Unassociated Document
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
For the quarterly period ended June 30,
2010
OR
For the
transition period from
to
Commission
File No. 000-12536
China
Recycling Energy Corporation
(Exact
Name of Registrant as Specified in Its Charter)
Nevada
|
90-0093373
|
(State
or other jurisdiction of
incorporation
or organization)
|
(I.R.S.
Employer
Identification
No.)
|
12/F,
Tower A
Chang
An International Building
No.
88 Nan Guan Zheng Jie
Xi’an City, Shaanxi Province,
China
(Address
of Principal Executive Offices, Zip Code)
Registrant’s
Telephone Number, Including Area Code: + 86-29-8769-1097
Indicate
by check mark whether the registrant: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
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 “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large
accelerated filer o
|
|
Non-accelerated
filer o
|
Smaller
reporting company x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
The
number of shares outstanding of the registrant’s Common Stock, as of June 30,
2010 was 38,778,035.
INDEX
|
Page
No.
|
PART
I - FINANCIAL INFORMATION
|
|
|
|
|
Item
1.
|
Financial
Statements
|
3
|
|
|
|
|
Consolidated
Balance Sheets as of June 30, 2010 (Unaudited) and December 31,
2009
|
3
|
|
|
|
|
Consolidated
Statements of Income and Comprehensive Income (Unaudited) – Three and Six
Months Ended June 30, 2010 and June 30, 2009
|
4
|
|
|
|
|
Consolidated
Statements of Cash Flows (Unaudited) – Six Months Ended June 30, 2010 and
June 30, 2009
|
5
|
|
|
|
|
Notes
to Consolidated Financial Statements (Unaudited)
|
6
|
|
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
26
|
|
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
40
|
|
|
|
Item
4.
|
Controls
and Procedures
|
40
|
|
|
PART
II - OTHER INFORMATION
|
|
|
|
|
Item
1.
|
Legal
Proceedings
|
40
|
|
|
|
Item
1A.
|
Risk
Factors
|
40
|
|
|
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
40
|
|
|
|
Item
3.
|
Defaults
Upon Senior Securities
|
40
|
|
|
|
Item
4.
|
[Removed
and Reserved]
|
40
|
|
|
|
Item
5.
|
Other
Information
|
41
|
|
|
|
Item
6.
|
Exhibits
|
41
|
PART
I – FINANCIAL INFORMATION
Item 1. Financial
Statements
CHINA
RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
|
|
June
30,
2010
(Unaudited)
|
|
|
December
31,
2009
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT
ASSETS
|
|
|
|
|
|
|
Cash
& cash equivalents
|
|
$ |
5,089,700 |
|
|
$ |
1,111,943 |
|
Restricted
cash
|
|
|
1,671,354 |
|
|
|
1,461,659 |
|
Investment
in sales type leases, net
|
|
|
5,861,246 |
|
|
|
4,396,395 |
|
Interest
receivable on sales type leases
|
|
|
770,178 |
|
|
|
437,626 |
|
Prepaid
expenses
|
|
|
167,310 |
|
|
|
445,458 |
|
Other
receivables
|
|
|
206,819 |
|
|
|
184,355 |
|
VAT receivables - current
|
|
|
673,979 |
|
|
|
383,027 |
|
|
|
|
|
|
|
|
|
|
Total
current assets
|
|
|
14,440,586 |
|
|
|
8,420,463 |
|
|
|
|
|
|
|
|
|
|
NON-CURRENT
ASSETS
|
|
|
|
|
|
|
|
|
VAT receivables - noncurrent |
|
|
1,617,203 |
|
|
|
957,567 |
|
Investment
in sales type leases, net
|
|
|
77,210,405 |
|
|
|
48,147,738 |
|
Property
and equipment, net
|
|
|
204,606 |
|
|
|
97,311 |
|
Construction
in progress
|
|
|
46,136,422 |
|
|
|
34,858,845 |
|
|
|
|
|
|
|
|
|
|
Total
non-current assets
|
|
|
125,168,636 |
|
|
|
84,061,461 |
|
|
|
|
|
|
|
|
|
|
TOTAL
ASSETS
|
|
$ |
139,609,222 |
|
|
$ |
92,481,924 |
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
5,602,415 |
|
|
$ |
3,583,219 |
|
Notes
payable - bank acceptances
|
|
|
2,076,308 |
|
|
|
1,461,659 |
|
Interest
payable
|
|
|
1,363,584 |
|
|
|
- |
|
Taxes
payable
|
|
|
1,100,159 |
|
|
|
681,707 |
|
Accrued
liabilities and other payables
|
|
|
2,632,080 |
|
|
|
2,785,796 |
|
Advance
from related parties, net
|
|
|
2,503,578 |
|
|
|
468,475 |
|
Convertible
note, net of discount due to beneficial conversion feature
|
|
|
3,564,348 |
|
|
|
- |
|
Accrued
interest on short term convertible note
|
|
|
64,050 |
|
|
|
- |
|
Deferred
tax liability-current
|
|
|
71,833 |
|
|
|
148,193 |
|
Loan
payable - current
|
|
|
1,325,304 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
Total
current liabilities
|
|
|
20,303,659 |
|
|
|
9,129,049 |
|
|
|
|
|
|
|
|
|
|
NONCURRENT
LIABILITIES
|
|
|
|
|
|
|
|
|
Deferred
tax liability, net
|
|
|
4,695,937 |
|
|
|
2,762,115 |
|
Convertible
notes
|
|
|
3,000,000 |
|
|
|
8,000,000 |
|
Accrued
interest on long term convertible notes
|
|
|
285,335 |
|
|
|
353,024 |
|
Loans
payable
|
|
|
40,222,944 |
|
|
|
25,570,429 |
|
|
|
|
|
|
|
|
|
|
Total
noncurrent liabilities
|
|
|
48,204,216 |
|
|
|
36,685,568 |
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
68,507,875 |
|
|
|
45,814,617 |
|
|
|
|
|
|
|
|
|
|
SHARES
TO BE ISSUED
|
|
|
11,780,471 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
CONTINGENCIES
AND COMMITMENTS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS'
EQUITY
|
|
|
|
|
|
|
|
|
Common
stock, $0.001 par value; 100,000,000 shares
|
|
|
|
|
|
|
|
|
authorized,
38,778,035 shares
|
|
|
|
|
|
|
|
|
issued
and outstanding as of June 30, 2010 and
|
|
|
|
|
|
|
|
|
December
31, 2009, respectively
|
|
|
38,779 |
|
|
|
38,779 |
|
Additional
paid in capital
|
|
|
42,042,866 |
|
|
|
38,319,163 |
|
Statutory
reserve
|
|
|
3,770,192 |
|
|
|
2,497,724 |
|
Accumulated
other comprehensive income
|
|
|
4,053,438 |
|
|
|
3,709,490 |
|
Retained
earnings
|
|
|
7,393,961 |
|
|
|
1,485,914 |
|
|
|
|
|
|
|
|
|
|
Total
Company stockholders' equity
|
|
|
57,299,236 |
|
|
|
46,051,070 |
|
|
|
|
|
|
|
|
|
|
Noncontrolling
interest
|
|
|
2,021,640 |
|
|
|
616,237 |
|
|
|
|
|
|
|
|
|
|
Total
equity
|
|
|
59,320,876 |
|
|
|
46,667,307 |
|
|
|
|
|
|
|
|
|
|
TOTAL
LIABILITIES AND EQUITY
|
|
$ |
139,609,222 |
|
|
$ |
92,481,924 |
|
The
accompanying notes are an integral part of these consolidated financial
statements.
