock to one of our major shareholders for $4,032,258.
We
believe we have sufficient cash to continue our current business through
December, 2009 due to increased sales, interest revenue and rental income from
operating activity as well as more than $11 million in working capital at the
end of 2008. As of Dec 31, 2008, we have 3 sale-type leases, 2 TRT and 1 CHPG,
and 2 operational leases, currently generating net cash flow. We believe we have
sufficient cash resources to cover our capital expenditures we anticipate in
2009.
We do not
believe that inflation had a significant negative impact on our results of
operations during 2008.
Off-Balance
Sheet Arrangements
We have
not entered into any other financial guarantees or other commitments to
guarantee the payment obligations of any third parties. We have not entered into
any derivative contracts that are indexed to our shares and classified as
stockholder’s equity or that are not reflected in our consolidated financial
statements. Furthermore, we do not have any retained or contingent interest in
assets transferred to an unconsolidated entity that serves as credit, liquidity
or market risk support to such entity. We do not have any variable interest in
any unconsolidated entity that provides financing, liquidity, market risk or
credit support to us or engages in leasing, hedging or research and development
services with us.
Contractual
Obligations
Convertible Notes
Payable
As
mentioned in Item 5, on November 16, 2007, the Company entered into a Stock and
Notes Purchase Agreement (“Purchase Agreement”) with Carlyle Asia Growth
Partners III, L.P. (“CAGP”) and CAGP III Co. Investment, L.P. (together with
CAGP, the “Investors”). Under the terms of the Purchase Agreement, the Company
sold to the Investors a 10% Secured Convertible Promissory Note in the principal
amount of $5,000,000 (the “First Note”). Additionally, the Purchase Agreement
provides for two subsequent transactions to be effected by the Company and the
Investors, which include (i) the issuance by the Company and subscription by the
Investors of a total of 4,066,706 shares of common stock of Company, at the
price of $1.23 per share for an aggregate purchase price of approximately
$5,000,000, and (ii) the issuance and sale by the Company to the Investors of a
5% Secured Convertible Promissory Note in the principal amount of $15,000,000
(the foregoing transactions, together with sale and purchase of the First Note,
are hereinafter referred to as the “Offering”). The subsequent transactions are
contingent upon the satisfaction of certain conditions specified in the Purchase
Agreement, including entry into specified energy and recycling project contracts
and the purchase of certain energy recycling systems.
The First
Note bore interest at 10% per annum and matured on November 16, 2009. The
principal face amount of the First Note, together with any interest thereon was
convertible at the option of the holders at any time on or prior to maturity,
into shares of the Company’s common stock at an initial conversion price of
$1.23 per share (subject to anti-dilution adjustments). The First Note was
subject to mandatory conversion upon the consummation of the aforementioned
issuance and subscription of shares of the Company’s common stock under the
Purchase Agreement. As more fully described in the First Note, the obligations
of the Company under the First Note ranked senior to all other debt of the
Company.
As
collateral for the First Note, the President and a major shareholder of the
Company pledged 9,653,471 shares of the Company’s common stock held by him to
secure the First Note.
The First
Note was considered to have an embedded beneficial conversion feature (“BCF”)
because the conversion price was less than the quoted market price at the time
of the issuance. Accordingly, the BCF of $5,000,000 was recorded separately as
unamortized beneficial conversion feature based on the intrinsic value method.
The First Note was recorded in the balance sheet at face value less the
unamortized BCF. The terms for the First Note were amended on April 29, 2008 and
the First Note was repaid in full on June 25, 2008, as described
below.
18
On April29, 2008, the Company entered into an Amendment to the Purchase Agreement with
the Investors (the “Amendment”). Under the terms of the Amendment, (i) the
Company issued and the Investors subscribed for 4,066,706 shares of common stock
of the Company, at $1.23 per share for an aggregate purchase price of
$5,002,048, as originally contemplated under the Agreement; (ii) the Investors
converted the principal amount under the First Note (and waived any accrued
interest thereon) into 4,065,040 shares of common stock of the Company at the
conversion price per share of $1.23, pursuant to the terms and conditions of the
First Note issued under the Agreement; (iii) the Company issued and sold to the
Investors a new 5% Secured Convertible Promissory Note in the principal amount
of $5,000,000 to the Investors (the “Second Note” and collectively with the
First Note, the “Notes”); and (iv) the Company granted to the Investors an
option to purchase a 5% Secured Convertible Promissory Note in the principal
amount of $10,000,000, exercisable by the Investors at any time within nine (9)
months following the date of the closing of the transactions contemplated by the
Amendment (the “Option Note”).
The
Second Note bears interest at 5% per annum and matures on April 29, 2011. The
principal face amount of the Second Note, together with any interest thereon, is
convertible at the option of the holders at any time on or after March 30, 2010
(or such earlier date if the audited consolidated financial statements of the
Company for the fiscal year ending December 31, 2009 are available prior to
March 30, 2010) and prior to maturity, into shares of the Company's common stock
at an initial conversion price that is tied to the after-tax net profits of the
Company for the fiscal year ending December 31, 2009. The obligation
of the Company under this note is ranked senior to all other debt of the
Company. The note is secured by a security interest granted to the Investors
pursuant to a share pledge agreement. The Second Note is not considered to have
an embedded beneficial conversion feature because the conversion price and
convertible shares are contingent upon future net profits. The terms
for the Note were amended and restated on April 29, 2009.
On June25, 2008, the Company and the Investors entered into a Rescission and
Subscription Agreement (the “Rescission”) to rescind the conversion of the First
Note and the issuance of conversion shares of Common Stock at the Second Closing
pursuant to the Amendment. The Company and the Investors rescinded the
conversion of the principal amount ($5,000,000) under the First Note into
4,065,040 shares of Common Stock, and the Investors waived accrued interest on
the First Note. Accordingly, the interest expense which had accrued on the note
has been recorded as a decrease in interest expense for the period. At the
Rescission closing, the Company repaid in full the First Note and issued to the
Investors 4,065,040 shares of Common Stock at the price of $1.23 per share for
an aggregate purchase price of $5,000,000. This was done through a
cross receipt arrangement; the amortized portion of BCF was reversed to
additional paid in stock. The Company has now concluded that in
substance the transaction resulted in the conversion of the first $5,000,000
note into common stock and that the remaining BCF of $3,472,603 at the date of
conversion should have been expensed.
On April29, 2009, CREG issued an 8% Secured Convertible Promissory Note in the principal
amount of $3 million to Carlyle Asia Growth Partners III, L.P. with maturity on
April 29, 2012. The note holder has the right to convert all or any part of the
aggregate outstanding principal amount of this note, together with interest, if
any, into shares of the Company’s common stock, at any time on or after March30, 2010 (or such earlier date if the audited consolidated financial statements
of the Company for the fiscal year ending December 31, 2009 are available on a
date prior to March 30, 2010) and prior to the maturity date (or such later date
on which this note is paid in full), at a conversion price per share of common
stock equal to US $0.80.
Bank Loan
Payable
On April13, 2009, Xi’an TCH entered into a one-year working capital loan agreement with
the Industrial Bank Co., Ltd. Xi’an branch, to borrow $2.9 million (RMB 20
million) at 5.3% and Xi’an TCH is required to make quarterly interest payments
on the outstanding loan balance. The loan agreement contains standard
representations, warranties and covenants, and the borrowed funds are to be
guaranteed through a separate guaranty contract with Shanxi Zhongze Investment
Co., Ltd.
Notes Payable – Bank
Acceptances
We had
notes payable for bank acceptances of $1,466,467 at September 30, 2009, which
were collateralized by cash in the bank recorded as restricted
cash. We endorsed the bank acceptances to vendors as payment of our
obligations. Most of the bank acceptances have a maturity of less
than six months.
In
September, 2008, the Company signed a contract to recycle waste gas and waste
heat for China Zhonggang Binhai Enterprise Ltd. (“Zhonggang Binhai”) in Cangzhou
City, Hebei Province, a world-class nickel-iron manufacturing joint venture
between China Zhonggang Group and Shanghai Baoshan Steel
Group. According to the contract, the Company will install a
7-Megawatt capacity electricity-generation system. It will be an integral part
of the facilities designed to produce 80,000 tons of nickel-iron per year. The
project will generate 7-megawatt capacity electricity and help reduce in excess
of 20,000 tons of carbon dioxide emissions every year. The project started
construction in March 2009 and will be completed within 11 months with
approximately $ 7.8 million (RMB 55 million) in total
investment.
19
Erdos’s
Phase One - Two 9-Megawatt Capacity Electricity Generation Project
On April14, 2009, the Company incorporated Erdos TCH for recycling waste heat from Erdos
‘s metal refining plants to generate power and steam, which will then be sold
back to Erdos with a term of 20 years. Erdos is the
world’s largest Ferrosilicon alloy producer with more than 500 kilo tons annual
capacity of Ferrosilicon alloy and 450 kilo tons of Silicon manganese
(approximately 15% world market share). The Company plans to recycle residual
heat from selected 54 furnaces over total 100 furnaces in the Erdos’s production
lines. Total investment for the project is estimated at approximately $74
million (RMB 500 million) for 11 power units with capacity of 70MW electricity,
with the potential to grow to 120 MW or more, and 30 tons of steam per hour. The
whole project is expected to complete by the end of 2011 and supply 10% of
Erdos’s current electricity need. The first phase, which includes two power
lines with total 18MW of capacity started in May 2009. One power line with 9MW
capacity is estimated to be complete at the end of 2009.
We
currently lease two office spaces, one in Xi’an and one in
Shanghai. On February 1, 2010, we expanded and moved our leased
office space in Xi’an within the Chang’an Metropolis Center where we previously
occupied part of a floor in Tower B. Our leased space in Xi-an is now
the 12th Floor
of Tower A at Chang’an Metropolis Center, No. 88, Nanguanzheng Street, Xi’an,
PRC. Our leased office space in Shanghai is located at Room 3163,
Floor 31, Jinmao Plaza, No.88 Century Avenue, Pudong New District, Shanghai,
PRC. Average monthly rent for all locations was $11,174 in 2009 and
is $16,937 in 2010.
20
ITEM
4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The
following table sets forth certain information by each of the following as of
December 31, 2009, (unless otherwise indicated) regarding their beneficial
ownership of our common stock: (i) each person who is known by us to
beneficially own more than 5% of our common stock; (ii) our Chief Executive
Officer and the other individual named in the Summary Compensation Table in this
Amended Report; (iii) each of our directors; and (iv) all of our directors and
executive officers as of December 31, 2009, as a group.
Beneficial
ownership is determined in accordance with the rules of the SEC and includes
voting and investment power with respect to the securities. Except as
indicated by footnote, and subject to applicable community property laws, the
persons and entities named in the table below have sole voting and sole
investment power with respect to the shares set forth opposite each person’s or
entity’s name.
All
executive officers and directors as a group
(9 persons)
18,868,943
(4)
48.66
%
*
Less than one percent
(1%) of outstanding
shares.
(1)
The
amount shown and the following information is derived from Amendment No. 1
to the Schedule 13D filed jointly by (i) Carlyle Asia Growth Partners III,
L.P., a Cayman Islands exempt limited partnership (“Asia Growth”), (ii)
CAGP III Co-Investment, L.P., a Cayman Islands exempt limited partnership
(“Co-Investment”), (iii) CAGP General Partner, L.P., a Cayman Islands
exempt limited partnership, (iv) CAGP Ltd., a Cayman Islands exempt
company, (v) TC Group Cayman, L.P., a Cayman Islands exempt limited
partnership (vi) TCG Holdings Cayman, L.P., a Cayman Islands exempt
limited partnership, and (vii) Carlyle Offshore Partners II, Ltd. A Cayman
Islands exempt company, reporting beneficial ownership as of April 29,2008. According to the amended Schedule 13D, Asia Growth and Co-Investment
are the record owners of 7,785,415 and 346,331 shares of Common Stock,
respectively. CAGP General Partner, L.P. is the general partner of both
Asia Growth and Co-Investment. CAGP General Partner, L.P. may, by virtue
of it being the general partner of Asia Growth and Co-Investment, be
deemed to have voting control and investment discretion over the
securities held by Asia Growth and Co-Investment. The sole general partner
of CAGP General Partner, L.P. is CAGP Ltd., a limited company that is
wholly owned by TC Group Cayman, L.P. The sole general partner of TC Group
Cayman, L.P. is TCG Holdings Cayman, L.P. Carlyle Offshore Partners II,
Ltd. Is the sole general partner of TCG Holdings Cayman, L.P. Each of CAGP
Ltd., TC Group Cayman, L.P., TCG Holdings Cayman, L.P., and Carlyle
Offshore Partners II, Ltd. may, by virtue of being the owner or general
partner, as the case may be, of CAGP General Partner, L.P., CAGP Ltd., TC
Group Cayman, L.P., and TCG Holdings Cayman, respectively, be deemed to
have voting control and investment discretion over the securities held by
Asia Growth and Co-Investment.
(2)
Includes 90,000 shares issuable
upon the exercise of
options.
(3)
Includes 36,000 shares issuable
upon the exercise of
options.
(4)
Includes 18,706,843 shares held
directly and 162,000 shares issuable upon the exercise of
options.
21
ITEM
5. DIRECTORS AND EXECUTIVE OFFICERS.
The
following table sets forth our executive officers and directors, their ages and
the positions held by them:
Name
Age
Position
Guohua
Ku
48
Chief
Executive Officer and Chairman of the Board
Lanwei
Li
28
Vice
President and Director of Business and Director
Lanwei Li
was appointed as a director on April 1, 2009. He has worked for the
Company and its predecessors since March 2005 and currently works as Vice
President and Director of Business, supervising the departments of Business
Development, Investment Management and Strategy Development. He has
a higher education background in investment economy
management.
Xinyu
Peng was appointed as Chief Financial Officer of the Company on August 4,2008. On December 10, 2008, the board of directors also appointed Mr.
Peng as Secretary of the Company. Prior to joining the Company, Mr.
Peng served as Vice President of Tavistock Group Asia from January 2008 to July
2008. From November 2006 to July 2008, Mr. Peng served as Chief Financial
Officer and Director of MOD3 Cabinets & Home LLC. From July 2003
to July 2008, he served as Chief Financial Officer of Creative Hospitality
Concepts LLC.
Zhigang
Wu was appointed as Vice President, Finance starting in October 2007
and is responsible for the securities and financing activities of the
Company. Before joining the Company, Mr. Wu worked for over a decade
in the securities and investment industries with Guotai-Junan Securities and
Zhongzheng Investment. Mr. Wu received a bachelor degree from
Inner-Mongolia Finance & Economy University in 1998, with a major in
international finance.
Nicholas
Shao was appointed as a director of the Company on June 3, 2008, in accordance
with the terms of the Shareholders Agreement between the Company and, among
other parties, certain Carlyle Asia Growth investors. Mr. Shao is
currently a Vice President of Carlyle Asia Growth and has worked in several
international investment banks, including Credit Suisse First Boston and
Morgan Stanley as a senior manager and analyst.
Dr.
Robert Chanson was appointed a director of the Company on January 20, 2010, by
the Board of Directors. Mr. Chanson has served as the Chairman of
Calventis SA, Switzerland since 2009 and the Chairman of Samba Minerals Ltd,
Australia since 2008. Mr. Chanson previously served as the Chairman
and chief executive officer of AmbioCare Holding from 2001 to 2007, a director
of Plant Health Care plc in the U.K. from 2004 through 2008, a director of Plant
Health Care, Inc. in the U.S. from 1995 through 2004, and a director of EHC
Viridian Ltd. in the U.K. from 1999 to 2001. Mr. Chanson received
both his Doctorate and Master in Law degrees from the University of Zurich and
his Bachelor Degree in Natural Sciences (Physics & Chemistry) with Latin
from Kantons- schule Zurich' in Zurich, Switzerland.
Timothy
Driscoll was appointed a director of the Company on October 30, 2009, by the
Board of Directors. Mr. Driscoll currently serves as the chief
executive officer of Proteus Industries, president of MTD Ventures, and
president and chief of executive officer of Driscoll Management Services. Mr.
Driscoll also serves as a director of American Oil and Supply International and
Proteus Industries. From 1994 through 1999, Mr. Driscoll was the
president and chief executive officer of Agrevo Environmental Health and was the
president and chief executive officer of Rouossel UCLAF Environmental Health
from 1991 to 1994. Mr. Driscoll received his MBA in Finance from
Xavier University and B.S. in Economics from Villanova University.
Julian Ha
was appointed a director of the Company on October 30, 2009, by the Board of
Directors. Since 2006, Mr. Ha has been a member of the Private
Equity, Financial Officers and Legal practice groups of Heidrick & Struggles
International, Inc. From 2005 through 2006, Mr. Ha was a Director in
the Corporate Finance group of Evolution Securities China
Limited. From 2001 to 2005, Mr. Ha was a Director of European
Business Development for CapitalKey Advisors and Capital IQ. Mr. Ha
was an Executive Vice President with DDL from 2000 to 2001, where he was
responsible for portfolio management. Mr. Ha trained as a corporate
lawyer and has practiced in New York, Washington, D.C., London, Singapore and
Shanghai. Mr. Ha received his BA from Cornell University , his
Masters degrees from the London School of Economics and Harvard University and
his JD from the NYU School of Law.
22
Sean Shao
was appointed a director of the Company on October 30, 2009, by the Board of
Directors. Mr. Shao currently serves as a director of Agria
Corporation and as the Chairman of its Compensation Committee since November
2008, as a director and Chairman of the Audit Committee of Yongye International,
Inc. since April 2009, and a director and Chairman of the Audit Committee of
China Biologic Products, Inc. since July 2008. Mr. Shao previously
served as the Chief Financial Officer of Trina Solar Limited (“Trina”) from
August 2006 to June 2008, and as the chief financial officer of ChinaEdu
Corporation from September 2005 to August 2006. Mr. Shao was the
chief financial officer of Watchdata Technologies Ltd. from August 2004 to
September 2005 and a senior manager at Deloitte Touche Tohmatsu Beijing from
October 1998 to July 2004 and Deloitte & Touche Toronto from December 1994
to November 1997. Mr. Shao received his master’s degree in health
care administration from the University of California at Los Angeles in 1988 and
his bachelor’s degree in art from East China Normal University in
1982. Mr. Shao is a CPA.
All
directors hold office until the next annual meeting of shareholders and until
their successors have been duly elected and qualified. There are no membership
qualifications for directors. Pursuant to the Shareholders
Agreement, dated as of November 16, 2007, between the Company and, amongst other
parties, Carlyle Asia Growth Partners III, L.P. and CAGP III Co-Investment,
L.P. CAGP III Co-Investment, L.P. has the right to appoint up to two
members of the board of directors for so long as they remain investors in the
Company. There are no other arrangements or understandings pursuant
to which our directors are selected or nominated.