CHINA
RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(UNAUDITED)
|
|
SIX
MONTHS ENDED JUNE 30,
(UNAUDITED)
|
|
|
THREE
MONTHS ENDED JUNE 30,
(UNAUDITED)
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
of systems
|
|
$ |
31,921,309 |
|
|
$ |
9,513,077 |
|
|
$ |
21,795,873 |
|
|
$ |
9,513,077 |
|
Contingent
rental income
|
|
|
742,638 |
|
|
|
- |
|
|
|
742,638 |
|
|
|
- |
|
Rental
income from operating lease
|
|
|
- |
|
|
|
5,946,892 |
|
|
|
- |
|
|
|
1,623,999 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenue
|
|
|
32,663,947 |
|
|
|
15,459,969 |
|
|
|
22,538,511 |
|
|
|
11,137,076 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of systems
|
|
|
24,600,160 |
|
|
|
7,317,751 |
|
|
|
16,801,915 |
|
|
|
7,317,751 |
|
Rental
expense
|
|
|
- |
|
|
|
4,148,572 |
|
|
|
- |
|
|
|
1,126,899 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
cost of sales
|
|
|
24,600,160 |
|
|
|
11,466,323 |
|
|
|
16,801,915 |
|
|
|
8,444,650 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
8,063,787 |
|
|
|
3,993,646 |
|
|
|
5,736,596 |
|
|
|
2,692,426 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income on sales-type leases
|
|
|
6,418,263 |
|
|
|
2,333,472 |
|
|
|
3,323,695 |
|
|
|
1,134,941 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
operating income
|
|
|
14,482,050 |
|
|
|
6,327,118 |
|
|
|
9,060,291 |
|
|
|
3,827,367 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
and administrative expenses
|
|
|
2,746,173 |
|
|
|
1,355,741 |
|
|
|
1,386,476 |
|
|
|
560,303 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
operating expenses
|
|
|
2,746,173 |
|
|
|
1,355,741 |
|
|
|
1,386,476 |
|
|
|
560,303 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from operations
|
|
|
11,735,877 |
|
|
|
4,971,377 |
|
|
|
7,673,815 |
|
|
|
3,267,064 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-operating
income (expenses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
|
21,434 |
|
|
|
- |
|
|
|
(37,705 |
) |
|
|
- |
|
Interest
expense
|
|
|
(1,188,449 |
) |
|
|
(433,768 |
) |
|
|
(737,075 |
) |
|
|
(375,549 |
) |
Other
income
|
|
|
(3,568 |
) |
|
|
(5,153 |
) |
|
|
92,691 |
|
|
|
(3,059 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-operating expenses, net
|
|
|
(1,170,583 |
) |
|
|
(438,921 |
) |
|
|
(682,089 |
) |
|
|
(378,608 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income tax
|
|
|
10,565,294 |
|
|
|
4,532,456 |
|
|
|
6,991,726 |
|
|
|
2,888,456 |
|
Income
tax expense (benefit)
|
|
|
2,898,043 |
|
|
|
225,151 |
|
|
|
1,861,277 |
|
|
|
(342,960 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income from operations
|
|
|
7,667,251 |
|
|
|
4,307,305 |
|
|
|
5,130,449 |
|
|
|
3,231,416 |
|
Less:
Income (loss) attributable to noncontrolling interest
|
|
|
486,573 |
|
|
|
(3,158 |
) |
|
|
92,132 |
|
|
|
(3,198 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income attributable to China Recycling Energy Corp
|
|
|
7,180,678 |
|
|
|
4,310,463 |
|
|
|
5,038,317 |
|
|
|
3,234,614 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
comprehensive item
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation (gain) loss attributable
to China Recycling Energy Corp
|
|
|
343,948 |
|
|
|
(1,092 |
) |
|
|
385,866 |
|
|
|
28,803 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income attributable to China Recycling Energy Corp
|
|
$ |
7,524,626 |
|
|
$ |
4,309,371 |
|
|
$ |
5,424,183 |
|
|
$ |
3,263,417 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income attributable to noncontrolling interest
|
|
$ |
509,913 |
|
|
$ |
- |
|
|
$ |
112,927 |
|
|
$ |
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
weighted average shares outstanding
|
|
|
38,778,035 |
|
|
|
37,348,071 |
|
|
|
38,778,035 |
|
|
|
38,260,905 |
|
Diluted
weighted average shares outstanding *
|
|
|
48,886,504 |
|
|
|
43,511,301 |
|
|
|
48,754,609 |
|
|
|
44,600,370 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
net earnings per share
|
|
$ |
0.19 |
|
|
$ |
0.12 |
|
|
$ |
0.13 |
|
|
$ |
0.08 |
|
Diluted
net earnings per share *
|
|
$ |
0.15 |
|
|
$ |
0.10 |
|
|
$ |
0.10 |
|
|
$ |
0.07 |
|
The
accompanying notes are an integral part of these consolidated financial
statements.