ITEM
6. EXECUTIVE COMPENSATION
Summary
Compensation Table
The
following table summarizes the compensation earned during the years ended
December 31, 2009 and 2008, by those individuals who served as our Chief
Executive Officer, or Chief Financial Officer during any part of 2009 or any
other executive officer with total compensation in excess of $100,000 during
2009. The individuals listed in the table below are referred to as
the “named executive officers.”
Mr.
Guohua Ku entered into an employment agreement with the Company to serve as its
CEO on December 10, 2008. The agreement has a two-year term starting
December 10, 2008 that includes a one-month probationary period. Mr.
Ku receives a salary of $17,876 annually for his service as CEO. The
Company may terminate the employment agreement at any time without any prior
notice to the employee if Mr. Ku engages in certain conduct, including, but not
limited to (i) the violation of the rules and procedures of the Company or
breaches the terms of the employment agreement; (ii) neglecting his duties or
engages in malpractice for personal gain that damages the Company; (iii)
entering into an employment relationship with any other employer during his
employment with the Company; or (iv) the commission of a crime. The Company also
may terminate the employment agreement upon 30 days written notice to Mr. Ku
under certain other conditions, including but not limited to (i) inability to
continue position due to non-work-related sickness or injury; (ii) incompetence;
and (iii) the need for mass layoffs or other restructuring. Mr.
Ku has the right to resign at any time upon a 30 days written notice to the
Company.
The board
of directors of the Company approved the China Recycling Energy Corporation 2007
Nonstatutory Stock Option Plan (the “2007 Plan”) on November 13, 2007, which
permits grants of nonstatutory stock options to all employees, officers,
directors and consultants of the Company or its affiliates. The 2007
Plan authorizes the issuance of up to 3,000,000 shares of common stock of the
Company and by its terms will expire on November 12, 2012. On
November 13, 2007, the Board authorized the issuance of options on all 3,000,000
shares to eligible recipients under the 2007 Plan. These stock
options had a five year term and an exercise price of $1.23 per
share.
The
recipients of the outstanding stock options forfeited all of the outstanding
options as of June 25, 2008 and new grants of stock options equaling
3,000,000 shares were made on August 4, 2008. These new stock options
were granted with an exercise price of $0.80 per share, the fair market value of
the Company's common stock on the date of grant. Subsequent stock
options were granted on November 12, 2009, with an exercise price of
$2.35. The options vest as to 15% on the date that was six months
from the date of grant; vest 15% on the first anniversary of the date of grant;
vest 50% on the second anniversary of the date of grant; and vest the remaining
20% on the third anniversary of the date of grant. The stock options also become
fully vested upon termination without cause, termination for good reason,
termination due to death or disability or in the event of a change in control of
the Company. The stock options expire on the fifth anniversary of the
date of grant.
Outstanding
Equity Awards at 2009 Fiscal Year-End
The
following table sets forth information regarding all outstanding equity awards
held by the named executive officers at December 31, 2009.
Option Awards
Stock Awards
Name
Number of Securities Underlying Unexercised Options (#) Exercisable
Number of
Securities
Underlying
Unexercised
Options (#) Unexercisable
Equity
Incentive Plan
Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options (#)
Option Exercise Price ($)
Option Expiration Date
Number
of Shares or
Units of
Stock That
Have Not
Vested (#)
Market Value of
Shares or
Units of Stock That Have Not Vested ($ )
Equity Incentive Plan Awards:
Number of
Unearned Shares, Units or Other
Rights That
Have Not
Vested (#)
Equity Incentive
Plan Awards:
Market or Payout
Value of Unearned
Shares, Units or
Other Rights That
Have Not Vested
($)
Guohua
Ku
–
–
–
–
–
–
–
–
–
Xinyu
Peng
–
–
–
–
–
–
–
–
–
Potential
Payments Upon Termination or Change of Control
Employment
Agreements
Certain
of our executive officers, including our CEO, have an employment agreement with
the Company. Under Chinese law, we may only terminate employment
agreements without cause and without penalty by providing notice of non-renewal
one month prior to the date on which the employment agreement is scheduled to
expire. If we fail to provide this notice or if we wish to terminate an
employment agreement in the absence of cause, as defined in the agreement, then
we are obligated to pay the employee one month’s salary for each year we have
employed the employee. We are, however, permitted to terminate an employee for
cause without penalty pursuant to the employment
agreement.
2007
Plan
To date,
the only awards outstanding under the 2007 Plan are stock
options. Under the terms of the 2007 Plan, recipients have the right
to exercise any vested options, in whole or in part, at any time after
termination during the remaining term of the option; provided, however, that the
Board may specify a shorter period for exercise following termination as it
deems reasonable and appropriate. In the event of the
recipient’s termination of employment by the Company without “cause” (as may be
defined in an employment agreement), by the recipient for “good reason” (as may
be defined in an employment agreement), or by reason of the recipient's death or
“disability” (as may be defined in an employment agreement), any portion of the
option that has not become vested and exercisable as of the date of the
termination of employment shall immediately vest and become
exercisable. The 2007 Plan is more fully described above in the
narrative following the Summary Compensation Table.
24
Director
Summary Compensation Table
The
following table sets forth certain information regarding the compensation earned
by or awarded during the 2009 fiscal year to each director that is not a named
executive officer and who served on our board of directors in the 2009 fiscal
year.
Name
Fees Earned
or Paid in
Cash ($)
Stock
Awards
($)
Option
Awards
($) (1)
Non-Equity
Incentive Plan
Compensation
($)
Nonqualified
Deferred
Compensation
Earnings
All Other
Compensation
($)
Total
($)
Nicholas
Shao
—
—
—
—
—
—
0
Hanqiao
Zheng
—
—
—
—
—
—
0
Timothy
Driscoll
4,000
4,000
Julian
Ha
4,000
4,000
Sean
Shao
4,000
4,000
(1)
The aggregate number of option
awards outstanding at December 31, 2009 for each of the directors was
as follows:
Name
Options
Nicholas
Shao
0
Hanqiao
Zheng
0
Sean
Shao
50,000
Julian
Ha
40,000
Timothy
Driscoll
40,000
Three
grants of stock options were made to non-employee directors in 2009 pursuant to
the Board’s authority to grant such awards. The recipients were Sean
Shao, Julian Ha and Timothy Driscoll.
Compensation
Committee Interlocks and Insider Participation
The
Company first formed a Compensation Committee on November 25, 2009, however, the
Compensation Committee did not hold any meetings in the fiscal year ended
December 31, 2009. Messrs. Nicholas Shao and Hanqiao Zheng
participated in deliberations of the Company’s board of directors concerning
executive officer compensation during the fiscal year ended December 31,2009.
The board
of directors must approve all related party transactions. All material related
party transactions will be made or entered into on terms that are no less
favorable to us than can be obtained from unaffiliated third
parties.
Director
Independence
Dr.
Robert Chanson, Timothy Driscoll, Julian Ha, Nicholas Shao, and Sean Shao are
our only non-employee directors, and our board of directors has determined that
they are independent pursuant to the listing rules of NASDAQ. All of
the members of each of the Audit Committee, Compensation Committee and
Nominating and Corporate Governance Committee are independent pursuant to the
listing rules of NASDAQ.
ITEM
8. LEGAL PROCEEDINGS
The
Company is not a party to any legal proceedings that it believes will have a
material adverse effect upon the conduct of its business or its financial
position.
25
ITEM
9. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT’S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
Our
common stock is currently traded on the NASD’s Over-the-Counter Bulletin Board
under the symbol “CREG.” (“CHDW” prior to March 8, 2007). On August 6, 2004 we
changed our name from Boulder Acquisitions, Inc. to China Digital Wireless, Inc.
and changed our symbol from “BAQI” to “CHDW.” On March 8, 2007, we changed our
name from China Digital Wireless, Inc. to China Recycling Energy Corporation,
and changed our symbol from “CHDW” to “CREG”. On February 1, 2010,
the last reported sales price for our common stock was $3.88 per share. As of
February 1, 2010, there were 38,778,035 shares of our common stock outstanding
held by approximately 2,881 shareholders of record.
The table
below provides information with respect to the Company’s quarterly stock prices
during 2009 and 2008:
2009
2008
4Q
3Q
2Q
1Q
4Q
3Q
2Q
1Q
High
$
4.30
$
1.80
$
1.00
$
0.75
$
1.09
$
1.34
$
1.88
$
2.72
Low
1.65
0.65
0.30
0.22
0.27
0.80
1.05
1.25
Close
4.12
1.73
0.99
0.44
0.51
1.10
1.24
1.45
Dividend
Policy
We did
not pay any cash dividends on our common stock in 2008 or 2009. We do not
anticipate paying any cash dividends on our common stock in the foreseeable
future. We currently intend to retain future earnings, if any, to finance
operations and the expansion of our business.
Equity
Compensation Plan Information
Information
about our equity compensation plans at December 31, 2009 that were either
approved or not approved by our shareholders was as follows:
Equity
compensation plans approved by security holders
-
-
-
Equity
compensation plans not approved by security holders
3,000,000
$
0.95
0
Total
3,000,000
$
0.95
0
ITEM
10. RECENT SALES OF UNREGISTERED SECURITIES.
On
January 24, 2007, a group of individual purchasers entered a share purchase
agreement with a group of shareholders of China Digital Wireless, Inc.
(“Company”) to purchase 12,911,835 shares of Company’s common stock owned by
Sellers, $ 0.001 par value, for an aggregate purchase price of $ 490,000.
Purchasers were Guohua Ku, Hanqiao Zheng, Ping Sun, Qianping Huang, Xiaohong
Zhang and Lixia Zhang. Sellers are Caihua Tai, Ming Mao, Ying Shi, Sixing Fu,
Xiaodong Zhang, Tianqi Huang, Wei Huang, Jing Song, Ruijie Yu, and Weiping Jing,
all of whom are shareholders of Company. In accordance with the share purchase
agreement, Guohua Ku acquired 9,073,700 shares. Hanqiao Zheng acquired 2,406,365
shares. Ping Sun acquired 745,880 shares. Qianping Huang acquired 157,755
shares. Xiaohong Zhang acquired 72,018 shares. Lixia Zhang acquired 456,117
shares. This sale was a sale of restricted shares between the shareholders of
the Company and the individual purchasers under Rule 144A of the Securities Act
of 1933. Therefore, the Company did not issue any new shares to purchasers and
this sale did not change the total number of issued and outstanding shares of
the Company. The proceeds of the sale were directly paid by the purchasers to
the sellers and Company neither was entitled to nor received the proceeds of the
sale.
On August22, 2007, Guohua Ku executed and consummated a share exchange agreement with
another group of individual shareholders of Yingfeng. Under the terms of this
Agreement, Guohua Ku sold 623,410 shares of CREG’s common stock he owned to the
Purchasers for a total of 1,870,230 shares of Yingfeng’s common stock. As the
result of this share exchange transaction, this group of Yingfeng Shareholders
acquired in total 623,410 shares of CREG’s common stock. None of them acquired
more than 1% of the total issued and outstanding common stock of CREG in this
transaction. Guohua Ku, owns 8,160,863 shares of CREG’s common stock after the
consummation of this transaction.
On August23, 2007, Guohua Ku executed and consummated a share purchase agreement with
Hanqiao Zheng to sell 8,160,863 shares of CREG’s common stock he owned to
Hanqiao Zheng for US $2,040,215. As the result of this share purchase
transaction, Hanqiao Zheng acquired 8,160,863 shares of CREG’s common stock.
Guohua Ku, owns 0 shares of CREG’s common stock after the consummation of this
transaction.
On
November 14, 2007, the Company entered into an Assets Transfer and Share
Issuance Agreement (the “Agreement A”) with Hanqiao Zheng Hanqiao, the President
and major shareholder of the Company and TCH. Under the Agreement A, Hanqiao
Zheng sold and transferred two TRT systems equipment (the “Assets”) amounting to
$9,677,420 (equivalent to RMB 72,000,000) to the Company for 7,867,821 shares of
common stock of the Company at a 23-days weighted average market price of $1.23
per share. Under the same Agreement A, the Company subsequently sold and
transferred to TCH the aforementioned Assets for $9,677,420 (equivalent to RMB
72,000,000). Currently, the management of TCH has no intention to engage the
Assets to any new direct financing projects.
Also on
November 14, 2007, the Company entered into a Share Purchase Agreement (the
“Agreement B”) with Hanqiao Zheng for a cash investment of $4,032,258 for
3,278,259 shares of common stock of the Company issued at a 23-days weighted
average market price of $1.23 per share.
On
November 16, 2007, the Company entered into a Stock and Notes Purchase Agreement
(“Purchase Agreement”) with Carlyle Asia Growth Partners III, L.P. (“CAGP”) and
CAGP III Co. Investment, L.P. (together with CAGP, the “Investors”). Under the
terms of the Purchase Agreement, the Company sold to the Investors a 10% Secured
Convertible Promissory Note of $5,000,000 (the “First Note”). Additionally, the
Purchase Agreement provides for two subsequent transactions to be effected by
the Company and the Investors, which include (i) the issuance by the Company and
subscription by the Investors of a total of 4,066,706 shares of common stock of
Company, at the price of $1.23 per share for an aggregate purchase price of
$5,000,000, and (ii) the issuance and sale by the Company to the Investors of a
5% Secured Convertible Promissory Note of $15,000,000 (the foregoing
transactions, together with sale and purchase of the First Note, are hereinafter
referred to as the “Offering”). The subsequent transactions are contingent upon
the satisfaction of certain conditions specified in the Purchase Agreement,
including entry into specified energy and recycling project contracts and the
purchase of certain energy recycling systems.
The First
Note bore interest at 10% and matured on November 16, 2009. The principal face
amount of the First Note, together with any interest thereon was convertible at
the option of the holders at any time on or prior to maturity, into shares of
the Company’s common stock at an initial conversion price of $1.23 per share
(subject to anti-dilution adjustments). The First Note was subject to mandatory
conversion upon the consummation of the aforementioned issuance and subscription
of shares of the Company’s common stock under the Purchase Agreement. As more
fully described in the First Note, the obligations of the Company under the
First Note ranked senior to all other debt of the Company.
As
collateral for the First Note, the President and a major shareholder of the
Company pledged 9,653,471 shares of the Company’s common stock held by him to
secure the First Note.
The First
Note was considered to have an embedded beneficial conversion feature (“BCF”)
because the conversion price was less than the quoted market price at the time
of the issuance. Accordingly, the BCF of $5,000,000 was recorded separately as
unamortized beneficial conversion feature based on the intrinsic value method.
The First Note was recorded in the balance sheet at face value less the
unamortized BCF. The terms for the First Note were amended on April 29, 2008 and
the First Note was repaid in full on June 25, 2008, as described
below.
27
On April29, 2008, the Company entered into an Amendment to the Purchase Agreement with
the Investors (the “Amendment”). Under the terms of the Amendment, (i) the
Company issued and the Investors subscribed for 4,066,706 shares of common stock
of the Company, at $1.23 per share for $5,002,048, as originally contemplated
under the Agreement; (ii) the Investors converted the principal amount under the
First Note (and waived any accrued interest thereon) into 4,065,040 shares of
common stock of the Company at the conversion price per share of $1.23, pursuant
to the terms and conditions of the First Note issued under the Agreement; (iii)
the Company issued and sold to the Investors a new 5% Secured Convertible
Promissory Note of $5,000,000 to the Investors (the “Second Note” and
collectively with the First Note, the “Notes”); and (iv) the Company granted to
the Investors an option to purchase a 5% Secured Convertible Promissory Note of
$10,000,000, exercisable by the Investors at any time within nine (9) months
following the date of the closing of the transactions contemplated by the
Amendment (the “Option Note”).
The
Second Note bears interest at 5% and matures on April 29, 2011. The principal
face amount of the Second Note, together with any interest thereon, is
convertible at the option of the holders at any time on or after March 30, 2010
(or such earlier date if the audited consolidated financial statements of the
Company for the fiscal year ending December 31, 2009 are available prior to
March 30, 2010) and prior to maturity, into shares of the Company's common stock
at an initial conversion price that is tied to the after-tax net profits of the
Company for the fiscal year ending December 31, 2009, as described in the Second
Note. The Second Note is subject to mandatory conversion upon the listing of the
Company's common stock on the National Association of Securities Dealers
Automated Quotations main-board, the New York Stock Exchange or the American
Stock Exchange. As more fully described in the Second Note, the obligations of
the Company under the Second Note shall rank senior to all other debt of the
Company.
The
Second Note and the Option Note are both secured by a security interest granted
to the Investors pursuant to the Share Pledge Agreement.
The
Second Note was not considered to have an embedded BCF because the conversion
price and convertible shares are contingent upon future net
profits.
On June25, 2008, the Company and the Investors entered into a Rescission and
Subscription Agreement (the “Rescission”) to rescind the conversion of the First
Note and the issuance of conversion shares of Common Stock at the Second Closing
pursuant to the Amendment. The Company and the Investors rescinded the
conversion of $5,000,000 under the First Note into 4,065,040 shares of Common
Stock, and the Investors waived accrued interest on the First Note. Accordingly,
the interest expense which had accrued on the note was recorded as a decrease in
interest expense for the period. At the Rescission closing, the Company repaid
in full the First Note and issued to the Investors 4,065,040 shares of Common
Stock at the price of $1.23 per share for $5,000,000. This was done
through a cross receipt arrangement; the amortized portion of BCF was reversed
to additional paid in stock. The Company has now concluded that in
substance the transaction resulted in the conversion of the first $5,000,000
note into common stock and that the remaining BCF of $3,472,603 at the date of
conversion should have been expensed.
On
November 13, 2007, the Company approved the 2007 Non-statutory Stock Option Plan
(the “2007 Plan”). Pursuant to the 2007 Plan, the Company may issue stock, or
grant options to acquire the Company’s common stock at par value $0.001 (the
“Stock”), with an aggregate amount of 3,000,000 shares of the Stock, from time
to time to employees and directors of the Company or other individuals,
including consultants or advisors, all on the terms and conditions set forth in
the 2007 Plan. The exercise price of the options is the closing price per share
of the Company’s common stock on the grant date. On August 4, 2008, the Company
approved the forms of Nonstatutory Stock Option Agreement – Manager Employee and
Nonstatutory Stock Option Agreement – Non-Manager Employee for grants under the
2007 Plan. The vesting terms of option grants under the 2007 Plan are
subject to the agreements for managerial and non-managerial employees. For
managerial employees, no more than 15% of the total stock options shall vest and
become exercisable on the six month anniversary of the grant date. An additional
15% and 50% of the total stock options shall vest and become exercisable on the
first and second year anniversary of the grant date, respectively. The remaining
20% of the total stock options shall vest and become exercisable on the third
year anniversary of the grant date. For non-managerial employees, no more than
30% of the total stock options shall vest and become exercisable on the first
year anniversary of the grant date. An additional 50% of the total stock options
shall vest and become exercisable on the second year anniversary of the grant
date. The remaining 20% of the total stock options shall vest and become
exercisable on the third year anniversary of the grant date. Each stock option
shall become vested and exercisable over a period of no longer than five years
from the grant date. Accelerated vesting of options may also
occur upon a change in control or termination of employment due to death or
disability.