CHINA
RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(UNAUDITED)
|
|
SIX
MONTHS ENDED
JUNE
30,
|
|
|
|
2010
|
|
|
2009
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
Income
including noncontrolling interest
|
|
$ |
7,667,251 |
|
|
$ |
4,307,305 |
|
Adjustments
to reconcile income including noncontrolling
|
|
|
|
|
|
|
|
|
interest
to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
25,323 |
|
|
|
15,018 |
|
Amortization
of discount related to conversion feature of convertible
note
|
|
|
880,466 |
|
|
|
- |
|
Stock
options and warrants
|
|
|
1,407,547 |
|
|
|
442,191 |
|
Accrued
interest on convertible notes
|
|
|
(3,639 |
) |
|
|
167,342 |
|
Changes
in deferred tax
|
|
|
1,832,221 |
|
|
|
123,438 |
|
(Increase)
decrease in current assets:
|
|
|
|
|
|
|
|
|
Interest
receivable on sales type lease
|
|
|
(258,972 |
) |
|
|
230,051 |
|
Prepaid
expenses
|
|
|
279,184 |
|
|
|
3,899,203 |
|
VAT
receivable and other receivables
|
|
|
(973,351 |
) |
|
|
(1,708 |
) |
Inventory
|
|
|
- |
|
|
|
(299,355 |
) |
Increase
(decrease) in current liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
|
(1,362,890 |
) |
|
|
2,055,791 |
|
Taxes
payable
|
|
|
412,624 |
|
|
|
(1,041,599 |
) |
Interest
payable
|
|
|
1,356,732 |
|
|
|
- |
|
Accrued
liabilities and other payables
|
|
|
(166,058 |
) |
|
|
(906,267 |
) |
|
|
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
|
11,096,438 |
|
|
|
8,991,410 |
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Gross
investment in sales type leases
|
|
|
(6,122,391 |
) |
|
|
(8,988,974 |
) |
Restricted
cash
|
|
|
(200,653 |
) |
|
|
- |
|
Acquisition
of property & equipment
|
|
|
(131,547 |
) |
|
|
(14,297 |
) |
Construction
in progress
|
|
|
(18,201,622 |
) |
|
|
(766,900 |
) |
|
|
|
|
|
|
|
|
|
Net
cash used in investing activities
|
|
|
(24,656,213 |
) |
|
|
(9,770,171 |
) |
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Insurance
of common stock
|
|
|
- |
|
|
|
2,000,000 |
|
Insurance
of convertible notes
|
|
|
- |
|
|
|
3,000,000 |
|
Cash
contribution from noncontrolling interest
|
|
|
908,279 |
|
|
|
263,439 |
|
Proceeds
from loans
|
|
|
15,757,780 |
|
|
|
2,927,101 |
|
Advance
from (repayment to) related parties
|
|
|
850,408 |
|
|
|
(3,440 |
) |
|
|
|
|
|
|
|
|
|
Net
cash provided by financing activities
|
|
|
17,516,467 |
|
|
|
8,187,100 |
|
|
|
|
|
|
|
|
|
|
EFFECT
OF EXCHANGE RATE CHANGE ON CASH & CASH EQUIVALENTS
|
|
|
21,065 |
|
|
|
(13,479 |
) |
|
|
|
|
|
|
|
|
|
NET
INCREASE IN CASH & CASH EQUIVALENTS
|
|
|
3,977,757 |
|
|
|
7,394,860 |
|
CASH
& CASH EQUIVALENTS, BEGINNING OF PERIOD
|
|
|
1,111,943 |
|
|
|
7,267,344 |
|
|
|
|
|
|
|
|
|
|
CASH
& CASH EQUIVALENTS, END OF PERIOD
|
|
$ |
5,089,700 |
|
|
$ |
14,662,204 |
|
|
|
|
|
|
|
|
|
|
Supplemental
Cash flow data:
|
|
|
|
|
|
|
|
|
Income
tax paid
|
|
$ |
945,165 |
|
|
$ |
1,074,560 |
|
Interest
paid
|
|
$ |
201,635 |
|
|
$ |
261,858 |
|
The
accompanying notes are an integral part of these consolidated financial
statements.
CHINA
RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2010 (UNAUDITED) AND DECEMBER 31, 2009
1. ORGANIZATION
AND DESCRIPTION OF BUSINESS
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 (“Shanghai TCH”), sells and leases
energy saving systems and equipment. On March 8, 2007, the Company changed
its name to “China Recycling Energy Corporation”.
On
February 1, 2007, the Company’s subsidiary, Shanghai TCH, conditionally 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”) which were approved and made effective by our Board of Directors on
April 8, 2007. 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
Joint-Operation Agreement, Shanghai TCH and Yingfeng jointly pursued a top gas
recovery turbine project ("TRT Project") which was to design, construct, install
and operate a TRT Project for Zhangzhi Iron and Steel Holdings Ltd.
("Zhangzhi"). This TRT Project was initiated by a Contract to Design and
Construct TRT System (“Project Contract”) entered by Yingfeng and Zhangzhi in
2006. Due to Yingfeng’s lack of capital in pursuing this Project alone, Yingfeng
sought Shanghai TCH’s cooperation. Shanghai TCH provided various forms of
investments and properties into this TRT Project including cash, hardware,
software, equipment, major components and devices. In return, Shanghai TCH
obtained all the rights, titles, benefits and interests that Yingfeng originally
had under this Project Contract, including but not limited to the regular cash
payments made by Zhangzhi and other property rights and interests. This project
was completed and put into operation in February 2007.
Under
another Joint-Operation Agreement, Shanghai TCH and Yingfeng jointly pursued
another TRT project to design, construct, install and operate a TRT
Project for Xingtai Iron and Steel Company, Ltd. (“Xingtai”). This Project was
initiated by a Contract to Design and Construct TRT Project (“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. 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 investments and properties into the Project including cash, hardware,
software, equipment, major components and devices. In return, Shanghai TCH
obtained all the rights, titles, benefits and interests that Yingfeng originally
had under this Project Contract, including but not limited to the regular cash
payments made by Xingtai and other property rights and interests. This project
was completed and put into operation in August 2007.
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 on
April 8, 2007 were terminated.
In
November 2007, Shanghai TCH signed a cooperative agreement with Shengwei Group
to build two sets of 12MW pure low temperature cement waste heat power generator
systems (“CHPG”) for Shengwei’s two 2,500-tons-per-day cement manufacturing
lines in Jin Yang and for a 5,000-tons-per-day cement manufacturing line in Tong
Chuan. Total investment in these projects was $12,593,000 (RMB
93,000,000). At the end of 2008, construction of the CHPG in Tong Chuan
was completed at a cost of $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 Shengwei from the date the system was put into
service. Shanghai TCH is responsible for the daily maintenance and repair
of the system, and charges Shengwei 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 Shengwei 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, Shanghai TCH will have no further obligations under the
cooperative agreement. On May 20, 2009, Shanghai TCH entered into a
supplementary agreement with Shengwei Group to amend the timing for title
transfer to the end of the lease term. In addition, the supplementary agreement
provided that Shanghai TCH will charge Shengwei based on actual power usage
subject to a minimum of $0.31 million (RMB 2.1 million) per month
during the operating period.
On June
29, 2009, construction of the CHPG in Jin Yang was completed at a cost of
$7,318,000 (RMB 50,000,000) and put into operation. Shanghai TCH charges
Shengwei a technical service fee of $336,600 (RMB 2,300,000) monthly for the
sixty months of the lease term. Shengwei has the right to purchase the CHPG
systems for $29,000 (RMB 200,000) at the end of the lease term. Shengwei 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, Shanghai TCH outsourced the operation and maintenance of
the CHPG systems in Tong Chuan and JinYang to a third party for $732,000 (RMB
5,000,000) per year.
On April
14, 2009, the Company incorporated a joint venture (“JV”) with Erdos Metallurgy
Co., Ltd. (“Erdos”) to recycle waste heat from Erdos’ 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 registered capital of $2,635,000 (RMB 18,000,000).
On September 30, 2009, Xi’an TCH Energy Technology Co., Ltd. (“Xi’an TCH”)
injected additional capital of $4.03 million (RMB 27,500,000). In November 2009,
Xi’an TCH injected further capital of $5.05 million (RMB 34,500,000). As of
December 31, 2009, total registered capital was $11.71 million (RMB 80,000,000),
of which, $11.45 million (RMB 78,200,000) was from Xi’an TCH, and $0.26 million
(RMB 1,800,000) was from Erdos. On April 14, 2010, total registered
capital was raised to $17.55 million (RMB 120 million), of which, $16.37 million
(RMB112 million) was contributed by Xi’an TCH and $1.18 million (RMB 8
million) was from Erdos. Total investment for the project is estimated at
approximately $74 million (RMB 500 million) with an initial investment of $17.55
million (RMB 120,000,000). Erdos contributed 10% of the total investment of the
project, and Xi’an TCH contributed 90%. According to Xi’an TCH and Erdos’
agreement on profit distribution, Xi’an TCH and Erdos will receive 80% and 20%
of the profit 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 from the JV, respectively. The profits to be distributed will be
computed based on Chinese generally accepted accounting principles. The main
difference between US GAAP (Generally Accepted Accounting Principles) and
Chinese GAAP with regards to Erdos is that Erdos is treated as a sales-type
lease under US GAAP and as an operating lease under Chinese GAAP. When the term
of the JV expires, Xi’an TCH will transfer its equity in the JV to Erdos at no
additional cost.
On April
18, 2009, Erdos TCH signed a Cooperation Agreement with Erdos to recycle heat
from groups of furnaces of Erdos Metallurgy’s metal refining plants to generate
power and steam, which will then be sold back to Erdos Metallurgy. According to
the contract, Erdos TCH will install a group of power generation projects with a
total of 70MW power capacity, which may expand up to 120MW, and 30-ton steam per
hour, with an estimated total investment in excess of $75 million (RMB 500
million). The construction of the projects was split into three
phases, two power generation systems in Phase I with a total of 18MW power
capacity, three power generation systems in Phase II with a total of 27MW power
capacity and one power generation system in Phase III with 25MW power
capacity.
At the
end of 2009, Erdos TCH completed the first 9MW power station of Phase I of the
project and put it into operation. Phase I includes two 9MW units for
a combined 18MW power capacity. Pursuant to the Co-operation Agreement and
the supplement agreements signed between Erdos and Erdos TCH, Erdos shall
purchase all the electricity and steam to be generated from the JV’s power
generation projects. Erdos TCH leased the two 9 MW units to Erdos and will be
responsible for the operation and maintenance of the units.
For each
phase of the project, the lease term is 20 years starting from the date of
completion of the phase. Erdos agreed to pay a fixed minimum of $0.22
million (RMB 1.5 million) per month for each 9MW capacity power generation
unit. In addition Erdos will pay the actual amount if the sale of the
electricity generated by each unit is more than $0.22 million (RMB 1.5 million)
monthly.
Effective
January 1, 2010, Erdos TCH outsourced to an independent third party the
operation and maintenance of the first 9MW power generation project for $
922,000 (RMB 6.27 million) per year. After 20 years, the units will be
transferred to Erdos without charge. In March of 2010, the Company
completed the second 9MW capacity power station and put it into operation.
Effective April 1, 2010, Erdos TCH outsourced to an independent third party the
operation and maintenance of the second 9MW power generation project for
$922,000 (RMB 6.27 million) per year. After 20 years, the units will be
transferred to Erdos without charge.
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 subleased 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 Jiujiang Trading Co.,
Ltd. (“Shenmu”) a set of three 6 MW 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 term of
these 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 be
supplied back to Shenmu. Shenmu agrees to supply Xi’an TCH the coke-oven
gas free of charge. Shenmu will pay the Company an annual “energy-saving
service fee” of approximately $5.6 million in 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 per
month. 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. If gas supply is less,
Shenmu agrees to pay Xi’an TCH energy-saving service fee described above or up
to 10.8 million kilowatt-hours per month. Xi’an TCH maintains the ownership of
the project for 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 charge. Shenmu gave a
lien on its production line to guarantee its performance under the
contracts. Shenmu’s three major shareholders provide an unlimited joint
liability guarantee to Xi’an TCH for Shenmu’s performance under the contracts
and the Yulin Huiyuan Group, an independent third party, provides a guarantee to
Xi’an TCH for Shenmu’s performance under the contracts.
On
January 20, 2010, Xi’an TCH entered into a Technical Reconstruction Letter of
Intent with Xueyi
Dong (“Dong”) a natural person with Chinese citizenship for Xi’an TCH
reconstructing and transforming a Thermal Power Generation Systems owned by Dong
into a 12MW Biomass Power Generation Systems (“Biomass Systems” or “BMPG”) for
approximately RMB 15 million (approximately $2.2 million), of which, RMB 7
million ( approximately $1.03 million) was payable to Dong, and RMB 8 million
(approximately $1.18 million) was payable to one of the Company’s shareholder,
who had previously paid that amount to Dong on behalf of the Company. These
amounts are part of accounts payable and other payables respectively as at June
30, 2010.
After the successful
transformation of the system, Xi’an TCH entered into a Biomass Power
Generation Asset Transfer Agreement (the “Transfer Agreement”) with Dong on June
29, 2010. Under the Transfer Agreement, Dong transferred the Biomass
Systems to Xi’an TCH, and Xi’an TCH will pay Dong RMB 100,000,
000 (approximately $14,705,900) for the systems, including RMB 20,000,000 in
cash and RMB 80,000,000 with equivalent shares of the Company’s common stock.