The
Company issued 3,278,259 shares of its Common Stock to one of the Company’s
shareholders, who paid $4,032,258 to the Company during 2008. This
purchase was part of an investment agreement by the shareholder entered into in
November 2007 to purchase the shares at $1.23 per share.
On April29, 2009, CREG issued an 8% Secured Convertible Promissory Note of $3 million to
CAGP with a maturity of April 29, 2012. The note holder has the right
to convert all or any part of the aggregate outstanding principal amount of this
note, together with interest, if any, into shares of the Company’s common stock,
at any time on or after March 30, 2010 (or such earlier date if the audited
consolidated financial statements of the Company for the fiscal year ending
December 31, 2009 are available on a date prior to March 30, 2010) and prior to
the maturity date (or such later date on which this note is paid in full), at a
conversion price per share of common stock equal to US $0.80. The
conversion feature of this note is not beneficial to the holder as the stock
price on April 29, 2009 was $0.47.
28
On April29, 2009, CREG amended and restated the 5% secured convertible promissory note
(the “Second Note”), which was issued as part of the amendment of the First Note
on April 28, 2008. Accordingly the Conversion Rights and Conversion Price were
amended so that the holder of the Second Note has the right, but not the
obligation, to convert all or any part of the aggregate outstanding principal
amount of the Second Note, together with interest, into shares of the Company’s
common stock, at any time on or after March 30, 2010 (or such earlier date if
the audited consolidated financial statements of the Company for the fiscal year
ending December 31, 2009 are available on a date prior to March 30, 2010) and
prior to the maturity date (or such later date on which this Note is paid in
full), at the following conversion price: (a) an amount equal to (i) the
Company’s net profit, adjusted in accordance with the Second Note, multiplied by
(ii) 5.5, and less (iii) the principal amount of the Second Note, together with
accrued interest, divided by (b) the then total shares of the Company’s common
stock outstanding on a fully-diluted basis.
On April29, 2009, to the Company also agreed with certain investors to amend and restate
the Registration Rights Agreement for the convertible notes to amend the rights
for demand registration by certain investors and the applicable liquidated
damages for the Company if it fails to timely comply with the demand for
registration.
On
April 20, 2009, the Company entered into a Stock Purchase Agreement with an
accredited private investor. Pursuant to the agreement, CREG issued
approximately 2.4 million shares, with a one-year lock-up period not to sell,
for an aggregate of $2 million, or $0.85 per share.
ITEM
11. DESCRIPTION OF REGISTRANT’S SECURITIES TO BE REGISTERED.
Our
Articles of Incorporation authorizes the issuance of 100,000,000 shares of
common stock with a par value of $0.001 per share (the “Common Stock”), of which
38,778,035 shares were issued and outstanding as of February 1,2010.
All
outstanding shares of Common Stock are of the same class and have equal rights
and attributes. The holders of Common Stock are entitled to one vote per share
on all matters submitted to a vote of stockholders of the Company. All
stockholders are entitled to share equally in dividends, if any, as may be
declared from time to time by the board of directors out of funds legally
available. In the event of liquidation, the holders of Common Stock are entitled
to share ratably in all assets remaining after payment of all liabilities. The
stockholders do not have cumulative or preemptive rights.
ITEM
12. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
With
certain exceptions involving ouster, securities violations, commodities
violations, receiving deposits in insolvent banks with knowledge of insolvency,
and recovery by an insurer of profits realized from transactions made with
unfair use of information, under Section 78.138 of the Nevada Revised
Statutes, directors and officers of the Company will not be individually liable
to the Company, its stockholders or creditors for any damages as a result of any
act or failure to act in their capacity as a director or officer unless it is
proven that the act or failure to act breached fiduciary duties as a director or
officer and such breach
involved intentional misconduct, fraud, or a knowing violation of
law.
Pursuant
to our Bylaws, we are required to indemnify and hold harmless, to the fullest
extent permitted by Nevada law, each officer and director of the Company who is
made or is threatened to be made a party or are otherwise involved in any
action, suit or proceeding, whether civil, criminal, administrative or
investigative, by reason of the fact that such person is or was a director or
officer of ours or, while a director or officer of ours, is or was serving at
our request as a director, officer, employee or agent of another corporation or
of a partnership, joint venture, trust, enterprise or nonprofit entity, against
all expenses, liabilities and losses (including without limitation attorneys'
fees, judgments, fines, taxes, penalties, and amounts paid or to be paid in
settlement) reasonably incurred or suffered by such person. Under
Nevada law, any such indemnification is only available if such person is not
liable under Section 78.138 of the Nevada Revised Statutes, as described above,
or such person acted in good faith and in a manner which he reasonably believed
to be in or not opposed to the best interests of the corporation, and, with
respect to any criminal action or proceeding, had no reasonable cause to believe
his conduct was unlawful. The indemnification provided by our Bylaws
is not exclusive of any other rights to which those indemnified may be entitled
under any statute, provision of the Company's Articles of Incorporation or
Bylaws, agreement, vote of stockholders or Directors, or otherwise and shall
continue as to a person who has ceased to be a director or officer and shall
inure to the benefit of the heirs, executors, and administrators of such
person.
Insofar
as indemnification for liabilities arising under the Securities Act of 1933 may
be permitted to our directors, officers and controlling persons pursuant to the
foregoing, or otherwise, we have been advised that in the opinion of the SEC
such indemnification is against public policy as expressed in the Securities Act
of 1933 and is, therefore, unenforceable.
29
The
Company is entitled to purchase insurance on behalf of the officers and
directors of the Company and is required to do so pursuant agreements between
the Company and each of the directors.
ITEM
14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM
15. FINANCIAL STATEMENTS AND EXHIBITS.
(a)
Financial Statements and
Schedules
(1)
The Financial Statements listed
on page F-1 are filed as a part of this
report:
(2)
All schedules for which provision
is made in the applicable accounting regulations of the Securities and
Exchange Commission are not required under the related instructions or are
inapplicable and, therefore, have been
omitted.
(3)
Exhibits. Please see the list of
exhibits set forth on our Exhibit Index, which is incorporated herein by
reference.
Common
stock, $0.001 par value; 100,000,000 shares authorized, 38,778,035 and
36,425,094 shares issued and outstanding as of September 30, 2009 and
December 31, 2008, respectively
38,778
36,425
Additional
paid in capital
37,074,978
30,475,360
Statutory
reserve
2,349,198
1,319,286
Accumulated
other comprehensive income
3,617,330
3,582,587
Retained
Earnings (Accumulated deficit)
613,562
(2,991,995
)
Total
Company stockholders’ equity
43,693,846
32,421,663
Noncontrolling
interest
252,679
16,179
Total
equity
43,946,525
32,437,842
TOTAL
LIABILITIES AND EQUITY
$
63,536,753
$
45,117,536
The accompanying notes are
an integral part of these consolidated financial statements.
F-2
CHINA
RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
(UNAUDITED)
NINE MONTHS
ENDED
SEPTEMBER 30
THREE MONTHS
ENDED
SEPTEMBER 30
2009
2008
2009
2008
(Restated)
(Restated)
Revenue
Sales
of products
$
27,938,697
$
-
$
18,425,620
$
-
Rental
income
5,946,892
6,876,223
-
4,259,807
Total
revenue
33,885,589
6,876,223
18,425,620
4,259,807
Cost
of sales
Cost
of products
21,497,172
-
14,179,421
-
Rental
expense
4,148,572
4,810,011
-
2,977,402
Total
cost of sales
25,645,744
4,810,011
14,179,421
2,977,402
Gross
profit
8,239,845
2,066,212
4,246,199
1,282,405
Interest
income on sales-type leases
4,117,305
1,716,544
1,783,833
576,817
Total
operating income
12,357,150
3,782,756
6,030,032
1,859,222
Operating
expenses
General
and administrative expenses
2,730,971
2,543,563
1,375,230
1,039,784
Total
operating expenses
2,730,971
2,543,563
1,375,230
1,039,784
Income
from operations
9,626,179
1,239,193
4,654,802
819,438
Non-operating
income (expenses)
Interest
income
29,702
-
29,702
(57,029
)
Interest
expense
(320,546
)
(4,706,567
)
113,222
-
Other
expense
(68,842
)
(2,239
)
(66,078
)
(1,238
)
Other
income
-
1,621
-
17
Exchange
loss
(2,718
)
(81,969
)
(329
)
(1,524
)
Total
non-operating income (expenses)
(362,405
)
(4,789,154
)
76,516
(59,774
)
Income
(loss) before income tax
9,263,774
(3,549,961
)
4,731,318
759,664
Income
tax expense
1,166,684
796,458
941,962
427,960
Net
income (loss) from operations
8,097,089
(4,346,419
)
3,789,355
331,704
Less:
Net income (loss) attributable to noncontrolling interest
(10,898
)
83
(7,740
)
27
Net
income (loss)
8,107,987
(4,346,502
)
3,797,095
331,677
Other
comprehensive item
Foreign
currency translation gain (loss)
34,743
1,918,236
35,835
807,806
Comprehensive
income (loss)
$
8,142,730
$
(2,428,266
)
$
3,832,930
$
1,139,483
Basic
weighted average shares outstanding
37,829,964
30,642,187
38,778,035
36,425,094
Diluted
weighted average shares outstanding **
43,915,609
34,256,352
47,900,894
37,404,892
Basic
net earnings (loss) per share *
$
0.21
$
(0.14
)
$
0.10
$
0.01
Diluted
net earning (loss) per share *
$
0.19
$
(0.14
)
$
0.08
$
0.01
The accompanying notes are
an integral part of these consolidated financial statements.
F-3
CHINA
RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
China
Recycling Energy Corporation (the “Company” or “CREG”) (formerly China Digital
Wireless, Inc.) was incorporated on May 8, 1980, under the laws of the State of
Colorado. On September 6, 2001, the Company re-domiciled its state of
incorporation from Colorado to Nevada. The Company, through its subsidiary,
Shanghai TCH Energy Technology Co., Ltd (“TCH” or “Shanghai TCH”), sells and
leases energy saving systems and equipment. The businesses of mobile phone
distribution and provision of pager and mobile phone value-added information
services were discontinued in 2007. On March 8, 2007, the Company
changed its name to “China Recycling Energy Corporation”.
Beginning
January 2007, the Company phased out and scaled down most of its business of
mobile phone distribution and provision of pager and mobile phone value-added
information services. In the first and second quarters of 2007, the Company did
not engage in any substantial transactions or activity in connection with these
businesses. On May 10, 2007, the Company discontinued the businesses related to
mobile phones and pagers.
On
February 1, 2007, the Company’s subsidiary, TCH, entered into two top gas
recovery turbine systems (“TRT”) projects, each evidenced by a joint-operation
agreement, with Xi’an Yingfeng Science and Technology Co., Ltd. (“Yingfeng”).
TRT is an electricity generating system that utilizes the exhaust pressure and
heat produced in the blast furnace of a steel mill to generate electricity.
Yingfeng is a joint stock company registered in Xi’an, Shaanxi Province, Peoples
Republic of China (the “PRC”), and engages in designing, installing, and
operating TRT systems and sales of other renewable energy
products.
Under the
first joint-operation agreement, TCH and Yingfeng jointly operated a top gas
recovery turbine project (“TRT Project”), which designed, constructed, installed
and operated a TRT system and leased it to Zhangzhi Iron and Steel Holdings Ltd.
(“Zhangzhi”). TCH provided capital and various properties into the TRT Project,
including hardware, software, equipment, major components and devices. The TRT
Project was completed and put into operation in August 2007. In October 2007,
the Company terminated the joint-operation agreement with Yingfeng. TCH became
entitled to the rights, titles, benefits and interests in the TRT Project and
receives monthly rental payments of approximately $147,000 (equivalent to RMB
1,100,000) from Zhangzhi for a lease term of thirteen years. At the end of the
lease term, TCH will transfer the rights and titles of the TRT Project to
Zhangzhi without cost.
Under the
second joint-operation agreement, TCH and Yingfeng jointly operated a TRT
Project, which designed, constructed, installed and operated a TRT system and
leased it to Xingtai Iron and Steel Company Ltd. (“Xingtai”). TCH provided
capital and various properties into the TRT Project, including hardware,
software, equipment, major components and devices. The TRT Project was completed
and put into operation in August 2007. In October 2007, the Company
terminated the joint-operation agreement with Yingfeng. TCH became fully
entitled to all the rights, titles, benefits and interests of the TRT Project
and receives monthly rental payments of approximately $117,000 (equivalent to
RMB 900,000) from Xingtai for a lease term of five years. At the end of the
lease term, TCH will transfer all the rights and titles of the TRT Project to
Xingtai without cost.
In
November 2007, TCH signed a cooperative agreement with Shengwei Group for a
Cement Waste Heat Power Generator Project (“CHPG”). TCH will build two sets of
12MW pure low temperature cement waste heat power generator systems for
Shengwai’s two 2500 tons per day cement manufacturing lines in Jin Yang and a
5,000 tons per day cement manufacturing line in Tong Chuan. At the end of 2008,
construction of the CHPG in Tong Chuan was completed and put into
operation. Under the original agreement, the ownership of the power
generator system would belong to Tong Chuan from the date the system is put into
service. TCH is responsible for the daily maintenance and repair of
the system, and charges Tong Chuan a monthly electricity fee based on the actual
power generated by the system at 0.4116 RMB per KWH for an operating period of
five years with the assurance from Tong Chuan of proper functioning of 5000 tons
per day cement manufacturing line and not less than 7440 heat hours per year for
the electricity generator system. Shengwei Group collateralized the
cement manufacturing line in Tong Chuan to guarantee its obligations to provide
the minimum electricity income from the power generator system under the
agreement during the operating period. At the end of the five years operating
period, TCH will have no further obligations under the cooperative
agreement. On May 20, 2009, TCH entered into a supplementary
agreement with Shengwei Group to amend the timing for title transfer until the
end of the leasing term.
On June29, 2009, construction of the CHPG in Jin Yang was completed and put into
operation. TCH will charge Jin Yang a technical service fee of
$336,600 (RMB 2,300,000) monthly for sixty months. Jin Yang has the
right to purchase the ownership of the CHPG systems for $29,000 (RMB 200,000) at
the end of lease term. Jin Yang is required to provide assurance of proper
functioning of 5000 tons per day cement manufacturing lines and not less than
7440 heat hours per year for the electricity generator
system. Shengwei Group collateralized the cement manufacturing line
in Jin Yang to guarantee its obligations to provide the minimum electricity
income from the power generator system under the agreement during the operating
period. Effective July 1, 2009, TCH outsourced the operation and
maintenance of the CHPG systems in Tong Chuan and JinYang to an unrelated third
party for $732,000 (RMB 5,000,000) per year.
F-5
On April14, 2009, the Company incorporated a joint venture (“JV”) with Erdos Metallurgy
Co., Ltd. (“Erdos”) for recycling waste heat from Erdos 's metal
refining plants to generate power and steam, which will then be sold back to
Erdos. The name of the JV is Inner Mongolia Erdos TCH Energy Saving
Development Co., Ltd (“Erdos TCH”) with a term of 20 years, and the registered
capital of JV is $2,635,000 (RMB 18,000,000). On September 30, 2009,
Xi’An TCH injected additional capital of $4.03 million (RMB 27,500,000). Total
investment for the project is estimated at approximately $74 million (RMB 500
million) with an initial investment of $8,773,000 (RMB 60,000,000).
Erdos contributed 10% of the total investment of the project, and Xi'an TCH
contributed 90% of the total investment. Xi'an TCH and Erdos will receive 80%
and 20% of the profit allocation from the JV, respectively, until Xi'an TCH has
received a return on its investment; Xi'an TCH and Erdos will then receive 60%
and 40% of the profit allocation from the JV, respectively. When the term of the
JV expires, Xi'an TCH will transfer its equity in the JV to Erdos at no
additional cost.
On
September 30, 2009, Xi’an TCH delivered to Shenmu County Juijiang Trading Co.,
Ltd. (“Shenmu”) a set of 18 megawatt capacity Waste Gas Power Generation
(“WGPG”) power generating systems pursuant to a Cooperative Contract on
Coke-oven Gas Power Generation Project (including its Supplementary Agreement)
and a Gas Supply Contract for Coke-oven Gas Power Generation
Project. The Contracts are for 10 years and provide that Xi’an TCH
will recycle coke furnace gas from the coke-oven plant of Shenmu to generate
power, which will then be supplied back to Shenmu. Shenmu agrees to
supply Xi’an TCH the coke-oven gas free of charge. Under the
Contracts, Shenmu will pay to the Company an annual “energy-saving service fee”
of approximately $5.6 million annually in approximately equal monthly
installments for the life of the Contracts, as well as such additional amount as
may result from the supply of power to Shenmu in excess of 10.8 million kilowatt
hours also paid on a monthly basis. The Company is responsible for
operating the systems and will do so through an unrelated third party. Shenmu
guarantees that monthly gas supply will not be lower than 21.6 million standard
cubic meters, delivered monthly. If gas supply is lower than that, Shenmu agrees
to pay Xi’an TCH the energy-saving service fee described above or up to 10.80
million kilowatt-hours a month. Xi’an TCH maintains the ownership of the project
throughout the term of the Contracts, including the already completed
investment, design, equipment, construction and installation as well as the
operation and maintenance of the project. At the end of the 10-year
term, ownership of the systems transfers to Shenmu at no additional
charge. Shenmu agrees to provide a lien on its production line to
guarantee its performance under the Contracts. Three individuals
provide an unlimited joint liability guarantee to Xi’an TCH for Shenmu’s
performance under the Contracts and the Yulin Huiyuan Group provides a guarantee
to Xi’an TCH for Shenmu’s performance under the Contracts.
The
unaudited financial statements included herein were prepared by the
Company, pursuant to the rules and regulations of the Securities and Exchange
Commission (“SEC”). The information furnished herein reflects all
adjustments (consisting of normal recurring accruals and adjustments) that are,
in the opinion of management, necessary to fairly present the operating results
for the respective periods. Certain information and footnote disclosures
normally present in annual financial statements prepared in accordance with
accounting principles generally accepted in the United States of America (“US
GAAP”) were omitted pursuant to such rules and regulations. These financial
statements should be read in conjunction with the audited financial
statements and footnotes included in the Company’s 2008 audited financial
statements included in the Company’s Annual Report on Form 10-K. The
results for the nine and three months ended September 30, 2009 are not
necessarily indicative of the results to be expected for the full year ending
December 31, 2009.
2. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
Basis of
presentation
These
accompanying consolidated financial statements were prepared in accordance with
US GAAP and pursuant to the rules and regulations of the SEC for quarterly
financial statements.
Basis of
consolidation
The
consolidated financial statements include the accounts of CREG and, its
subsidiaries, Sifang Holdings, TCH, and TCH’s subsidiaries Xi’an TCH Energy Tech
Co., Ltd. (“Xi’an TCH”) and Xingtai Huaxin Energy Tech Co., Ltd. (“Huaxin”), and
Xi’an TCH’s 90% owned subsidiary Erdos TCH , and Sifang Holding’s subsidiary,
Huahong New Energy Technology Co., Ltd. (“Huahong”). Xi’an TCH, Huaxin, Erdos
TCH and Huahong engage in the same business as TCH. Substantially all of the
Company’s revenues are derived from the operations of TCH and its subsidiaries,
which represent substantially all of the Company’s consolidated assets and
liabilities as of September 30, 2009 and December 31, 2008, respectively. All
significant inter-company accounts and transactions were eliminated in
consolidation.
Use of
estimates
In
preparing these consolidated financial statements, management makes estimates
and assumptions that affect the reported amounts of assets and liabilities in
the balance sheets and revenues and expenses during the period reported. Actual
results may differ from these estimates.
F-6
Cash and cash
equivalents
Cash and
cash equivalents are carried at cost and represent 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 and concentration
of credit risk
Accounts
receivable are recorded at the invoiced amounts and do not bear interest. The
Company extends unsecured credit to its customers in the ordinary course of
business but mitigates the associated risks by performing credit checks and
actively pursuing past due accounts. The Company does not require collateral or
other security to support these receivables. The Company conducts periodic
reviews of its clients’ financial condition and customer payment practices to
minimize collection risk on accounts receivable. As of September 30, 2009 and
December 31, 2008, the Company had accounts receivable of $0.
An
allowance for doubtful accounts is established and determined based on
management’s assessment of known requirements, aging of receivables, payment
history, the customer’s current credit worthiness and the economic environment.
As of September 30, 2009 and December 31, 2008, the Company had an accounts
receivable allowance of $0.
Financial
instruments that potentially subject the Company to credit risk consist
primarily of accounts receivable, receivables on sales-type leases, and other
receivables. The carrying amounts reported in the balance sheets for the leases
and other financial instruments are a reasonable estimate of fair value because
of the short period of their maturity.
The
operations of the Company are located in the People’s Republic of China (“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, as well as by the general state of the PRC
economy.
Inventory
Inventory
is valued at the lower of cost or market. Cost of work in progress and finished
goods comprises direct material cost, direct production cost and an allocated
portion of production overheads.
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 ranging from 5 to 20 years as
follows:
Building
20
years
Vehicle
2 -
5 years
Office
and Other Equipment
2 -
5 years
Software
2 -
3 years
Impairment of long-life
assets
In
accordance with SFAS 144 (codified in Financial Accounting Standards Board
(“FASB”) Accounting Standards Codification (“ASC”) Topic 360), the Company
reviews its long-lived assets, including property, plant 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 of the
expected undiscounted future net cash flows is less than the carrying amount of
the asset, a loss is recognized for the difference between the fair value and
carrying amount of the asset. There was no impairment as of September 30, 2009
and December 31, 2008.
Sales-type leasing and related
revenue recognition
The
Company leases TRT, CHPG and WGPG systems to its customers. The Company usually
transfers all benefits, risks and ownership of the TRT or CHPG system to its
customers at the end of each lease term. The Company’s investment in
these projects is recorded as investment in sales-type leases in accordance with
SFAS No. 13, “Accounting for Leases” (codified in FASB ASC Topic 840) and its
various amendments and interpretations. The Company manufactures and constructs
the TRT, CHPG and WGPG systems and power generating system, and finances its
customers for the price of the systems. The sales and cost of goods
sold are recognized at the point of sale or inception of the lease. The
investment in sales-type leases consists of the sum of the total minimum lease
payments receivable less unearned interest income and estimated executory cost.
Unearned interest income is amortized to income over the lease term as to
produce a constant periodic rate of return on the net investment in the
lease.
F-7
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 rental expenses for two pieces of power generation equipment for the
operating lease.
Income
taxes
The
Company utilizes SFAS No. 109, “Accounting for Income Taxes,” (codified in FASB
ASC Topic 740), which requires recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that were
included in the financial statements or tax returns. 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 adopted the provisions of Financial Accounting Standards Board (“FASB”)
Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (“FIN
48”), codified in FASB ASC Topic 740, on January 1, 2007. As a result of the
implementation of FIN 48, the Company made a comprehensive review of its
portfolio of tax positions in accordance with recognition standards established
by FIN 48, and the Company recognized no material adjustments to liabilities or
stockholders equity. 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. Interest associated with unrecognized tax benefits are
classified as interest expense and penalties are classified in selling, general
and administrative expenses in the statements of income. The adoption of FIN 48
did not have a material impact on the Company’s financial
statements. At September 30, 2009 and December 31, 2008, the
Company did not take any uncertain positions that would necessitate recording of
tax related liability.
Statement of cash
flows
In
accordance with SFAS No. 95, “Statement of Cash Flows” (codified in FASB ASC
Topic 230), 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
SFAS No.
107, “Disclosures about Fair Value of Financial Instruments” (codified in FASB
ASC Financial Instruments, Topic 825), requires the Company to disclose
estimated fair values of financial instruments. The carrying
amounts reported in the statements of financial position for investment in
sales-type leases, current assets and current liabilities, and convertible notes
qualifying as financial instruments are a reasonable estimate of fair
value.
Fair Value
Measurements
On
January 1, 2008, the Company adopted SFAS No. 157 “Fair Value Measurements”
(codified in FASB ASC Topic 820); SFAS 157 defines fair value, establishes a
three-level valuation hierarchy for disclosures of fair value measurement and
enhances disclosures requirements for fair value measures. The three
levels are defined as follow:
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
the fair value measurement.
As
of September 30, 2009, the Company did not identify any assets and liabilities
that are required to be presented on the balance sheet at fair
value.
Stock Based
Compensation
The
Company accounts for its stock-based compensation in accordance with SFAS No.
123R, “Share-Based Payment, an Amendment of FASB Statement No.
123” (codified in FASB ASC Topic 718). The Company recognizes in
its statement of operations the grant-date fair value of stock options and other
equity-based compensation issued to employees and
non-employees.
F-8
Basic and Diluted Earnings per
Share
Basic
earnings per share (“EPS”) is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding for the
period. Diluted EPS is computed similar to basic net income per share except
that the denominator is increased to include the number of additional common
shares that would have been outstanding if the potential common shares had been
issued and if the additional common shares were dilutive. Diluted net earnings
per share is based on the assumption that all dilutive convertible shares and
stock options were converted or exercised. Dilution is computed by applying the
treasury stock method. Under this method, options and warrants are assumed to be
exercised at the beginning of the period (or at the time of issuance, if later),
and as if funds obtained thereby were used to purchase common stock at the
average market price during the period. The following table presents a
reconciliation of basic and diluted earnings per share:
Interest
expense on convertible note was added back to net income (loss) for the
computation of diluted earnings per
share.
(2)
Diluted
weighted average shares outstanding includes shares estimated upon
conversion of the Second Note issued on April 29, 2008 with conversion
price contingent upon future net
profits.
(3)
Basic
and diluted loss per share is the same due to anti-dilutive feature of the
securities.
(4)
Diluted
weighted average shares outstanding for the nine and three months ended
September 30, 2008 did not include estimated shares upon conversion of the
Second Note issued on April 29, 2008 as the number of such shares cannot
be determined based on the conversion
formula.
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”) 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 has been no significant fluctuation
in the exchange rate for the conversion of RMB to USD after the balance sheet
date.
The
Company uses SFAS 130 “Reporting Comprehensive Income” (codified in FASB ASC
Topic 220). Comprehensive income is comprised of net income and all changes to
the statements of stockholders’ equity, except those due to investments by
stockholders, changes in paid-in capital and distributions to
stockholders.
Segment
Reporting
SFAS No.
131, “Disclosures about Segments of an Enterprise and Related Information”
(codified in FASB ASC Topic 280) 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. SFAS 131 has no effect on
the Company’s financial statements as substantially all of the Company’s
operations are conducted in one industry segment. All of the Company’s assets
are located in the PRC.
F-9
Reclassifications
Certain
prior year amounts were reclassified to conform to the manner of presentation in
the current period.
New Accounting
Pronouncements
On July1, 2009, the Company adopted Accounting Standards Update (“ASU”) No.
2009-01, “Topic 105 - Generally Accepted Accounting Principles - amendments
based on Statement of Financial Accounting Standards No. 168 , “The FASB
Accounting Standards Codification™ and the Hierarchy of Generally Accepted
Accounting Principles” (“ASU No. 2009-01”). ASU No. 2009-01
re-defines authoritative GAAP for nongovernmental entities to be only comprised
of the FASB Accounting Standards Codification™ (“Codification”) and, for SEC
registrants, guidance issued by the SEC. The Codification is a
reorganization and compilation of all then-existing authoritative GAAP for
nongovernmental entities, except for guidance issued by the SEC. The
Codification is amended to effect non-SEC changes to authoritative
GAAP. Adoption of ASU No. 2009-01 only changed the referencing
convention of GAAP in Notes to the Consolidated Financial
Statements.
In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No.
46(R)” (“SFAS 167”), codified as FASB ASC Topic 810-10, which modifies how a
company determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be consolidated. SFAS 167
clarifies that the determination of whether a company is required to consolidate
an entity is based on, among other things, an entity’s purpose and design and a
company’s ability to direct the activities of the entity that most significantly
impact the entity’s economic performance. SFAS 167 requires an ongoing
reassessment of whether a company is the primary beneficiary of a variable
interest entity. SFAS 167 also requires additional disclosures about a company’s
involvement in variable interest entities and any significant changes in risk
exposure due to that involvement. SFAS 167 is effective for fiscal years
beginning after November 15, 2009. The Company does not believe the adoption of
SFAS 167 will have an impact on its financial condition, results of operations
or cash flows.
In June
2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial
Assets — an amendment of FASB Statement No. 140” (“SFAS 166”), codified as FASB
Topic ASC 860, which requires entities to provide more information regarding
sales of securitized financial assets and similar transactions, particularly if
the entity has continuing exposure to the risks related to transferred financial
assets. SFAS 166 eliminates the concept of a “qualifying special-purpose
entity,” changes the requirements for derecognizing financial assets and
requires additional disclosures. SFAS 166 is effective for fiscal years
beginning after November 15, 2009. The Company does not believe the adoption of
SFAS 166 will have an impact on its financial condition, results of operations
or cash flows.
In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”) codified in
FASB ASC Topic 855-10-05, which provides guidance to establish general standards
of accounting for and disclosures of events that occur after the balance sheet
date but before financial statements are issued or are available to be issued.
SFAS 165 also requires entities to disclose the date through which subsequent
events were evaluated as well as the rationale for why that date was selected.
SFAS 165 is effective for interim and annual periods ending after June 15, 2009,
and accordingly, the Company adopted this pronouncement during the second
quarter of 2009. SFAS 165 requires that public entities evaluate subsequent
events through the date that the financial statements are issued. The Company
has evaluated subsequent events through November 9, 2009.
In April
2009, the FASB issued FSP No. SFAS 107-1 and APB 28-1, “Interim Disclosures
about Fair Value of Financial Instruments,” which is codified in FASB ASC Topic
825-10-50. This FSP essentially expands the disclosure about fair value of
financial instruments that were previously required only annually to also be
required for interim period reporting. In addition, the FSP requires certain
additional disclosures regarding the methods and significant assumptions used to
estimate the fair value of financial instruments. These additional disclosures
are required beginning with the quarter ending June 30, 2009.
In
April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition
and Presentation of Other-Than-Temporary Impairments,” which is codified in FASB
ASC Topic 320-10. This FSP modifies the requirements for recognizing
other-than-temporarily impaired debt securities and changes the existing
impairment model for such securities. The FSP also requires additional
disclosures for both annual and interim periods with respect to both debt and
equity securities. Under the FSP, impairment of debt securities will be
considered other-than-temporary if an entity (1) intends to sell the security,
(2) more likely than not will be required to sell the security before recovering
its cost, or (3) does not expect to recover the security’s entire amortized cost
basis (even if the entity does not intend to sell). The FSP further indicates
that, depending on which of the above factor(s) causes the impairment to be
considered other-than-temporary, (1) the entire shortfall of the security’s fair
value versus its amortized cost basis or (2) only the credit loss portion would
be recognized in earnings while the remaining shortfall (if any) would be
recorded in other comprehensive income. FSP 115-2 requires entities to initially
apply the provisions of the standard to previously other-than-temporarily
impaired debt securities existing as of the date of initial adoption by making a
cumulative-effect adjustment to the opening balance of retained earnings in the
period of adoption. The cumulative-effect adjustment potentially reclassifies
the noncredit portion of a previously other-than-temporarily impaired debt
security held as of the date of initial adoption from retained earnings to
accumulate other comprehensive income. The Company adopted FSP No. SFAS 115-2
and SFAS 124-2 beginning April 1, 2009. This FSP had no material impact on the
Company’s financial position, results of operations or cash flows.
F-10
In April
2009, the Financial Accounting Standards Board (“FASB”) issued FSP
No. SFAS 157-4, “Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly” (“FSP No. SFAS 157-4”). FSP
No. SFAS 157-4, which is codified in FASB ASC Topics 820-10-35-51 and
820-10-50-2, provides additional guidance for estimating fair value and
emphasizes that even if there has been a significant decrease in the volume and
level of activity for the asset or liability and regardless of the valuation
technique(s) used, the objective of a fair value measurement remains the same.
The Company adopted FSP No. SFAS 157-4 beginning April 1, 2009.
This FSP had no material impact on the Company’s financial position, results of
operations or cash flows.
3. NET
INVESTMENT IN SALES-TYPE LEASES
Under
sales-type leases, TCH leased TRT systems to Xingtai and Zhangzhi with terms of
five years and thirteen years, respectively; and CHPG systems to Tongchuan
Shengwei and Jin Yang Shengwei respectively for five years, and WGPG systems to
Shenmu for ten years respectively. The components of the net investment in
sales-type leases as of September 30, 2009 (unaudited) and December 31, 2008 are
as follows:
4. RESTRICTED
CASH, NOTES RECEIVABLE – BANK ACCEPTANCES, NOTES PAYABLE – BANK
ACCEPTANCES
Restricted cash represented $4,395,153
held in the bank as collateral for the bank to issue the same amount of bank
acceptances without charging interest. The Company endorses the bank
acceptances to vendors as payment of their own obligations. Most of
the bank acceptances has maturity of less than six
months. During the quarter ended September 30, 2009, the
Company endorsed bank acceptances of $1,466,467 to an independent contractor for
constructing the waste heat power generation systems in Erdos TCH,; the Company
also received notes receivable for bank acceptances of $292,869 from the
minority shareholder of Erdos TCH as payment for their investment.
5. PREPAID
EXPENSES
Prepaid
equipment rent for operating leases
On April10, 2008, the Company leased energy recycling power generation equipment under a
one-year, non-cancellable lease for approximately $4,455,000 (RMB 31,000,000).
At the end of this lease, the Company had the right to renew the lease for
another four-year term at an aggregate of approximately $10,940,000 (RMB
75,000,000). The lease payment of approximately $4,455,000 was paid in
full. The Company did not renew the lease at the end of the one-year
lease.
On the
same day, the Company entered into a lease with a lessee to sublease the above
power generation equipment under a one-year, non-cancellable lease for
approximately $583,000 (RMB 4,000,000) per month with an option to renew. The
lessee would have paid a monthly payment of approximately $486,000 (RMB
3,333,000) if the Company had renewed the lease of the equipment from the
ultimate lessor after one year. The lessee was unable to renew the
lease as the Company did not renew its lease.
On May21, 2008, the Company leased energy recycling power generation equipment from
the same lessor under a one-year, non-cancellable lease for approximately
$6,560,000 (RMB 45,000,000). At the end of the one-year lease term, the Company
had the right to renew the lease for another four-year term at an aggregate of
approximately $17,500,000 (RMB 120,000,000) with a separate agreement. The lease
payment of approximately $6,560,000 was paid in full. The Company did
not renew the lease at the end of the one-year lease.
F-11
On the
same day, the Company entered into a lease with the same lessee referenced in
the second paragraph of this Note 5 to sublease the above power generation
equipment under a one-year, non-cancellable lease for approximately $887,000
(RMB 5,850,000) per month with an option to renew. The lessee would have paid a
monthly payment of approximately $729,000 (RMB 5,000,000) if the Company had
renewed the lease of the equipment from the ultimate lessor after one
year. The lessee was unable to renew the lease as the Company did not
renew its lease.
At
September 30, 2009 and December 31, 2008, the prepaid equipment rent for
operating leases was approximately $0 and $3,821,000, respectively.
Prepaid
expenses – other
Other
prepaid expenses mainly consisted of prepayment for office rental, parking
space, salary, insurance and legal fees. Other prepaid expenses were
$0 and approximately $28,000 at September 30, 2009 and December 31, 2008,
respectively.
6. INVENTORY
At
December 31, 2008, Inventory of $10,543,633 (RMB 72,000,000) consisted of two
equipment systems that will be used for TRT, CHPG or WGPG. During 2009, the
systems were incorporated into the Shenmu project.
7. ADVANCE
FOR EQUIPMENT
“Advance
for equipment” represented advance payment of approximately $2,640,000 (RMB
18,000,000) to an independent contractor for constructing a power generation
system and purchase of the equipment that will be used for the construction. At
December 31, 2008, this project was terminated; during the first quarter of
2009, the title of the equipment officially transferred to the Company as the
Company’s inventory. This equipment was incorporated into of the
Shenmu project during the third quarter of 2009.
8. CONSTRUCTION
IN PROGRESS
“Construction
in progress” represented the amount paid for constructing power generation
systems. At September 30, 2009 and December 31, 2008, the construction in
progress was $9.4 million for the power generation system projects in Erdos TCH
and Zhonggang Binhai and $3.7 million for the Jin Yang project,
respectively. The Jin Yang project was completed and put into
operation at June 30, 2009.
Payables
for employee training, labor union expenditure, social insurance
payable
$
74,348
$
125,323
Consulting
and legal expenses
376,035
371,125
Payable
to Yingfeng
1,678,175
1,676,878
Security
deposit from lessee
-
1,024,252
Short
term advance from third parties
488,098
-
Total
other payables
2,616,656
3,197,578
Accrued
payroll and welfare
238,368
258,443
Accrued
maintenance expense
122,938
72,506
Total
$
2,977,962
$
3,528,527
F-12
“Consulting
and legal expenses” was the expenses paid by a third party for the Company and
will be repaid by the Company. “Payable to Yingfeng” represented the
cost of obtaining the ownership of two TRT projects that were previously owned
by Yingfeng. “Deposit from lessee” represented a deposit received for leasing
out the power generation equipment.
11. NONCONTROLLING
INTEREST
“Non-controlling
interest” represents the 20% equity interest of the outside shareholder in
Huaxin at December 31, 2008. The Company acquired the remaining 20%
equity interest in Huaxin from this shareholder during the third quarter of
2009.
As of
September 30, 2009, Erdos Metallurgy Co., Ltd. owns a 10% equity interest in
Erdos TCH but receives a 20% share of the profit of Erdos TCH until the
investment on the project is fully returned and a 40% share of the profit
thereafter.
Huaxin
and Erdos TCH engage in business similar to that of TCH. The minority
share of the income (loss) was $(10,898) and $83 for the nine months ended
September 30, 2009 and 2008, and $(7,740) and $27 for the three months ended
September 30, 2009 and 2008, respectively.
12. DEFERRED
TAX
Deferred
tax asset arose from the accrued maintenance cost on two TRT machines that can
be deducted for tax purposes in the future. Deferred tax liability
represented differences between the tax bases and book bases of sales-type
leases.
Effective
January 1, 2008, the PRC government implemented a new corporate income tax law
with a new maximum corporate income tax rate of 25%. The Company is governed by
the Income Tax Law of the PRC concerning privately-run enterprises, which are
generally subject to tax at a statutory rate of 25% (33% prior to 2008) on
income reported in the statutory financial statements after appropriate tax
adjustments. Under the new Chinese tax law the tax treatment of
finance and sales type leases is similar to US GAAP rules. However,
the local tax bureau continues to treat the sales type lease as operating
leases. Accordingly, the Company has recorded deferred income
taxes.
The
Company’s subsidiaries generate substantially all of their net income from their
PRC operations. Shanghai TCH’s effective income tax rate for 2009 and 2008 are
20% and 18%, respectively. Xi’an TCH’s effective income tax rate for 2009 and
2008 is 15% as a result of its high tech enterprise status that has been
approved by the taxing authority. Xingtai Huaxin’s effective income tax rate for
2009 and 2008 is 25%. Huahong and Erdos TCH’s effective income tax
rate for 2009 is 25%. Shanghai TCH, Xi’an TCH, Xingtai Huaxin,
Huahong and Erdos TCH file separate income tax returns.
Shanghai
TCH, as a business in the Development Zone, is subject to a 15% income tax rate.
According to the new income tax law that became effective January 1, 2008, for
those enterprises to which the 15% tax rate was applicable previously, the
applicable rates shall increase over five-years as follows:
Year
Tax Rate
2007
15
%
2008
18
%
2009
20
%
2010
22
%
2011
24
%
2012
25
%
There is
no income tax for companies domiciled in the Cayman Islands. Accordingly, the
Company’s consolidated financial statements do not present any income tax
provisions related to Cayman Islands tax jurisdiction where Sifang Holding is
domiciled.
F-13
The
parent company, China Recycling Energy Corporation, is taxed in the U.S. and has
net operating loss carry forwards for income taxes of approximately $1,970,000
at September 30, 2009 which may be available to reduce future years’
taxable income as NOL can be carried forward up to 20 years from the year the
loss is incurred. Management believes the realization of benefits from these
losses appears uncertain due to the Company’s limited operating history and
continuing losses. Accordingly, a 100% deferred tax asset valuation
allowance was provided.
Foreign
pretax earnings approximated $11,267,000 and $5,500,000 for the nine months
ended September 30, 2009 and 2008, respectively. Pretax earnings of a foreign
subsidiary are subject to U.S. taxation when effectively repatriated. The
Company provides income taxes on the undistributed earnings of non-U.S.
subsidiaries except to the extent that such earnings are indefinitely invested
outside the United States. At September 30, 2009, approximately $9,836,000 of
accumulated undistributed earnings of non-U.S. subsidiaries was indefinitely
invested. At the existing U.S. federal income tax rate, additional taxes of
approximately $2,878,000 would have to be provided if such earnings were
remitted currently.
The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the nine months ended September 30, 2009 and 2008,
respectively:
On April13, 2009, Xi’an TCH entered into a one-year working capital loan agreement with
the Industrial Bank Co., Ltd. Xi’an branch, to borrow $2.9 million (RMB 20
million) at an interest rate of 5.3% and Xi’an TCH is required to make quarterly
interest payments on the outstanding loan balance. The loan agreement
contains standard representations, warranties and covenants, and the borrowed
funds are to be guaranteed through a separate guaranty contract with Shanxi
Zhongze Investment Co., Ltd.
15. CONVERTIBLE
NOTES PAYABLE
On
November 16, 2007, the Company entered into a Stock and Notes Purchase Agreement
(“Purchase Agreement”) with Carlyle Asia Growth Partners III, L.P. (“CAGP”) and
CAGP III Co. Investment, L.P. (together with CAGP, the “Investors”). Under the
terms of the Purchase Agreement, the Company sold the Investors a 10% Secured
Convertible Promissory Note of $5,000,000 (the “First Note”). Additionally, the
Purchase Agreement provides for two subsequent transactions to be effected by
the Company and the Investors, which include (i) the issuance by the Company of
and subscription by the Investors for 4,066,706 shares of common stock of
Company, at $1.23 per share for $5,000,000, and (ii) the issuance and sale by
the Company to the Investors of a 5% Secured Convertible Promissory Note in the
principal amount of $15,000,000 (the foregoing transactions, together with sale
and purchase of the First Note, are hereinafter referred to as the “Offering”).
The subsequent transactions are contingent upon the satisfaction of certain
conditions specified in the Purchase Agreement, including entry into specified
energy and recycling project contracts and the purchase of certain energy
recycling systems.
The First
Note bore interest at 10% per annum and was due on November 16, 2009.
The principal face amount of the First Note, together with any interest thereon,
converted, at the option of the holders at any time on or prior to maturity,
into shares of the Company’s common stock at an initial conversion price of
$1.23 per share (subject to anti-dilution adjustments). The First Note was
subject to mandatory conversion upon the consummation of the aforementioned
issuance and subscription of shares of the Company’s common stock under the
Purchase Agreement. As more fully described in the First Note, the obligations
of the Company under the First Note ranked senior to all other debt of the
Company.
As
collateral for the First Note, the President and a major shareholder of the
Company pledged 9,653,471 shares of the Company’s common stock held by him to
secure the First Note.
The First
Note was considered to have an embedded beneficial conversion feature (“BCF”)
because the conversion price was less than the quoted market price at the time
of issuance. Accordingly, the beneficial conversion feature of $5,000,000 was
recorded separately as unamortized beneficial conversion feature based on the
intrinsic value method. As the BCF was greater than the face value of the note,
all of the proceeds were allocated to the BCF. No value was assigned to the note
option or the equity option (two subsequent transactions discussed above). The
First Note was recorded in the balance sheet at face value less the unamortized
beneficial conversion feature. The terms for the First Note were amended on
April 29, 2008 and the First Note was repaid in full on June 25, 2008, as
described below.
F-14
On April29, 2008, the Company entered into an Amendment to the Purchase Agreement with
the investors. Under the terms of the Amendment, (i) the Company issued and the
Investor subscribed for 4,066,706 shares of common stock of the Company, at
$1.23 per share for $5,002,048, as originally contemplated under the Agreement;
(ii) the Investors converted the principal under the First Note (and
waived any accrued interest thereon) into 4,065,040 shares of common stock of
the Company at the conversion price per share of $1.23, pursuant to the terms
and conditions of the First Note issued under the Agreement; (iii) the Company
issued and sold to the Investors a new 5% Secured Convertible Promissory of
$5,000,000 (the “Second Note” and collectively with the First Note, the
“Notes”); and (iv) the Company granted to the Investors an option to purchase a
5% Secured Convertible Promissory Note of $10,000,000, exercisable by the
Investors at any time within nine (9) months following the date of the closing
of the transactions contemplated by the Amendment (the “Option
Note”).
The
Second Note bears interest at 5% per annum and matures on April 29, 2011. The
principal face amount of the Second Note, together with any interest thereon,
convert, at the option of the holders at any time on or after March 30, 2010 (or
such earlier date if the audited consolidated financial statements of the
Company for the fiscal year ending December 31, 2009 are available prior to
March 30, 2010) and prior to maturity, into shares of the Company’s common stock
at an initial conversion price that is tied to the after-tax net profits of the
Company for the year ending December 31, 2009, as described in the Second Note.
The Second Note is subject to mandatory conversion upon the listing of the
Company’s common stock on the National Association of Securities Dealers
Automated Quotations main-board, the New York Stock Exchange or the American
Stock Exchange. As more fully described in the Second Note, the obligations of
the Company under the Second Note shall rank senior to all other debt of the
Company.
The
Second Note and the Option Note are both secured by a security interest granted
to the Investors pursuant to the Share Pledge Agreement.
The
Second Note was not considered to have an embedded beneficial conversion feature
because the conversion price and convertible shares are contingent upon future
net profits.
On June25, 2008, the Company and investors entered into a Rescission and Subscription
Agreement to rescind the conversion of the First Note and the issuance of
conversion shares of Common Stock at the Second Closing pursuant to Amendment to
Stock and Notes Purchase Agreement dated on April 29, 2008. The Company and the
Investors rescinded the conversion of the principal amount ($5,000,000) under
the First Note into 4,065,040 shares of Common Stock, and the Investors waived
accrued interest on the First Note. Accordingly, the interest expense which had
accrued on the note has been recorded as a decrease on interest expense for the
period. At the Rescission and Subscription Closing, the Company repaid in full
the First Note and issued to the Investors, 4,065,040 shares of Common Stock at
the price of $1.23 per share for an aggregate of $5,000,000. This was
done through a cross receipt arrangement; the BCF was reversed to additional
paid in stock. The Company has now concluded that in substance the
transaction resulted in the conversion of the first $5,000,000 note into common
stock, and based on substance over form, the remaining BCF of $3,472,603 at the
date of conversion should have been expensed (see Restatement Note
21).
On April29, 2009, CREG issued an 8% Secured Convertible Promissory Note in the principal
amount of $3 million to CAGP with a maturity of April 29, 2012. The note holder
has the right to convert all or any part of the aggregate outstanding principal
amount of this note, together with interest, if any, into shares of the
Company’s common stock, at any time on or after March 30, 2010 (or such earlier
date if the audited consolidated financial statements of the Company for the
fiscal year ending December 31, 2009 are available on a date prior to March 30,2010) and prior to the maturity date (or such later date on which this note is
paid in full), at a conversion price per share of common stock equal to US
$0.80. The conversion feature of this note is not beneficial to the
holder as the stock price on April 29, 2009 was $0.47.
On April29, 2009, CREG amended and restated the 5% secured convertible promissory note
(the “Second Note”), which was issued as part of the amendment of the First Note
on April 28, 2008. Accordingly the Conversion Rights and Conversion Price were
amended so that the holder of the Second Note has the right, but not the
obligation, to convert all or any part of the aggregate outstanding principal
amount of the Second Note, together with interest, into shares of the Company’s
common stock, at any time on or after March 30, 2010 (or such earlier date if
the audited consolidated financial statements of the Company for the fiscal year
ending December 31, 2009 are available on a date prior to March 30, 2010) and
prior to the maturity date (or such later date on which this Note is paid in
full), at the following conversion price: (a) an amount equal to (i) the
Company’s net profit, adjusted in accordance with the Second Note, multiplied by
(ii) 5.5, and less (iii) the principal amount of the Second Note, together with
accrued interest, divided by (b) the then total shares of the Company’s common
stock outstanding on a fully-diluted basis.
On April29, 2009, to the Company also agreed with certain investors to amend and restate
the Registration Rights Agreement for the convertible notes to amend the rights
for demand registration by certain investors and the applicable liquidated
damages for the Company if it fails to timely comply with the demand for
registration.
F-15
16. STOCK-BASED
COMPENSATION PLAN
On
November 13, 2007, the Company approved the 2007 Non-statutory Stock Option
Plan, which was later amended and restated in August 2008 (the “2007
Plan”), and granted 3,000,000 options to acquire the Company’s common stock at
$1.23 per share to twenty (20) managerial and non-managerial employees under the
2007 Plan.
The
vesting terms of options granted under the 2007 Plan are subject to the
Non-Statutory Stock Option Agreements for managerial and non-managerial
employees. For managerial employees, no more than 15% of the total stock options
shall vest and become exercisable on the six month anniversary of the grant
date. An additional 15% and 50% of the total stock options shall vest and become
exercisable on the first and second year anniversary of the grant date,
respectively. The remaining 20% of the total stock options shall vest and become
exercisable on the third year anniversary of the grant date. For non-managerial
employees, no more than 30% of the total stock options shall vest and become
exercisable on the first year anniversary of the grant date. An additional 50%
of the total stock options shall vest and become exercisable on the second year
anniversary of the grant date. The remaining 20% of the total stock options
shall vest and become exercisable on the third year anniversary of the grant
date. Each stock option shall become vested and exercisable over a period of no
longer than five years from the grant date.
Based on
the fair value method under SFAS No. 123 (Revised) “Share Based Payment” (“SFAS
123(R)”), codified in FASB ASC Topic 718, the fair value of each stock option
granted is estimated on the date of the grant using the Black-Scholes option
pricing model. The Black-Scholes option pricing model 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 fair value of each option grant to
employees is calculated by the Black-Scholes method and is recognized as
compensation expense over the vesting period of each stock option award. For
stock options issued, the fair value was estimated at the date of grant using
the following range of assumptions:
The
options vest over a period of three years and have a life of 5 years. The fair
value of the options was calculated using the following assumptions, estimated
life of five years, volatility of 100%, risk free interest rate of 3.76%, and
dividend yield of 0%. No estimate of forfeitures was made as the Company has a
short history of granting options.
Effective
June 25, 2008, the Company cancelled all vested shares and accepted optionees’
forfeiture of any unvested shares underlying the currently outstanding
options.
On August4, 2008, the Company granted stock options to acquire an aggregate amount
of 3,000,000 shares of the Company’s common stock, par value $0.001, at
$0.80 per share to 17 employees under the 2007 Plan. The options vest over a
period of three years and have a life of 5 years. The fair value of the options
was calculated using the following assumptions, estimated life of five years,
volatility of 100%, risk free interest rate of 2.76%, and dividend yield of 0%.
No estimate of forfeitures was made as the Company has a short history of
granting options. The options were accounted as modification to the options
that were cancelled on June 25, 2008.
F-16
The
following table summarizes activity for employees in the Company’s Plan for the
nine months ended September 30, 2009:
The
Company recorded $1,129,328 and $687,137 of compensation expense for employee
stock options during the nine and three months ended September 30, 2009,
respectively. There were no options exercised during the nine months
ended September 30, 2009.
During
the nine months ended September 31, 2008, The Company recorded $1,129,151
(restated) of compensation expense including amortized portion of incremental
cost arising from the modification to the employee stock options.
17. SHAREHOLDERS’
EQUITY
On April29, 2008, the Company issued and certain investors subscribed for 4,066,706
shares of common stock of the Company, at $1.23 per share for $5,002,048 under
the Purchase Agreement.
On June25, 2008, the Company and the Investors entered into a Rescission and
Subscription Agreement to rescind the conversion of the First Note and the
issuance of conversion shares of Common Stock pursuant to the Amendment to Stock
and Notes Purchase Agreement dated on April 29, 2008. The Company and the
investors rescinded the conversion of the principal amount ($5,000,000) under
the First Note into 4,065,040 shares of Common Stock and repaid the First Note
in full. At the Rescission and Subscription Closing, the Company issued the
investors, 4,065,040 shares of Common Stock at $1.23 per share for
$5,000,000.
The
Company issued 3,278,259 shares of its Common Stock to one of the Company’s
shareholders who paid $4,032,258 to the Company during 2008. This purchase was
part of an investment agreement by the shareholder entered into in November 2007
to purchase the shares at $1.23 per share.
On
April 20, 2009, the Company entered into a Stock Purchase Agreement with an
accredited private investor. Pursuant to the agreement, CREG issued
approximately 2.4 million shares, with a one-year lock-up period not to sell,
for an aggregate of $2 million, or $0.85 per share.
18. STATUTORY
RESERVES
Pursuant
to the new corporate law of the PRC effective January 1, 2006, the Company is
now 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 is required to transfer 10% of its 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.
F-17
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 shareholdings or by increasing the par value
of the shares currently held by them, provided that the remaining reserve
balance after such issuance is not less than 25% of the registered
capital.
Common
Welfare Fund
The
common welfare fund is a voluntary fund that the Company can elect to transfer
5% to 10% of its net income to this fund. 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.
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 affect the
remittance.
In
September, 2008, the Company signed a contract to recycle waste gas and waste
heat for China Zhonggang Binhai Enterprise Ltd. (“Zhonggang Binhai”) in Cangzhou
City, Hebei Province, a world-class nickel-iron manufacturing joint venture
between China Zhonggang Group and Shanghai Baoshan Steel
Group. According to the contract, the Company will install a
7-Megawatt capacity electricity-generation system. It will be an integral part
of the facilities designed to produce 80,000 tons of nickel-iron per year. The
project will generate 7-megawatt capacity electricity and help reduce in excess
of 20,000 tons of carbon dioxide emissions every year. The project started
construction in March 2009 and will be completed within 11 months with
approximately $ 7.8 million (RMB 55 million) in total investment.
Erdos’s Phase One - Two
9-Megawatt Capacity Electricity Generation Project
On April14, 2009, the Company incorporated Erdos TCH for recycling waste heat from Erdos
's metal refining plants to generate power and steam, which will then be sold
back to Erdos with a term of 20 years. Erdos is the
world’s largest Ferrosilicon alloy producer with more than 500 kilotons annual
capacity of Ferrosilicon alloy and 450 kilotons of Silicon manganese
(approximately 15% of the world market share). The Company plans to recycle
residual heat from selected 54 furnaces from over 100 furnaces in the Erdos’s
production lines. Total investment for the project is estimated at approximately
$74 million (RMB 500 million) for 11 power units with capacity of 70MW
electricity, with the potential to grow to 120 MW or more, and 30 tons of steam
per hour. The whole project is expected to be completed by the end of 2011 and
supply 10% of Erdos’s current electricity need. The first phase, which includes
two power lines with total 18MW of capacity, started in May 2009. One power line
with 9MW capacity is estimated to be completed at the end of 2009.