The stock price will be the same price as the Company’s public offering price in
the first public offering which occurs in 2010 or 2011 but in no circumstance
less than $4 per share. The exchange rate between U.S. Dollar and
Chinese RMB in connection with the stock issuance is 1:6.8. At June 30, 2010, the
Company recorded accounts payable of RMB 20,000,000 (approximately $2.94
million), and shares to be issued of $11.78 million in connection with this
transaction.
On June
29, 2010, Xi’an TCH entered into a Biomass Power Generation Project Lease
Agreement with PuCheng XinHengYuan Biomass Power Generation Co., Ltd.,
(“XHY”). Under this lease agreement, Xi’an TCH leased this same set
of 12MW biomass power generation systems to XHY at minimum RMB 1,900,000 per
month (approximately $279,400) for 15 years. The leasing fee will
increase proportionately with the biomass generated electricity fee in China
during the term of this lease agreement.
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”) 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 2009 audited financial
statements included in the Company’s Annual Report on Form 10-K. The
results for the six and three months ended June 30, 2010 are not necessarily
indicative of the results to be expected for the full year ending on December
31, 2010.
2. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
Basis of
Consolidation
The
consolidated financial statements include the accounts of CREG and, its
subsidiary, Sifang Holdings, its wholly owned subsidiaries, Huahong New Energy
Technology Co., Ltd. ("Huahong") and Shanghai TCH, Shanghai 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 subsidiary Erdos TCH Energy Saving
Development Co., Ltd, in which 90% of the investment will be from Xi’an
TCH. Substantially all of the Company’s revenues are derived from the
operations of Shanghai TCH and its subsidiaries, which represent substantially
all of the Company’s consolidated assets and liabilities as of June 30, 2010 and
December 31, 2009, 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.
Revenue
Recognition
Sales-type Leasing and
Related Revenue Recognition
We
construct and then lease waste energy recycling power generating projects to our
customers. We usually transfer ownership of the waste energy recycling power
generating projects to our customers at the end of each lease. Our
investment in these projects is recorded as investment in sales-type leases in
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 13,
“Accounting for Leases” (codified in Financial Accounting Standards Board
(“FASB”) Accounting Standards Codification (“ASC”) Topic 840) and its various
amendments and interpretations. We finance our manufacture and construction of
the waste energy recycling power generating projects and we finance our
customers for the price of the projects. The sales and cost of sales are
recognized at the time of sale or inception of the lease. The investment in
sales-type leases consists of the sum of the total minimum lease payments
receivable less unearned interest income and estimated executory cost. Unearned
interest income is amortized to income over the lease term so as to produce a
constant periodic rate of return on the net investment in the lease. While
a portion of revenue is recognized at the inception of the lease, the cash flow
from the sales-type lease occurs over the course of the lease. Revenue is net of
Value Added Tax.
Contingent
Rental Income
The Company records income from actual
electricity usage in addition to minimum lease payment of each project as
contingent rental income in the period contingent rental income is earned.
Contingent rent is not part of minimum lease payments.
Operating
Leases
During
2008, we leased two energy recycling power generation equipment systems which
were then subleased to two sublessees under one-year, non-cancellable leases
with the rents paid in full. The leases and the subleases were not renewed
when they expired in April 2009. These transactions were accounted for as
operating leases. In an operating lease revenue is recognized as payments
are received; the initial direct costs were deferred and amortized over the
lease term on a straight-line basis, thus matching them against rental
revenue.
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 June 30, 2010 and
December 31, 2009, 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 June 30, 2010 and December 31, 2009, the Company had accounts receivable
allowance of $0.
The
operations of the Company are located in the P.R.C.(the “People’s Republic of
China”) 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.
Property and
Equipment
Property
and equipment are stated at cost, net of accumulated depreciation. Expenditures
for maintenance and repairs are expensed as incurred; additions, renewals and
betterments are capitalized. When property and equipment are retired or
otherwise disposed of, the related cost and accumulated depreciation are removed
from the respective accounts, and any gain or loss is included in operations.
Depreciation of property and equipment is provided using the straight-line
method over the estimated lives as follows:
Building
|
20 years
|
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 FASB 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 June 30, 2010 and
December 31, 2009.
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 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 adopted the provisions of 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 June 30, 2010 and December 31, 2009, the Company did
not take any uncertain positions that would necessitate recording of tax related
liability.
Non-Controlling
Interest
Effective
January 1, 2009, the Company adopted FASB ASC Topic 810, “Consolidation,” which
established new standards governing the accounting for and reporting of
noncontrolling interests (NCIs) in partially owned consolidated subsidiaries and
the loss of control of subsidiaries. Certain provisions of this standard
indicate, among other things, that NCIs (previously referred to as minority
interests) be treated as a separate component of equity, not as a liability (as
was previously the case), that increases and decreases in the parent’s ownership
interest that leave control intact be treated as equity transactions rather than
as step acquisitions or dilution gains or losses, and that losses of a partially
owned consolidated subsidiary be allocated to the NCI even when such allocation
might result in a deficit balance.
The net
income (loss) attributed to the NCI was separately designated in the
accompanying statements of income and other comprehensive income. Losses
attributable to the NCI in a subsidiary may exceed the NCI’s interests in the
subsidiary’s equity. The excess attributable to the NCI is attributed to those
interests. The NCI shall continue to be attributed its share of losses even if
that attribution results in a deficit NCI balance.
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. Cash flows from
investing and financing activities exclude the cost of purchasing
the Biomass System of $16.93 million (RMB 115,000,000) and transfer from
construction in progress of approximately $7.14 million for a system that was
sold for the Erdos Phase I project. Cash flows from operating activities
includes conversion of trade accounts payable to notes payable of
approximately $600,000 because the conversion of accounts payable to notes
payable is merely an extension of credit terms by the vendors.
Fair
Value of Financial Instruments
For
certain of the Company’s financial instruments, including cash and cash
equivalents, restricted cash, accounts receivable, other receivables, accounts
payable, accrued liabilities and short-term debt, the carrying amounts
approximate their fair values due to their short maturities. Receivables on
sales-type leases are based on interest rates implicit in the
lease.
ASC Topic
820, “Fair Value Measurements and Disclosures,” requires disclosure of the fair
value of financial instruments held by the Company. ASC Topic 825, “Financial
Instruments,” defines fair value, and establishes a three-level valuation
hierarchy for disclosures of fair value measurement that enhances disclosure
requirements for fair value measures. The carrying amounts reported in the
consolidated balance sheets for receivables and current liabilities each qualify
as financial instruments and are a reasonable estimate of their fair values
because of the short period of time between the origination of such instruments
and their expected realization and their current market rate of interest. The
three levels of valuation hierarchy are defined as follows:
·
|
Level
1 inputs to the valuation methodology are quoted prices (unadjusted) for
identical assets or liabilities in active markets.
|
|
|
·
|
Level
2 inputs to the valuation methodology include quoted prices for similar
assets and liabilities in active markets, and inputs that are observable
for the asset or liability, either directly or indirectly, for
substantially the full term of the financial
instrument.
|
·
|
Level
3 inputs to the valuation methodology are unobservable and significant to
the fair value measurement.
|
The
Company analyzes all financial instruments with features of both liabilities and
equity under ASC 480, “Distinguishing Liabilities from Equity,” and ASC
815.