21.
RESTATEMENT OF FINANCIAL STATEMENTS
The
consolidated balance sheet at December 31, 2008 and consolidated statement of
operations for the nine and three months ended September 30, 2008 were restated
to reflect the following:
Reclassification
of current tax payable to deferred tax of liability of $823,407 on sales-type
leases at December 31, 2008 as the Company did not separately record the
deferred tax liability.
The
Company initially recorded the rescission of the first $5,000,000 convertible
note and cross receipt transactions as the settlement of the note and the
reacquisition of the BCF (Note 15). The Company’s management has
concluded that in substance the transaction resulted in the conversion of the
first $5,000,000 note into common stock and based on substance over form, should
have been accounted for as such. Accordingly, in accordance with EITF
00-27 (codified in FASB ASC Topic 470), the remaining BCF of $3,472,603 at the
date of conversion has been expensed during the nine months ended September 30,2008.
F-18
The
Company originally recorded the employee stock options expense for those options
that had vested up to the cancellation date. The Company’s management has
now concluded that the options subsequently issued on August 4, 2008 were a
modification of the options cancelled and forfeited on June 25, 2008.
Accordingly, the Company recorded the difference between the fair values of the
options before and after the modification date as incremental cost and amortized
such cost including the unamortized grant date fair value over the new vesting
period during the three months ended September 30, 2008.
At March31, 2009, the Company treated the modification to options (Note 16) under
variable accounting, and accordingly, recorded the fair value of the options as
liability. During the quarter ended June 30, 2009, management
concluded that the options should be classified as equity, accordingly, the
options as a liability at March 31, 2009 was reclassified to additional paid in
capital. The reclassification did not have any material impact to the
results of operations for the six and three months ended June 30, 2009, and for
the nine months ended September 30, 2009.
All the
restatement adjustments did not have an impact to the statement of cash flows
except the reclassification within the operating activities.
The
following table presents the effects of the restatement adjustment on the
accompanying consolidated statement of operations for the nine months ended
September 30, 2008:
As Previously
Net
Reported
Restated
Adjustment
Consolidated Statement of Operations and Comprehensive
loss
General
and administrative expenses
$
2,142,728
$
2,543,563
$
400,835
Total
operating expenses
$
2,142,728
$
2,543,563
$
400,835
Interest
expense
$
(1,233,964
)
$
(4,706,567
)
$
(3,472,603
)
Total
non-operating expenses
$
(1,316,551
)
$
(4,789,154
)
$
(3,472,603
)
(Loss)
income before income taxes
$
323,477
$
(3,549,961
)
$
(3,873,438
)
Net
Loss
$
(473,064
)
$
(4,346,502
)
$
(3,873,438
)
Comprehensive
(loss) income
$
1,445,172
$
(2,428,266
)
$
(3,873,438
)
Net
Loss per common share — basic
$
(0.01
)
$
(0.14
)
$
(0.13
)
Net
Loss per common share — diluted
$
(0.01
)
$
(0.14
)
$
(0.13
)
The
following table presents the effects of the restatement adjustment on the
accompanying consolidated statement of operations for the three months ended
September 30, 2008:
As Previously
Net
Reported
Restated
Adjustment
Consolidated
Statement of Operations and Comprehensive loss
General
and administrative expenses
$
638,949
$
1,039,784
$
400,835
Total
operating expenses
$
638,949
$
1,039,784
$
400,835
Income
before income taxes
$
1,160,499
$
759,664
$
(400,835
)
Net
income
$
732,512
$
331,677
$
(400,835
)
Comprehensive
income
$
1,540,318
$
1,139,483
$
(400,835
)
Net
(loss) income per common share — basic
$
0.02
$
0.01
$
(0.01
)
Net
(loss) income per common share — diluted
$
0.02
$
0.01
$
(0.01
)
The
following table presents the effects of the restatement adjustment on the
accompanying consolidated balance sheet at December 31, 2008:
On
October 26, 2009, Xi'an TCH and Erdos TCH (collectively “the Borrower”) jointly
entered into a Non Promissory Short Term Revolving Financing Agreement, dated
and effective from October 12, 2009, with Citi Bank (China) Co., Ltd., Shanghai
Branch (the “Lender”).
The
maximum financing provided under the Agreement is RMB 20 million (about US$2.9
million). The Agreement allows for the Borrowers to borrow money to maintain
current liquidity for notes receivable, such as trade notes payable to the
Company, or in order to capitalize on discounts for early payment of accounts
payable, such as for equipment or raw materials. The maximum maturity date for
each financing is six months. The interest rate for any note discount financing
will be determined by the relevant note discount documents and the interest rate
for accounts payable financing will be determined by the relevant accounts
payable documents.
The
proceeds received under the financing arrangement are to be used for working
capital and to purchase raw materials. The amounts received pursuant to the
Agreement will be secured by an account maintained by the Company with the
Lender, accounts receivable of the Borrowers and the guarantees of Shanghai TCH,
an affiliate of Xi'an TCH, and Guohua Ku, the Chairman of the Board and Chief
Executive Officer of the Company.
The
penalty interest rate is subject to the lowest penalty interest rate allowed by
People's Bank of China's relevant policy on over-due loans (including principal
and interest). Upon the default of certain conditions by the Company, the Lender
has the discretion to accelerate the maturity date of the outstanding loans and
request payment as well as to cancel or terminate the financing. The Borrowers
agree not to use the loan to pay for related party transactions without the
Lender's permission. The Borrowers agree to deposit their income from sales of
products and services into the accounts with the Lender (“income amount") and
average monthly income amount of the Borrowers should be no less than RMB 5
million. The condition for the Borrowers' first draw from the loan is when the
single month income amount reaches 80% of expected income amount as set forth in
the Agreement for that month. The expected income amount for each month required
by the Agreement is as below:
Incoming Month
Expected Incoming Payment (RMB)
November,
2009
11,900,000
January,
2010
11,900,000
February,
2010
11,900,000
March,
2010
11,900,000
April,
2010
11,900,000
May,
2010
11,900,000
June,
2010
11,900,000
July,
2010
11,900,000
August,
2010
11,900,000
September,
2010
11,900,000
October,
2010
11,900,000
F-20
Report
of Independent Registered Public Accounting Firm
Board of
Directors and Shareholders of China Recycling Energy Corporation:
We have
audited the accompanying consolidated balance sheets of China Recycling Energy
Corporation (the “Company” or “CREG”) and subsidiaries as of December 31, 2008
and 2007 and the related consolidated statements of income and other
comprehensive income, shareholders’ equity, and cash flows for the years ended
December 31, 2008 and 2007. These consolidated financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall consolidated financial statement presentation. We believe that our
audits provides a reasonable basis for our opinion.
In our
opinion, the consolidated financial statements as restated referred to above
present fairly, in all material respects, the consolidated financial position of
China Recycling Energy Corporation and Subsidiaries as of December 31, 2008 and
2007 and the consolidated results of their operations and their consolidated
cash flows for the years ended December 31, 2008 and 2007, in conformity with
U.S. generally accepted accounting principles.
As
discussed in Note 21 to the consolidated financial statements, certain errors
resulting in the classification of current and deferred income tax liability and
understatement of previously reported expenses for the year ended December 31,2008 were discovered by the Company's management on August 25, 2009.
Accordingly, the 2008 financial statements have been restated.
Convertible
notes, net of discount due to beneficial conversion
feature
5,000,000
378,082
Total
current liabilities
11,687,793
5,505,499
DEFERRED
TAX LIABILITY
823,407
342,540
ACCRUED
INTEREST ON CONVERTIBLE NOTES
168,494
-
CONTINGENCIES
AND COMMITMENTS
MINORITY
INTEREST
16,179
15,080
STOCKHOLDERS'
EQUITY
Common
stock, $0.001 par value; 100,000,000 shares authorized, 36,425,094 and
25,015,089 shares issued and outstanding as of December 31, 2008 and
December 31, 2007, respectively
36,425
25,015
Additional
paid in capital
34,528,289
19,070,908
Statutory
reserve
1,319,286
832,467
Accumulated
other comprehensive income
3,582,587
1,718,260
Accumulated
deficit
(7,044,924
)
(4,338,441
)
Total
Company stockholders' equity
32,421,663
17,308,209
TOTAL
LIABILITIES AND EQUITY
$
45,117,536
$
23,171,328
The
accompanying notes are an integral part of these consolidated financial
statements.
F-22
CHINA
RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
* Diluted
weighted average shares outstanding includes estimated shares will be converted
from the Second Note issued on Apr 29, 2008 with conversion price contingent
upon future net profits.
** Basic
and diluted loss per share are the same because common stock equivalents are
anti-dilutive.
***
Interest expense on convertible notes are added back to net income for the
computation of diluted EPS.
The
accompanying notes are an integral part of these consolidated financial
statements.
China
Recycling Energy Corporation (the “Company” or “CREG”) (formerly China Digital
Wireless, Inc.) was incorporated on May 8, 1980, under the laws of the State of
Colorado. On September 6, 2001, the Company re-domiciled its state of
incorporation from Colorado to Nevada. The Company, through its subsidiary,
Shanghai TCH Energy Technology Co., Ltd (“TCH”), sells and leases energy saving
equipment. The businesses of mobile phone distribution and provision of pager
and mobile phone value-added information services were discontinued in 2007. On
March 8, 2007, the Company changed its name to “China Recycling Energy
Corporation”.
Since
January 2007, the Company has gradually phased out and substantially scaled down
most of its business of mobile phone distribution and provision of pager and
mobile phone value-added information services. In the first and second quarters
of 2007, the Company did not engage in any substantial transactions or activity
in connection with these businesses. On May 10, 2007, the Company discontinued
the businesses related to mobile phones and pagers. These businesses are
reflected in continuing operations for all periods presented based on the
criteria for discontinued operations prescribed by Statement of Financial
Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets (“SFAS 144”).
On
February 1, 2007, the Company’s subsidiary, TCH, entered into two TRT Project
Joint-Operation Agreements (“Joint-Operation Agreement”) with Xi’an Yingfeng
Science and Technology Co., Ltd. (“Yingfeng”). TRT is an electricity generating
system that utilizes the exhaust pressure and heat produced in the blast furnace
of a steel mill to generate electricity. Yingfeng is a joint stock company
registered in Xi’an, Shaanxi Province, Peoples Republic of China (the “PRC”),
and engages in the business of designing, installing, and operating TRT systems
and sales of other renewable energy products. In October 2007, the Company
terminated the joint operation agreement with Yingfeng and became fully entitled
to the rights, titles, benefits and interests in the TRT Projects.
Under the
Joint-Operation Agreement, TCH and Yingfeng jointly operated a top gas recovery
turbine project (“TRT Project”) which designed, constructed, installed and
operated a TRT system and leased it to Zhangzhi Iron and Steel Holdings Ltd.
(“Zhangzhi”). The total costs contributed by TCH were approximately $1,426,000
(equivalent to Renminbi (“RMB”) 10,690,000). TCH provided various forms of
investments and properties into the TRT Project including cash, hardware,
software, equipment, major components and devices. The construction of the TRT
Project was completed and put into operation in August 2007. In October 2007,
the Company terminated the Joint-Operation Agreement with Yingfeng. TCH became
entitled to the rights, titles, benefits and interests in the TRT Project and
receives monthly rental payments of approximately $147,000 (equivalent to RMB
1,100,000) from Zhangzhi for a lease term of thirteen years. At the end of the
lease term, TCH will transfer the rights and titles of the TRT Project to
Zhangzhi without cost.
Under
another Joint-Operation Agreement, TCH and Yingfeng jointly operated a TRT
Project which designed, constructed, installed and operated a TRT system and
lease to Xingtai Iron and Steel Company Ltd. (“Xingtai”). TCH provided various
forms of investments and properties into the TRT Project including cash,
hardware, software, equipment, major components and devices. The total estimated
costs of this TRT Project were approximately $3,900,000 (equivalent to RMB
30,000,000). The construction of the TRT Project was completed and put into
operation in February 2007. In October 2007, the Company terminated the
Joint-Operation Agreement with Yingfeng. TCH became fully entitled to all the
rights, titles, benefits and interests of the TRT Project and receives monthly
rental payments of approximately $117,000 (equivalent to RMB 900,000) from
Xingtai for a lease term of five years. At the end of the lease term, TCH will
transfer all the rights and titles of the TRT Project to Xingtai without
cost.
In
November 2007, TCH signed a cooperative agreement with Shengwei Group for a
Cement Waste Heat Power Generator Project. TCH will build two sets of 12MW pure
low temp cement waste heat power generator systems for its two 2500 tons
per day cement manufacturing lines in Jin Yang and a 5,000 tons per day
cement manufacturing line in Tong Chuan. Total investment will
be approximately $12,593,000 (93 million RMB). At the end of 2008,
construction of the Power Generator Project in Tong Chuan was completed at a
total cost of approximately $6,191,000 (RMB 43,000,000) and put into
operation. The ownership of the power generator system belongs to
Tong Chuan from the date the system is put into service. TCH is
responsible for the daily maintenance and repair of the system, and charges Tong
Chuan the monthly electricity fee based on the actual power generated by the
system at 0.4116 RMB per KWH for an operating period of five years with the
assurance from Tong Chuan of proper functioning of 5000t/d cement manufacturing
line and not less than 7440 hrs/yr heat providing hours to the electricity
generator system. Shengwei Group has collateralized the cement
manufacturing line in Tongchuan to guarantee its obligations to provide the
minimum electricity income from the power generator system under the agreement
during the operating period. At the end of the five years operating period, TCH
will have no further obligations under the cooperative agreement.
F-26
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis
of presentation
These
accompanying consolidated financial statements have been prepared in accordance
with generally accepted accounting principles in the United States of America
(“US GAAP”) and pursuant to the rules and regulations of the SEC for annual
financial statements.
Basis
of consolidation
The
consolidated financial statements include the accounts of CREG and, its
subsidiaries, Sifang Holdings, TCH, and TCH’s subsidiaries Xi'an TCH Energy Tech
Co., Ltd. (“Xi’an TCH”) and Xingtai Huaxin Energy Tech Co., Ltd. (“Huaxin”).
Xi’an TCH and Huaxin engage in the same business as TCH. Substantially all of
the Company's revenues are derived from the operations of TCH and its
subsidiaries, which represent substantially all of the Company’s consolidated
assets and liabilities as of December 31, 2008 and 2007, respectively. All
significant inter-company accounts and transactions have been eliminated in
consolidation.
Use
of estimates
In
preparing these consolidated financial statements, management makes estimates
and assumptions that affect the reported amounts of assets and liabilities in
the balance sheets and revenues and expenses during the period reported. Actual
results may differ from these estimates.
Cash
and cash equivalents
Cash and
cash equivalents are carried at cost and represent 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 and concentration of credit risk
Accounts
receivable are recorded at the invoiced amounts and do not bear interest. The
Company extends unsecured credit to its customers in the ordinary course of
business but mitigates the associated risks by performing credit checks and
actively pursuing past due accounts. The Company does not require collateral or
other security to support these receivables. The Company conducts periodic
reviews of its clients' financial condition and customer payment practices to
minimize collection risk on accounts receivable.
An
allowance for doubtful accounts is established and determined based on
managements’ assessment of known requirements, aging of receivables, payment
history, the customer’s current credit worthiness and the economic environment.
As of each of December 31, 2008 and December 31, 2007, the Company had an
accounts receivable allowance of $0.
Financial
instruments that potentially subject the Company to credit risk consist
primarily of accounts receivable, leases, accounts payable, convertible notes
and other receivables. The carrying amounts reported in the balance sheets for
these financial instruments are a reasonable estimate of fair value because of
the short period of their maturity, The convertible notes rate
of interest is equal to the current market rate of
interest.
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, as well as by the
general state of the PRC economy.
Inventory
Inventory
is valued at the lower of cost or market. Cost of work in progress and finished
goods comprises direct material cost, direct production cost and an allocated
portion of production overheads (See Note 5).
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 ranging from 5 to 20 years as
follows:
Building
20
years
Vehicle
2 -
5 years
Office
and Other Equipment
2 -
5 years
Software
2 -
3 years
F-27
Impairment
of long-life assets
In
accordance with SFAS 144, the Company reviews
its long-lived assets, including property, plant 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 of the expected
undiscounted future net cash flows is less than the carrying amount of the
asset, a loss is recognized for the difference between the fair value and
carrying amount of the asset. There has been no impairment as of December 31,2008 and 2007.
Sales-type
leasing and related revenue recognition
The
Company leases TRT and CHPG systems to its customers. The Company usually will
transfer all benefits, risks and ownership of the TRT and CHPG systems to its
customers at the end of each lease term. In one system, the Company
transferred the ownership of the power generated system at the time of the
system put into operation. The Company’s investment in these projects
is recorded as investment in sales-type leases in accordance with SFAS No. 13,
“Accounting for Leases” and its various amendments and interpretations. The
Company manufactures and constructs the TRT and CHPG systems and power generated
system, and finances its customers for the selling price of the
systems. The sales and cost of goods sold are recognized at the point
of sale. The investment in sales-type leases consists of the sum of the total
minimum lease payments receivable less unearned interest income and estimated
executory cost. Unearned interest income is amortized to income over the lease
term as to produce a constant periodic rate of return on the net investment in
the lease.
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 rental expenses for two pieces of power generation equipment for the
operating lease.
Income
taxes
The
Company utilizes SFAS No. 109, “Accounting for Income Taxes,” which requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been included in the financial statements or
tax returns. 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 does not have any significant deferred tax asset or liability that
related to tax jurisdictions not covered by the tax holiday provided by Tax
Bureau of the PRC.
The
Company adopted the provisions of Financial Accounting Standards Board (“FASB”)
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes,
(“FIN 48”), on January 1, 2007. As a result of the implementation of FIN 48, the
Company made a comprehensive review of its portfolio of tax positions in
accordance with recognition standards established by FIN 48. As a result of the
implementation of FIN 48, the Company recognized no material adjustments to
liabilities or stockholders equity. 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. Interest associated with unrecognized
tax benefits are classified as interest expense and penalties are classified in
selling, general and administrative expenses in the statements of income. The
adoption of FIN 48 did not have a material impact on the Company’s financial
statements.
Statement
of cash flows
In
accordance with SFAS No. 95, “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.
F-28
Fair
Value of Financial Instruments
SFAS No.