As of
June 30, 2010 and December 31, 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.
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 for six and three months
ended:
|
|
Six
Months Ended
|
|
|
Three
Months Ended
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
Net
income for common shares
|
|
$
|
7,180,678
|
|
|
$
|
4,310,463
|
|
|
$
|
5,038,317
|
|
|
$
|
3,234,614
|
|
Interest
expense on convertible notes*
|
|
|
-
|
|
|
|
167,342
|
|
|
|
-
|
|
|
|
104,329
|
|
Net
income for diluted shares
|
|
|
7,180,678
|
|
|
|
4,477,805
|
|
|
|
|
|
|
|
3,338,943
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding - basic
|
|
|
38,778,035
|
|
|
|
37,348,071
|
|
|
|
38,778,035
|
|
|
|
38,260,905
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Convertible
notes**
|
|
|
7,625,969
|
|
|
|
6,163,230
|
|
|
|
7,596,154
|
|
|
|
6,339,465
|
|
Options
granted
|
|
|
2,357,500
|
|
|
|
-
|
|
|
|
2,264,454
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants
granted
|
|
|
125,000
|
|
|
|
-
|
|
|
|
115,966
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding – diluted
|
|
|
48,886,504
|
|
|
|
43,511,301
|
|
|
|
48,754,609
|
|
|
|
44,600,370
|
|
Earnings
(loss) per share – basic
|
|
$
|
0.19
|
|
|
$
|
0.12
|
|
|
$
|
0.13
|
|
|
$
|
0.08
|
|
Earnings
(loss) per share – diluted
|
|
$
|
0.15
|
|
|
$
|
0.10
|
|
|
$
|
0.10
|
|
|
$
|
0.07
|
|
*
|
Interest
expense on convertible notes was added back to net income for the
computation of diluted earnings per share.
|
|
|
**
|
Diluted
weighted average shares outstanding includes shares issuable upon
conversion of the Second Note issued on April 29, 2008 for which
conversion price is tied to 2009 audited after-tax profit (See note
15).
|
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 was 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.
Registration
Rights Agreement
The Company accounts for
payment arrangements under a registration rights agreement in accordance with
ASC Topic 825, “Financial Instruments,” which requires the contingent obligation
to make future payments or otherwise transfer consideration under a registration
payment arrangement, whether issued as a separate agreement or included as a
provision of a financial instrument or other agreement, be separately recognized
and measured in accordance with ASC Topic 450, “Contingencies.”
Reclassifications
Certain
prior year amounts were reclassified to conform to the manner of presentation in
the current period.
New Accounting
Pronouncements
On July
1, 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.
On
February 25, 2010, the FASB issued ASU No. 2010-09 Subsequent Events Topic 855
“Amendments to Certain Recognition and Disclosure Requirements,” effective
immediately. The amendments in the ASU remove the requirement for an SEC filer
to disclose a date through which subsequent events have been evaluated in both
issued and revised financial statements. Revised financial statements include
financial statements revised as a result of either correction of an error or
retrospective application of US GAAP. The FASB believes these amendments remove
potential conflicts with the SEC’s literature. The adoption of this ASU did not
have a material impact on the Company’s consolidated financial
statements.
On March
5, 2010, the FASB issued ASU No. 2010-11 Derivatives and Hedging Topic 815
“Scope Exception Related to Embedded Credit Derivatives.” This ASU clarifies the
guidance within the derivative literature that exempts certain credit related
features from analysis as potential embedded derivatives requiring separate
accounting. The ASU specifies that an embedded credit derivative feature related
to the transfer of credit risk that is only in the form of subordination of one
financial instrument to another is not subject to bifurcation from a host
contract under ASC 815-15-25, Derivatives and Hedging — Embedded Derivatives —
Recognition. All other embedded credit derivative features should be analyzed to
determine whether their economic characteristics and risks are “clearly and
closely related” to the economic characteristics and risks of the host contract
and whether bifurcation is required. The ASU is effective for the Company on
July 1, 2010. Early adoption is permitted. The adoption of this ASU will not
have a material impact on the Company’s consolidated financial
statements.
In April
2010, the FASB codified the consensus reached in Emerging Issues Task Force
Issue No. 08-09, “Milestone Method of Revenue Recognition.” FASB ASU
No. 2010-17 provides guidance on defining a milestone and determining when
it may be appropriate to apply the milestone method of revenue recognition for
research and development transactions. FASB ASU No. 2010-17 is
effective for fiscal years beginning on or after June 15, 2010, and is
effective on a prospective basis for milestones achieved after the adoption
date. The Company does not expect this ASU will have a material impact on
its financial position or results of operations when it adopts this update on
January 1, 2011.
3. NET INVESTMENT IN SALES-TYPE
LEASES
Under
sales-type leases, Shanghai TCH has leased TRT systems to Xingtai and Zhangzhi
with terms of five years and thirteen years, respectively; and CHPG systems to
Tong Chuan Shengwei and Jin Yang Shengwei respectively for five years, WGPG
systems to Shenmu for ten years, BPG systems to Pucheng for fifteen years, and a
power and steam generating system from waste heat from metal refining to Erdos
for twenty years. The components of the net investment in sales-type leases as
of June 30, 2010 and December 31, 2009 are as follows:
|
|
2010
|
|
|
2009
|
|
Total
future minimum lease payments receivables
|
|
$
|
244,629,031
|
|
|
$
|
150,847,917
|
|
Less:
executory cost
|
|
|
(52,327,236)
|
|
|
|
(6,971,144)
|
|
Less:
unearned interest income
|
|
|
(109,230,144
|
)
|
|
|
(91,332,640
|
)
|
Net
investment in sales - type leases
|
|
|
83,071,651
|
|
|
|
52,544,133
|
|
|
|
|
|
|
|
|
|
|
Current
portion
|
|
|
(5,861,246
|
)
|
|
|
(4,396,395
|
)
|
Noncurrent
portion
|
|
$
|
77,210,405
|
|
|
$
|
48,147,738
|
|
As of
June 30, 2010, the future minimum rentals to be received on non-cancelable
sales-type leases by years are as follows:
Years ending June
30,
|
|
|
|
2011
|
|
$
|
25,393,627
|
|
2012
|
|
|
24,275,658
|
|
2013
|
|
|
23,347,668
|
|
2014
|
|
|
21,491,687
|
|
2015
|
|
|
15,599,676
|
|
Thereafter
|
|
|
134,520,715
|
|
Total
|
|
|
244,629,031
|
|
Less:
executory cost
|
|
|
(52,327,236)
|
|
|
|
$
|
192,301,795
|
|
4.