107, “Disclosures about Fair Value of Financial Instruments,” requires the
Company disclose estimated fair values of financial
instruments. The carrying amounts reported in the statements of
financial position for current assets and current liabilities qualifying as
financial instruments are a reasonable estimate of fair value.
Fair
Value Measurements
On
January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements.”
SFAS 157 defines fair value, establishes a three-level valuation hierarchy for
disclosures of fair value measurement and enhances disclosures requirements for
fair value measures. The three levels are defined as follow:
·
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 the fair value
measurement.
As of
December 31, 2008, the Company did not identify any assets and liabilities that
are required to be presented on the balance sheet at fair value.
Stock
Based Compensation
The
Company accounts for its stock-based compensation in accordance with SFAS No.
123R, “Share-Based Payment, an Amendment of FASB Statement No. 123.” The
Company recognizes in the statement of operations the grant-date fair value of
stock options and other equity-based compensation issued to employees and
non-employees.
Basic
earnings per share (“EPS”) is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding for the
period. Diluted EPS is computed similar to basic net income per share except
that the denominator is increased to include the number of additional common
shares that would have been outstanding if the potential common shares had been
issued and if the additional common shares were dilutive. Diluted net earnings
per share is based on the assumption that all dilutive convertible shares and
stock options were converted or exercised. Dilution is computed by applying the
treasury stock method. Under this method, options and warrants are assumed to be
exercised at the beginning of the period (or at the time of issuance, if later),
and as if funds obtained thereby were used to purchase common stock at the
average market price during the period. The following table presents a
reconciliation of basic and diluted earnings per share:
Net
income (loss) for basic weighted average shares
$
(2,219,664
)
$
1,878,313
Net
income (loss) for diluted weighted average shares *
(2,051,088
)
1,941,327
Weighted
average shares outstanding - basic
32,095,814
18,160,385
Effect
of dilutive securities:
Convertible
notes
16,583,080
**
507,485
Options
granted
1,023,304
188,027
Weighted
average shares outstanding - diluted
49,702,199
18,855,897
(Loss)
Earnings per share – basic ***
$
(0.07
)
$
0.10
(Loss)
Earnings per share – diluted ***
$
(0.07
)
$
0.10
*
Interest expense on convertible note has been added back to net income for the
computation of diluted earnings per share.
**
Diluted weighted average shares outstanding includes estimated shares will
be converted from the Second Note issued on April 29, 2008 with conversion price
contingent upon future net profits.
*** These
securities are anti-dilutive, therefore, basic and diluted loss per share are
the same.
F-29
Foreign
Currency Translation and Comprehensive Income (Loss)
The
Company’s functional currency is the Renminbi (“RMB”). For financial reporting
purposes, RMB has been translated into United States dollars (“USD”) 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 has been no significant fluctuation
in the exchange rate for the conversion of RMB to USD after the balance sheet
date.
The
Company uses SFAS 130 “Reporting 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
SFAS No.
131, “Disclosures about Segments of an Enterprise and Related Information”
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. SFAS 131 has no effect on the Company's financial
statements as substantially all of the Company's operations are conducted in one
industry segment. All of the Company's assets are located in the
PRC.
Reclassifications
Certain
prior year amounts have been reclassified to conform to the manner of
presentation in the current year.
New
Accounting Pronouncements
Accounting for Financial
Guarantee Insurance Contracts
In May
2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee
Insurance Contracts, an interpretation of FASB Statement No. 60.” The
scope of this Statement is limited to financial guarantee insurance (and
reinsurance) contracts, as described in this Statement, issued by enterprises
included within the scope of Statement 60. Accordingly, this Statement does not
apply to financial guarantee contracts issued by enterprises excluded from the
scope of Statement 60 or to some insurance contracts that seem similar to
financial guarantee insurance contracts issued by insurance enterprises (such as
mortgage guaranty insurance or credit insurance on trade receivables). This
Statement also does not apply to financial guarantee insurance contracts that
are derivative instruments included within the scope of FASB Statement No. 133,
“Accounting for Derivative Instruments and Hedging Activities.” This Statement
will not have an impact on the Company’s financial statements.
The Hierarchy of Generally
Accepted Accounting Principles
In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles.” This Statement identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (“GAAP”)
in the United States. This Statement will not have an impact on the
Company’s financial statements.
Disclosures about Derivative
Instruments and Hedging Activities
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities an amendment of FASB Statement No. 133 (“SFAS
133”). This Statement changes the disclosure requirements for derivative
instruments and hedging activities. Entities are required to provide enhanced
disclosures about (i) how and why an entity uses derivative instruments, (ii)
how derivative instruments and related hedged items are accounted for under SFAS
133 and its related interpretations, and (iii) how derivative instruments and
related hedged items affect an entity’s financial position, financial
performance, and cash flows. Based on current conditions, the Company does
not expect the adoption of SFAS 161 to have a significant impact on its results
of operations or financial position.
Noncontrolling Interests in
Consolidated Financial Statements - An Amendment of ARB No.
51
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements - An Amendment of ARB No. 51” (“SFAS
160”). SFAS 160 establishes new accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. Specifically, this statement requires the recognition of a
noncontrolling interest (minority interest) as equity in the consolidated
financial statements and separate from the parent’s equity. The amount of net
income attributable to the noncontrolling interest will be included in
consolidated net income on the face of the income statement. SFAS 160 clarifies
that changes in a parent’s ownership interest in a subsidiary that do not result
in deconsolidation are equity transactions if the parent retains its controlling
financial interest. In addition, this statement requires that a parent recognize
a gain or loss in net income when a subsidiary is deconsolidated. Such gain or
loss will be measured using the fair value of the noncontrolling equity
investment on the deconsolidation date. SFAS 160 also includes expanded
disclosure requirements regarding the interests of the parent and its
noncontrolling interest. SFAS 160 is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008.
The Company expects SFAS 160 will have an impact on accounting for business
combinations once adopted but the effect is dependent upon acquisitions at that
time.
F-30
Business
Combinations
In
December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business
Combinations” (“SFAS 141R”). SFAS 141R will significantly change the accounting
for business combinations. Under SFAS 141R, an acquiring entity will be required
to recognize all the assets acquired and liabilities assumed in a transaction at
the acquisition-date fair value with limited exceptions. SFAS 141R will change
the accounting treatment for certain specific items, including:
·
Acquisition costs will be
generally expensed as
incurred;
·
Noncontrolling interests
(formerly known as “minority interests” - see SFAS 160 discussion above)
will be valued at fair value at the acquisition
date;
·
Acquired contingent liabilities
will be recorded at fair value at the acquisition date and subsequently
measured at either the higher of such amount or the amount determined
under existing guidance for non-acquired
contingencies;
·
In-process research and
development will be recorded at fair value as an indefinite-lived
intangible asset at the acquisition
date;
·
Restructuring costs associated
with a business combination will be generally expensed subsequent to the
acquisition date; and
·
Changes in deferred tax asset
valuation allowances and income tax uncertainties after the acquisition
date generally will affect income tax
expense.
SFAS 141R
also includes a substantial number of new disclosure requirements. SFAS 141R
applies prospectively to business combinations for which the acquisition date is
on or after the beginning of the first annual reporting period beginning on or
after December 15, 2008. Earlier adoption is prohibited. Accordingly, since
we are a calendar year-end company, we will continue to record and disclose
business combinations following existing GAAP until January 1, 2009. We
expect SFAS 141R will have an impact on accounting for business combinations
once adopted but the effect is dependent upon acquisitions at that
time.
Accounting for Nonrefundable
Advance Payments for Goods or Services Received for use in Future Research and
Development Activities
In June
2007, the FASB issued FASB Staff Position No. EITF 07-3, “Accounting for
Nonrefundable Advance Payments for Goods or Services Received for use in Future
Research and Development Activities” (“FSP EITF 07-3”), which addresses whether
nonrefundable advance payments for goods or services that used or rendered for
research and development activities should be expensed when the advance payment
is made or when the research and development activity has been
performed. EITF 07-03 is effective for fiscal years beginning after
December 15, 2008. Management is currently evaluating the effect of this
pronouncement on financial statements.
Employers’ Accounting for
Defined Benefit Pension and Other Postretirement Plans, an Amendment of FASB
Statements No. 87, 88, 106, and 132R
In
September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans, an Amendment of FASB Statements
No. 87, 88, 106, and 132R” (“SFAS 158”), which requires companies to recognize
the underfunded or overfunded status of their defined benefit pension and other
post-retirement plans as an asset or liability and to recognize changes in that
funded status through comprehensive income in the year in which the changes
occur. As required, we adopted the recognition provision of SFAS No.
158 on December 31, 2006.
SFAS No. 158
also requires companies to measure the funded status of defined benefit pension
and other post-retirement plans as of their year-end reporting date. The
measurement date provisions of SFAS No. 158 were effective for us as
of December 31, 2008. We applied the measurement provisions by measuring
our benefit obligations as of September 30, 2007, our prior measurement
date, and recognizing a pro-rata share of net benefit costs for the transition
period from October 1, 2007 to December 31, 2008 as a cumulative
effect of change in accounting principle in retained earnings as of
December 31, 2008. The adoption of the measurement date
provisions of SFAS No. 158 did not have a material impact on our
financial position or results of operations for the periods
presented.
3.
NET INVESTMENT IN SALES-TYPE LEASES
Under
sales-type leases, TCH leased TRT systems to Xingtai and Zhangzhi, and CHPG
systems to Tongchuan Shengwei with terms of five years, thirteen years and five
years, respectively. The components of the net investment in sales-type leases
as of December 31, 2008 and December 31, 2007 are as follows:
F-31
2008
2007
Total
future minimum lease payments receivables
$
41,431,868
$
27,162,928
Less:
unearned interest income
(24,623,398
)
(18,147,167
)
Net
investment in sales - type leases
$
16,808,470
$
9,015,761
Current
portion
$
1,970,591
$
1,081,981
Noncurrent
portion
$
14,837,879
$
7,933,780
As of
December 31, 2008, the future minimum rentals to be received on non-cancelable
sales type leases are as follows:
On April10, 2008, the Company leased energy recycling power generation equipment for
operating under a one-year, non-cancellable lease for approximately $4,455,000
(RMB 31,000,000). At the end of this lease, the Company has the right to renew
the lease for another four-year term at an aggregate price of approximately
$10,940,000 (RMB 75,000,000). The lease payment of approximately $4,455,000 has
been paid in full.
On the
same day, the Company entered into a lease with a lessee to sublease the above
power generation equipment under a one-year, non-cancellable lease for
approximately $583,000 (RMB 4,000,000) per month with an option to renew. The
lessee will pay a lower monthly lease payment of approximately $486,000 (RMB
3,333,000) if the Company renews the lease of the equipment from the ultimate
lessor after one year.
On May21, 2008, the Company leased energy recycling power generation equipment from
the same lessor for operating under a one-year, non-cancellable lease for the
amount of approximately $6,560,000 (RMB 45,000,000). At the end of the one-year
lease term, the Company has the right to renew the lease for another four-year
term at an aggregate price of approximately $17,500,000 (RMB 120,000,000) with a
separate agreement. The lease payment of approximately $6,560,000 has been paid
in full.
On the
same day, the Company entered into a lease with the same lessee to sublease the
above power generation equipment under a one-year, non-cancellable lease for
approximately $887,000 (RMB 5,850,000) per month with an option to renew. The
lessee will pay a lower monthly lease payment of approximately $729,000 (RMB
5,000,000) if the Company renews the lease of the equipment from the ultimate
lessor after one year.
Prepaid expenses –
other
Other
prepaid expenses mainly consisted of prepayment for office rental, parking
space, insurance and legal fees. Other prepaid expenses were
approximately $28,000 and $0 at December 31, 2008 and 2007,
respectively.
5.
INVENTORY
Inventory
consisted of two equipment systems that will be used for TRT or CHPG projects in
the amount of $10,534,633 and $9,870,315 at December 31, 2008 and December 31,2007, respectively.
6.
ADVANCE FOR EQUIPMENT
“Advance
for equipment” represented advance payment of approximately $2,640,000 (RMB
18,000,000) to an independent contractor for constructing a power generation
system and purchase of the equipment that will be used for the construction. At
December 31, 2008, this project has been terminated; the advance for the
equipment will be recorded as the Company’s inventory when the title of the
equipment officially transfers to the Company.
F-32
7.
CONSTRUCTION IN PROGRESS
“Construction
in progress” represented the amount paid to an independent contractor for
constructing two power generation systems for the total amount of approximately
$10,046,935 (RMB 68,500,000). The construction project commenced in March 2008,
and will take about 11 months to complete. Upon completion, the Company will
sell the power that is generated from this system to predetermined customers
(See Note 20). At December 31, 2008, the construction in progress
amounted $3,731,016, one system has completed construction and was put into
operation, the other system is expected to be completed in March
2009.
8.
TAX PAYABLE
“Tax
payable” consisted of the following at December 31, 2008 and 2007,
respectively:
“Accrued
liabilities and other payables” consisted of the following at December 31,2008 and 2007, respectively:
2008
2007
Other
payables
$
$
Cash
advance from third parties
-
138,201
Employee
training and social insurance payable
125,323
17,646
Consulting
and legal expenses
371,125
371,000
Payable
to Yingfeng
1,676,878
1,747,958
Deposit
from lessee
1,024,252
-
Total
other payables
3,197,578
2,274,805
Employee
welfare payable
258,443
228,923
Accrued
maintenance expense
72,506
61,998
Total
$
3,528,527
$
2,565,726
“Consulting
and legal expenses” was the expenses paid by a third party on behalf of the
Company, which will be repaid by the Company. “Payable to Yingfeng”
represented the cost of obtaining the ownership of two TRT projects that were
previously owned by Yingfeng. “Deposit from lessee” represented deposit received
for leasing out the power generation equipments.
10.
ADVANCE FROM MANAGEMENT
“Advance
from management” represented the balances due to a director for unsecured
advances in 2007, which are interest free and repayable in the next twelve
months. This advance was repaid as of December 31, 2008.
11.
MINORITY INTEREST
“Minority
interest” represented a 20% equity interest in Huaxin. Huaxin was incorporated
in November 2, 2007, and engages in a similar business to TCH.
12. DEFERRED
TAX
Deferred
tax asset arose from accrued maintenance cost on two TRT machines and one CHPG
machine that can be deducted for tax purposes in the future.
Deferred
tax liability represented differences between the tax bases and book bases of
sales-type leases.
As of
December 31, 2008 and 2007, deferred tax asset (liability) consisted of the
following:
F-33
2008
(Restated)
2007
Deferred
tax asset - noncurrent
$
27,878
$
-
Deferred
tax liability - noncurrent
(851,285
)
(342,540
)
Deferred
tax liability, Net
$
(823,407
)
$
(342,540
)
13.
DISCONTINUED OPERATIONS
Since
January 2007, the Company has phased out and scaled down most of its business of
mobile phone distribution and provision of pager and mobile phone value-added
information services. In the first and second quarters of 2007, the Company did
not engage in any substantial transactions or activity in connection with these
businesses. On May 10, 2007, the Company discontinued these businesses.
Accordingly, the results of the discontinued operations have been segregated
from continuing operations. The discontinued operations had an income of $28,457
for the year ended December 31, 2007. The income represented the write down of
deferred revenue generated from the provision of pager value-added information
services.
14.
INCOME TAX
Effective
January 1, 2008, the PRC government implemented a new corporate income tax law
with a new maximum corporate income tax rate of 25%. The Company is governed by
the Income Tax Law of the PRC concerning privately-run enterprises, which are
generally subject to tax at a statutory rate of 25% (33% prior to 2008) on
income reported in the statutory financial statements after appropriate tax
adjustments.
The
Company’s subsidiaries generated substantially all of its net income from its
PRC operations. Shanghai TCH’s effective income tax rates for 2008 and 2007 are
18% and 15%, respectively. Xi’an TCH’s effective income tax rate for 2008 is
25%. Shanghai TCH and its subsidiaries Xi’an TCH and Xingtai Huaxin filed
separate income tax returns. Net income for 2008 would have been
lower by approximately $0 as Shanghai TCH incurred net loss for the year and
approximately $531,000 or $0.03 basic earnings per share for 2007, if the
Company did not benefit the from the income tax exemption.
There is
no income tax for companies domiciled in the Cayman Islands. Accordingly, the
Company's consolidated financial statements do not present any income tax
provisions related to Cayman Islands tax jurisdiction where Sifang Holding is
domiciled. At December 31, 2008 and 2007, Sifang Holing has net
operating losses of approximately $23,000 and $246,000 incurred in nontaxable
jurisdictions, respectively.
The
parent company, China Recycling Energy Co., Ltd., is taxed in the U.S. and has
net operating loss of approximately $1,633,000 at December 31, 2008. The pre-tax
loss per book of the parent company was approximately $6.68 million, of which,
$1.7 million was the tax effect of non-deductible expense of the beneficial
conversion feature of the $5,000,000 note payable. Net operating loss
can be used to offset future taxable income and can be carried-forward for 20
years from the year in which the loss occurred. A 100% valuation
allowance has been established due to the uncertainty of its
realization.
The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the years ended December 31, 2008 and 2007,
respectively:
On
November 16, 2007, the Company entered into a Stock and Notes Purchase Agreement
(“Purchase Agreement”) with Carlyle Asia Growth Partners III, L.P. (“CAGP”) and
CAGP III Co. Investment, L.P. (together with CAGP, the “Investors”). Under the
terms of the Purchase Agreement, the Company sold to the Investors a 10% Secured
Convertible Promissory Note in the principal amount of $5,000,000 (the “First
Note”). Additionally, the Purchase Agreement provides for two subsequent
transactions to be effected by the Company and the Investors, which include (i)
the issuance by the Company and subscription by the Investors of a total of
4,066,706 shares of common stock of Company, at the price of $1.23 per share for
an aggregate purchase price of approximately $5,000,000, and (ii) the issuance
and sale by the Company to the Investors of a 5% Secured Convertible Promissory
Note in the principal amount of $15,000,000 (the foregoing transactions,
together with sale and purchase of the First Note, are hereinafter referred to
as the “Offering”). The subsequent transactions are contingent upon the
satisfaction of certain conditions specified in the Purchase Agreement,
including entry into specified energy and recycling project contracts and the
purchase of certain energy recycling systems.
F-34
The First
Note bore interest at 10% per annum and matured on November 16, 2009. The
principal face amount of the First Note, together with any interest thereon was
convertible at the option of the holders at any time on or prior to maturity,
into shares of the Company’s common stock at an initial conversion price of
$1.23 per share (subject to anti-dilution adjustments). The First Note was
subject to mandatory conversion upon the consummation of the aforementioned
issuance and subscription of shares of the Company’s common stock under the
Purchase Agreement. As more fully described in the First Note, the obligations
of the Company under the First Note ranked senior to all other debt of the
Company.
As
collateral for the First Note, the President and a major shareholder of the
Company pledged 9,653,471 shares of the Company’s common stock held by him to
secure the First Note.
The First
Note was considered to have an embedded beneficial conversion feature (“BCF”)
because the conversion price was less than the quoted market price at the time
of the issuance. Accordingly, the BCF of $5,000,000 was recorded separately as
unamortized beneficial conversion feature based on the intrinsic value method.
The First Note was recorded in the balance sheet at face value less the
unamortized BCF. The terms for the First Note were amended on April 29, 2008 and
the First Note was repaid in full on June 25, 2008, as described
below.
On April29, 2008, the Company entered into an Amendment to the Purchase Agreement with
the Investors (the “Amendment”). Under the terms of the Amendment, (i) the
Company issued and the Investors subscribed for 4,066,706 shares of common stock
of the Company, at $1.23 per share for an aggregate purchase price of
$5,002,048, as originally contemplated under the Agreement; (ii) the Investors
converted the principal amount under the First Note (and waived any accrued
interest thereon) into 4,065,040 shares of common stock of the Company at the
conversion price per share of $1.23, pursuant to the terms and conditions of the
First Note issued under the Agreement; (iii) the Company issued and sold to the
Investors a new 5% Secured Convertible Promissory Note in the principal amount
of $5,000,000 to the Investors (the “Second Note” and collectively with the
First Note, the “Notes”); and (iv) the Company granted to the Investors an
option to purchase a 5% Secured Convertible Promissory Note in the principal
amount of $10,000,000, exercisable by the Investors at any time within nine (9)
months following the date of the closing of the transactions contemplated by the
Amendment (the “Option Note”).
The
Second Note bears interest at 5% per annum and matures on April 29, 2011. The
principal face amount of the Second Note, together with any interest thereon, is
convertible at the option of the holders at any time on or after March 30, 2010
(or such earlier date if the audited consolidated financial statements of the
Company for the fiscal year ending December 31, 2009 are available prior to
March 30, 2010) and prior to maturity, into shares of the Company's common stock
at an initial conversion price that is tied to the after-tax net profits of the
Company for the fiscal year ending December 31, 2009, as described in the Second
Note. The Second Note is subject to mandatory conversion upon the listing of the
Company's common stock on the National Association of Securities Dealers
Automated Quotations main-board, the New York Stock Exchange or the American
Stock Exchange. As more fully described in the Second Note, the obligations of
the Company under the Second Note shall rank senior to all other debt of the
Company.
The
Second Note and the Option Note are both secured by a security interest granted
to the Investors pursuant to the Share Pledge Agreement.
The
Second Note was not considered to have an embedded BCF because the conversion
price and convertible shares are contingent upon future net
profits.
On June25, 2008, the Company and the Investors entered into a Rescission and
Subscription Agreement (the “Rescission”) to rescind the conversion of the First
Note and the issuance of conversion shares of Common Stock at the Second Closing
pursuant to the Amendment. The Company and the Investors rescinded the
conversion of the principal amount ($5,000,000) under the First Note into
4,065,040 shares of Common Stock, and the Investors waived accrued interest on
the First Note. Accordingly, the interest expense which had accrued on the note
has been recorded as a decrease in interest expense for the period. At the
Rescission closing, the Company repaid in full the First Note and issued to the
Investors 4,065,040 shares of Common Stock at the price of $1.23 per share for
an aggregate purchase price of $5,000,000. This was done through a
cross receipt arrangement; the amortized portion of BCF was reversed to
additional paid in stock. The Company has now concluded that in
substance the transaction resulted in the conversion of the first $5,000,000
note into common stock and that the remaining BCF of $3,472,603 at the date of
conversion should have been expensed (see Note 21).
16.
STOCK-BASED COMPENSATION PLAN
On
November 13, 2007, the Company approved the 2007 Non-statutory Stock Option
Plan, which was later amended and restated in August 2008 (the “2007
Plan”), and granted stock options with an aggregate amount of 3,000,000 shares
of the stock at $1.23 per share to acquire the Company's common stock at par
value $0.001 to twenty (20) managerial and non-managerial employees under the
2007 Plan.
F-35
The
vesting terms of options granted under the 2007 Plan is subject to the
Non-Statutory Stock Option Agreements for managerial and non-managerial
employees. For managerial employees, no more than 15% of the total stock options
shall vest and become exercisable on the six month anniversary of the grant
date. An additional 15% and 50% of the total stock options shall vest and become
exercisable on the first and second year anniversary of the grant date,
respectively. The remaining 20% of the total stock options shall vest and become
exercisable on the third year anniversary of the grant date. For non-managerial
employees, no more than 30% of the total stock options shall vest and become
exercisable in the first year anniversary of the grant date. An additional 50%
of the total stock options shall vest and become exercisable in the second year
anniversary of the grant date. The remaining 20% of the total stock options
shall vest and become exercisable on the third year anniversary of the grant
date. Each stock option shall become vested and exercisable over a period of no
longer than five years from the grant date.
Based on
the fair value method under SFAS No. 123 (Revised) “Share Based Payment” (“SFAS
123(R)”), the fair value of each stock option granted is estimated on the date
of the grant using the Black-Scholes option pricing model. The Black-Scholes
option pricing model 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 fair value of each option grant to employees is
calculated by the Black-Scholes method and is recognized as compensation expense
over the vesting period of each stock option award. For stock options issued,
the fair value was estimated at the date of grant using the following range of
assumptions:
The
options vest over a period of three years and have a life of 5 years. The fair
value of the options was calculated using the following assumptions: estimated
life of five years, volatility of 100%, risk free interest rate of 3.76%, and
dividend yield of 0%. No estimate of forfeitures was made as the Company has a
short history of granting options.
Effective
June 25, 2008, the Company cancelled all vested shares and accepted optionees’
forfeiture of any unvested shares underlying the currently outstanding
options.
On August4, 2008, the Company granted stock options to acquire an aggregate amount
of 3,000,000 shares of the Company’s common stock, par value $0.001, at
$0.80 per share to 17 employees under the 2007 Plan. The new awards were
considered as replacement awards and were recorded in accordance with SFAS
123(R).The options vest over a period of three years and have a life of 5 years.
The fair value of the options was calculated using the following assumptions:
estimated life of five years, volatility of 100%, risk free interest rate of
2.76%, and dividend yield of 0%. No estimate of forfeitures was made as the
Company has a short history of granting options. The options have been accounted
for as a modification to the options which were cancelled on June 25,2008.
The
following table summarizes activity for employees in the Company’s Plan for 2008
and 2007:
During
2008, the Company recorded $1,436,533 compensation expense including amortized
portion of incremental cost arising from the modification to the employee stock
options. The weighted-average modification date fair value of stock options
granted to employees for the year ended December 31, 2008 was $0.88 per share.
There were no options exercised during 2008.
F-36
17.
SHAREHOLDERS’ EQUITY
On April29, 2008, the Company issued and the Investors subscribed for a total of
4,066,706 shares of common stock of the Company, at the price of $1.23 per share
for an aggregate purchase price of $5,002,048 under the Purchase
Agreement.
On June25, 2008, the Company and the Investors entered into a Rescission and
Subscription Agreement to rescind the conversion of the First Note and the
issuance of conversion shares of Common Stock pursuant to Amendment to Stock and
Notes Purchase Agreement dated on April 29, 2008. The Company and the Investors
rescinded the conversion of the principal amount ($5,000,000) under the First
Note into 4,065,040 shares of Common Stock and repaid the First Note in full. At
the Rescission and Subscription Closing, the Company issued to the Investors,
4,065,040 shares of Common Stock at the price of $1.23 per share for an
aggregate purchase price of $5,000,000.
The
Company issued 3,278,259 shares of its Common Stock to one of the Company’s
shareholders who paid $4,032,258 cash to the Company during 2008. This purchase
was part of an investment agreement by the shareholder entered into in November
2007 to purchase the shares at $1.23 per share.
18.
STATUTORY RESERVES
Pursuant
to the new corporate law of the PRC effective January 1, 2006, the Company is
now 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 is required to transfer 10% of its 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
common welfare fund is a voluntary fund that the Company can elect to transfer
5% to 10% of its net income to this fund. 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.
19.
CONTINGENCIES
The
Company’s operations in the PRC are subject to specific considerations and
significant risks not typically associated with companies in the 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 expenses 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 affect the
remittance.
20.
COMMITMENTS
Shengwei Cement Pure Low
Temperature Waste Heat Power Generator Project
In
November 2007, the Company signed a cooperative agreement with Shengwei Group
for building two sets of 12MW pure low temp cement waste heat power generator
systems for its two 2,500 tons per day cement manufacturing lines in
Jin Yang and a 5,000 tons per day cement manufacturing line in Tong Chuan. At
the end of 2008, the power generator system in Tong Chuan has completed
construction and was put into operation; the other system in Jin Yang is
expected to be complete in April 2009 with approximately $7,246,000 (RMB
53millon) in total investment.
In
September, 2008, the Company signed a contract to recycle waste gas and waste
heat for China Zhonggang Binhai Enterprise Ltd. (“Zhonggang Binhai”) in Cangzhou
City, Hebei Province, a world-class nickel-iron manufacturing joint venture
between China Zhonggang Group and Shanghai Baoshan Steel
Group. According to the contract, CREG will install a 7-Megawatt
capacity electricity-generation system. It will be an integral part of the
facilities designed to produce 80,000 tons of nickel-iron per year. The project
will generate 7-megawatt capacity electricity and help reduce in excess of
20,000 tons of carbon dioxide emissions every year. The project is expected to
start in March 2009 and be completed within 11 months with approximately $ 7.8
million (RMB 55 million) in total investment. At December 31, 2008,
this project had not commenced.
21 . RESTATEMENT OF FINANCIAL
STATEMENTS
The
financial statements for the balance sheet date at December 31, 2008 and for the
year ended December 31, 2008 were restated to reflect the
following:
1.
Reclassification of current tax
payable to deferred tax liability of $823,407 on sales-type leases as the
Company did not separately record the deferred tax
liability.
2.
The Company initially recorded
the rescission of the first $5,000,000 convertible note and cross receipt
transactions as the settlement of the note and the reacquisition of the
BCF (See Note 15). The Company’s management has now concluded
that in substance the transaction resulted in the conversion of the first
$5,000,000 note into common stock and should have been accounted for as
such. Accordingly, in accordance with EITF 00-27, the remaining
BCF of $3,472,603 at the date of conversion has been
expensed.
3.
The Company originally recorded
the employee stock options expense for those options that had vested up to
the cancellation date. The Company’s management has now concluded
that the options subsequently issued on August 4, 2008 should be accounted
for as a modification of the options cancelled and forfeited on June 25,2008. Accordingly, the Company recorded the difference between the
fair values of the options before and after the modification date as
incremental cost and amortized such cost including the unamortized grant
date fair value over the new vesting
period.
These
restatement adjustments did not have an impact to the statement of cash flows
except the reclassification within the operating activities.
The
following table presents the effects of the restatement adjustment on the
accompanying consolidated statement of operations for the year ended December31, 2008:
As
Previously
Net
Reported
Restated
Adjustment
Con Consolidated
Statement of Operations and Comprehensive loss
General
and administrative expenses
$
2,773,702
$
3,354,028
$
580,326
Total
operating expenses
$
2,773,702
$
3,354,028
$
580,326
Interest
expense
$
(1,314,689
)
$
(4,787,292
)
$
(3,472,603
)
Total
non-operating expenses
$
(1,261,705
)
$
(4,734,308
)
$
(3,472,603
)
(Loss)
income before income taxes
$
3,466,102
$
(586,827
)
$
(4,052,929
)
Net
(Loss) income
$
1,833,265
$
(2,219,664
)
$
(4,052,929
)
Comprehensive
(loss) income
$
3,697,592
$
(355,337
)
$
(4,052,929
)
Net
(Loss) income per common share — basic
$
0.06
$
(0.07
)
$
(0.13
)
Net
(Loss) income per common share — diluted
$
0.03
$
(0.07
)
$
(0.10
)
F-38
The
following table presents the effects of the restatement adjustment on the
accompanying consolidated balance sheet for the date at December 31,2008:
Pursuant
to Section 12 of the Securities Exchange Act of 1934, the registrant has duly
caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized.
The
following documents listed below that have been previously filed with the SEC
(1934 Act File No. 000-12536 unless otherwise stated) are incorporated herein by
reference:
Exhibit
No.
Description
3.1
Articles
of Incorporation (filed as Exhibit 3.05 to the Company’s Form 10-KSB for
the fiscal year ended December 31, 2001).
Securities
Exchange Agreement by and among Boulder Acquisitions, Inc., Sifang
Holdings Co., Ltd. and the shareholders of Sifang Holdings Co., Ltd.,
dated effective as of June 23, 2004 (filed as Exhibit 10.1 to the
Company’s Current Report on Form 8-K dated July 8,2004).
10.2
Share
Purchase Agreement, dated January 24, 2007, between individual purchasers
and shareholders of China Digital Wireless, Inc. (filed as Exhibit 11.1 to
the Company’s Current Report on Form 8-K dated January 26,2007).
10.3
TRT
Joint Operation Agreement between Shanghai TCH Energy Technology Co. Ltd.
and Xi’an Yingfeng Science and Technology Co. Ltd. dated February 1, 2007
(filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K dated
April 9, 2007)
10.4
Share
exchange agreement between Hanqiao Zheng and Guohua Ku and a group of
individual purchasers all of whom are shareholders of Xi’an Yingfeng
Science and Technology Co. Ltd (“Yingfeng”) signed on February 22, 2007
and consummated on June 21, 2007 (filed as Exhibit 10.1 to the Company’s
Current Report on Form 8-K dated June 22, 2007)
10.5
Share
exchange agreement between Guohua Ku and a group of individual purchasers
all of whom are shareholders of Xi’an Yingfeng Science and Technology Co.
Ltd (“Yingfeng”) dated on August 22, 2007 (filed as Exhibit 10.1 to the
Company’s Current Report on Form 8-K dated August 23,2007).
Assets
Transfer and Share Issuance Agreement between Company and Hanqiao Zheng on
November 14, 2007 (filed as Exhibit 10.1 to the Company’s Current Report
on Form 8-K dated November 16, 2007).
Stock
and Notes Purchase Agreement, between Company, Sifang Holdings Co., Ltd.,
Shanghai TCH Energy Technology Co., Ltd. and Carlyle Asia
Growth Partners III, L.P. and CAGP III Co-Investment, L.P. dated November16, 2007 (filed as Exhibit 10.1 to the Company’s Current Report on Form
8-K dated November 16, 2007).
10.10
Amendment
to Stock and Notes Purchase Agreement, between Company, Sifang Holdings
Co., Ltd., Shanghai TCH Energy Technology Co., Ltd. and Carlyle Asia
Growth Partners III, L.P. and CAGP III Co-Investment, L.P. dated April 29,2008 (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K
dated April 30,2008).
Exhibit
No.
Description
10.11
Form
of 10% Secured Convertible Promissory Note issued by the Company to
Carlyle Asia Growth Partners III, L.P. and CAGP III Co-Investment, L.P.
(filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K dated
November 16, 2007).
10.12
Form
of 5% Secured Convertible Promissory Note issued by the Company to Carlyle
Asia Growth Partners III, L.P. and CAGP III Co-Investment, L.P (filed as
Exhibit 10.3 to the Company’s Current Report on Form 8-K dated November16, 2007).
10.13
5%
Secured Convertible Promissory Note in the aggregate principal amount of
$5,000,000 issued by the Company to Carlyle Asia Growth Partners III, L.P.
and CAGP III Co-Investment, L.P 2008 (filed as Exhibit 10.2 to the
Company’s Current Report on Form 8-K dated April 30,2008).
10.14
Form
of 5% Secured Convertible Promissory Note in the aggregate principal
amount of $10,000,000 issued by the Company to Carlyle Asia Growth
Partners III, L.P. and CAGP III Co-Investment, L.P 2008 (filed as Exhibit
10.3 to the Company’s Current Report on Form 8-K dated April 30,2008).
Shareholders
Agreement between Company and Carlyle Asia Growth Partners III, L.P., CAGP
III Co-Investment, L.P., Hanqiao Zheng and Ping Sun dated November 16,2007 (filed as Exhibit 10.5 to the Company’s Current Report on Form 8-K
dated November 16, 2007).
10.17
Form
of Nonstatutory Stock Option Agreement - Manager Employee (filed as
Exhibit 10.1 to the Company’s Current Report on Form 8-K dated August 8,2008). *
10.18
2007
Nonstatutory Stock Option Plan (filed as Exhibit 10.1 to the Company’s
Registration Statement on Form S-8 dated November 13,2007).*
10.19
Form
of Nonstatutory Stock Option Agreement - Non-Manager Employee (filed as
Exhibit 10.2 to the Company’s Current Report on Form 8-K dated August 8,2008).
10.20
Stock
Purchase Agreement with Great Essential Investment, Ltd. (filed as Exhibit
10.1 to the Company’s Current Report on Form 8-K dated April 20,2009).
Note
Subscription and Amendment Agreement between the Company and Carlyle Asia
Growth Partners III, L.P. and CAGP III Co-Investment, L.P. (filed as
Exhibit 10.1 to the Company’s Current Report on Form 8-K dated April 29,2009).
10.23
Form
of 8% Secured Convertible Promissory Note issued to Carlyle Asia Growth
Partners III, L.P. and CAGP III Co-Investment, L.P. (filed as Exhibit 10.2
to the Company’s Current Report on Form 8-K dated April 29,2009).
10.24
Form
of Amended and Restated 5% Secured Convertible Promissory Note issued to
Carlyle Asia Growth Partners III, L.P. and CAGP III Co-Investment, L.P.
(filed as Exhibit 10.3 to the Company’s Current Report on Form 8-K dated
April 29, 2009).
10.25
Amended
and Restated Registration Rights Agreement between the Company and, among
others, Carlyle Asia Growth Partners III, L.P. and CAGP III Co-Investment,
L.P. (filed as Exhibit 10.4 to the Company’s Current Report on Form 8-K
dated April 29, 2009).
10.26
Joint
Venture Agreement between the Company and Erdos Metallurgy Co., Ltd.
(filed as Exhibit 10.1 to the Company’s Form 10-Q for the quarterly period
ended June 30,2009).
10.27
Loan
Agreement between Xi’an TCH Energy Technology Co., Ltd. A wholly owned
subsidiary of the Company, and Industrial Bank Co., Ltd., Xi’an Branch
(filed as Exhibit 10.2 to the Company’s Form 10-Q for the quarterly period
ended June 30, 2009).