RESTRICTED CASH, NOTES PAYABLE – BANK ACCEPTANCES
Restricted
cash at June 30, 2010 and December 31, 2009 represented $1,671,354 and
$1,461,659, respectively, held by the bank as collateral to issue bank
acceptances. The Company endorses bank acceptances to vendors as payment
of their own obligations. Most of the bank acceptances have maturities of
less than six months. At June 30, 2010 and December 31, 2009, the Company
had bank acceptances of $2,076,308 and $1,461,659, respectively.
5. PREPAID
EXPENSES
Prepaid
expenses mainly consisted of prepayment for interest, supplies, office rental,
parking space, insurance and legal fees.
6.
VAT (VALUE ADDED TAX) RECEIVABLES
VAT
receivable represented Input VAT the Company has paid in the purchase of the
equipment used to construct the Erdos power generation projects. The
Input VAT could be used as a deduction from the VAT payables (Output VAT), which
is taxed on the Company’s net revenue from generating electricity. As
of June 30, 2010 and December 31, 2009, the Company expected to collect VAT of
approximately $674,000 and $383,000 within one year, and approximately
$1,617,000 and $957,000 starting from year two till the end of the lease term,
respectively, at an estimated amount of $383,000 per year.
7. CONSTRUCTION IN
PROGRESS
”Construction
in progress” represented the amount paid for constructing power generation
systems. During the first quarter of 2010, Erdos power generation system
Phase I project was completed and put into operation. At June 30, 2010, the
Company paid approximately $44.17 million for Phase II and Phase III of Erdos
TCH power generation system projects, and approximately $1.97 million for
Zhongbao Binhai 7MW Capacity Electricity Generation Project (see note
21).
8. TAX
PAYABLE
“Tax
payable” consisted of the following at June 30, 2010 and December 31,
2009:
|
|
2010
|
|
|
2009
|
|
Income
tax payable
|
|
$
|
527,944
|
|
|
$
|
598,327
|
|
Business
tax payable
|
|
|
276,461
|
|
|
|
74,286
|
|
Other
taxes payable
|
|
|
295,754
|
|
|
|
9,094
|
|
|
|
$
|
1,100,159
|
|
|
$
|
681,707
|
|
9. ACCRUED LIABILITIES AND OTHER
PAYABLES
“Accrued
liabilities and other payables” consisted of the following at June 30, 2010
and December 31, 2009:
|
|
2010
|
|
|
2009
|
|
Employee
training, labor union expenditure and social insurance
payable
|
|
$
|
238,950
|
|
|
$
|
421,824
|
|
Consulting
and legal expenses
|
|
|
371,544
|
|
|
|
371,544
|
|
Payable
to Yingfeng
|
|
|
1,687,590
|
|
|
|
1,678,372
|
|
Total
other payables
|
|
|
2,298,084
|
|
|
|
2,471,740
|
|
Accrued
payroll and welfare
|
|
|
250,475
|
|
|
|
243,826
|
|
Accrued
maintenance expense
|
|
|
70,616
|
|
|
|
70,230
|
|
Other
|
|
|
12,905
|
|
|
|
-
|
|
Total
|
|
$
|
2,632,080
|
|
|
$
|
2,785,796
|
|
“Consulting
and legal expenses” were 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 (Zhangzhi
and Xingtai) that were previously owned by Yingfeng. This amount is non-interest
bearing and is payable on demand.
10. ADVANCE FROM RELATED PARTY,
NET
At June
30, 2010, “Advance from related party” was $2,503,578 representing $1,295,852
from Erdos (the minority shareholder of Erdos TCH) as an advance for the capital
needs of Erdos TCH; $1,178,047 short term advance from a shareholder to pay for
conversion and retrofit of Pucheng Biomass Power Generation systems,;and a
$29,679 payment by the Company’s management for paying certain operating
expenses on behalf of the Company. At December 31, 2009, there was $468,475
advanced from a related party; this represented $483,290 from Erdos as an
advance for the capital need of Erdos TCH, reduced by $14,815 which
was reimbursed to the Company’s management for their payments of certain
operating expenses on behalf of the Company.
11. NONCONTROLLING
INTEREST
“Non-controlling
interest” represented 10% equity interest of Erdos JV which is owned by Erdos
Metallurgy Co., Ltd. According to Xi’an TCH and Erdos’ agreement on
profit distribution, Xi’an TCH and Erdos will receive 80% and 20% of the profit
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 from
the JV, respectively.
As of
June 30, 2010, the total registered capital of Erdos JV is RMB 120,000,000
($17.55 million), of which, $16.37 million (RMB112 million) was contributed by
Xi’an TCH and $1.18 million (RMB 8 million) was from
Erdos.
Erdos TCH
engages in business similar to that of Xi’an TCH. Huaxin primarily does
design, research and development and consulting work. The minority share
of the income (loss) was $486,573 and $(3,158) for the six months ended June 30,
2010 and 2009, respectively, and $92,132 and $(3,198) for the three months ended
June 30, 2010 and 2009, respectively.
Erdos TCH
allocates its income to Xi’an TCH and Erdos at a proportion of 80% and 20% based
on net income calculated under Chinese GAAP. The main difference between
US GAAP and Chinese GAAP with respect to Erdos is that Erdos is treated as a
sales-type lease under US GAAP and as an operating lease under Chinese
GAAP. The following is the profit and loss statement of Erdos TCH,
prepared under Chinese GAAP for the six months ended June 30, 2010:
Net
Revenue
|
|
$
|
1,867,475
|
|
Cost
of Revenue
|
|
|
(1,061,170
|
)
|
Gross
Profit
|
|
|
806,305
|
|
Operating
expenses
|
|
|
17,826
|
|
Income
from operations
|
|
|
788,479
|
|
Non-operating
income
|
|
|
3,109
|
|
Income
tax expense
|
|
|
(197,897)
|
|
Net
Income
|
|
$
|
593,691
|
|
The
following is a reconciliation of net income per Chinese GAAP to net income per
US GAAP:
Net
income per Chinese GAAP
|
|
$
|
593,691
|
|
Revenue
per sales-type lease
|
|
|
8,263,693
|
|
Cost
of revenue
|
|
|
(6,626,393
|
)
|
Operating
expenses
|
|
|
2,116
|
|
Interest
income
|
|
|
791,978
|
|
Income
before income tax
|
|
|
3,025,085
|
|
Deferred
income tax expense
|
|
|
(592,219
|
)
|
Net
income per US GAAP
|
|
$
|
2,432,866
|
|
The
following is the balance sheet of Erdos TCH, prepared under Chinese GAAP at June
30, 2010:
Assets
|
|
|
|
Cash
and Cash equivalents
|
|
$
|
2,384,013
|
|
Other
current assets
|
|
|
535,180
|
|
Property
and equipment
|
|
|
17,796,706
|
|
Construction
in process
|
|
|
44,186,887
|
|
Total
Assets
|
|
$
|
64,902,786
|
|
Liabilities
|
|
|
|
|
Accounts
payable
|
|
$
|
1,233,268
|
|
Other
current liabilities
|
|
|
1,234,587
|
|
Long
term loan
|
|
|
44,176,766
|
|
Total
liabilities
|
|
|
46,644,621
|
|
Equity
|
|
|
|
|
Paid
in capital
|
|
|
17,573,578
|
|
Other
comprehensive income
|
|
|
100,072
|
|
Retained
earnings
|
|
|
584,515
|
|
Total
stockholders’ equity
|
|
|
18,258,165
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
64,902,786
|
|
There was
20% equity interest owned by the outside shareholder in Huaxin prior to August
of 2009. The Company acquired the remaining 20% equity interest in Huaxin
from this shareholder in August of 2009 for $110,000.
12. DEFERRED
TAX
Deferred
tax asset is a result of the accrued maintenance cost on power generation
systems 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
June 30, 2010 and December 31, 2009, deferred tax asset (liability) consisted of
the following:
|
|
2010
|
|
|
2009
|
|
Deferred
tax asset — noncurrent
|
|
$
|
24,793
|
|
|
$
|
24,658
|
|
Deferred
tax liability — noncurrent
|
|
|
(4,720,730
|
)
|
|
|
(2,786,773
|
)
|
Deferred
tax liability, net of deferred tax asset - noncurrent
|
|
|
(4,695,937
|
)
|
|
|
(2,762,115
|
)
|
Deferred
tax liability — current
|
|
$
|
71,833
|
|
|
$
|
148,193
|
|
13. INCOME
TAX
Effective
January 1, 2008, the PRC government implemented a new corporate income tax law
with a maximum 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
25% (33% prior to 2008) on income reported in the statutory financial statements
after appropriate tax adjustments. Under the 2008 Chinese tax law the tax
treatment of finance and sales-type leases is similar to US GAAP. However,
the local tax bureau continues to treat CREG sales-type leases as operating
leases. Accordingly, the Company recorded deferred income
taxes.
The
Company’s subsidiaries generate all of their net income from their PRC
operations. Shanghai TCH’s effective income tax rates for 2010 and 2009 are 22%
and 20%, respectively. Xi’an TCH’s effective income tax rate for 2010 and 2009
is 15% as a result of its high tech enterprise status that was approved by the
taxing authority. Xingtai Huaxin’s effective income tax rate for 2010 and 2009
is 25%. Huahong and Erdos TCH’s effective income tax rate for 2010 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, was 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.
The
parent company, China Recycling Energy Corporation, is taxed in the U.S. and has
net operating loss carry forwards for income taxes of $3,406,000 at June 30,
2010 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
$13,800,000 and $5,767,000 for the six months ended June 30, 2010 and 2009,
respectively. Pretax earnings of a foreign subsidiary are subject to U.S.
taxation when 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 June 30, 2010,
$30,359,000 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 $5,948,000 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 six months ended June 30, 2010 and 2009,
respectively:
|
|
2010
|
|
|
2009
|
|
US
statutory rates
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
Tax
rate difference – current provision
|
|
|
(11.8
|
)%
|
|
|
(25.5)
|
%
|
Effect
of tax holiday
|
|
|
(10.1
|
)%
|
|
|
(12.9)
|
%
|
Effect
of tax rate change on deferred tax items
|
|
|
4.9
|
%
|
|
|
-
|
%
|
Non-tax
deductible expense - beneficial conversion feature
|
|
|
2.8
|
%
|
|
|
-
|
%
|
Valuation
allowance on US NOL
|
|
|
7.6
|
%
|
|
|
9.4
|
%
|
Tax
per financial statements
|
|
|
27.4
|
%
|
|
|
5.0
|
%
|
The
provisions for income tax expenses for the six and three months ended June 30,
2010 and 2009 consisted of the following:
|
|
For
the Six Months
|
|
|
For
the Three Months
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
Income
tax expense - current
|
|
$ |
1,065,821
|
|
|
$ |
75,631
|
|
|
$ |
573,873
|
|
|
$ |
(492,480)
|
|
Income
tax benefit - deferred
|
|
|
1,832,222
|
|
|
|
149,520
|
|
|
|
1,287,404
|
|
|
|
149,520
|
|
Total
income tax expenses
|
|
$ |
2,898,043
|
|
|
$ |
225,151
|
|
|
$ |
1,861,277
|
|
|
$ |
(342,960)
|
|
14.
MAJOR CUSTOMERS
Two
customers accounted for 56% and 28% of the sales during the six months ended
June 30, 2010. Two customers accounted for 53% and 33% of the sales during the
six months ended June 30, 2009.
One
customer accounted for 85% of the total sales during the three months ended June
30, 2010. Two customers accounted for 78% and 13% of the total sales during the
three months ended June 30, 2009, respectively.
15.
LOAN PAYABLE
COLLECTIVE CAPITAL TRUST
PLAN
On
December 3, 2009, the Company and Beijing International Trust Co., Ltd.
(“Beijing Trust”) formed a Low Carbon Fortune-Energy Recycling No. 1 Collective
Capital Trust Plan (“Plan”). Under the Plan, Beijing Trust raised RMB
181,880,000 ($26.75 million) through sale of 181,880,000 trust units at RMB 1
per unit. All amounts raised under the Plan were loaned to Erdos TCH in
connection with its waste heat power generation projects Phase II and Phase III
construction and operation.
The Plan
included 145,500,000 category A preferred trust units ($21.4 million),
consisting of category A1 preferred trust 12,450,000 units ($1.8 million),
category A2 preferred trust 15,000,000 units ($2.2 million), category A3
preferred trust 118,050,000 units ($17.4 million); and 36,380,000 category B
secondary trust units ($5.35 million), consisting of category B1 secondary trust
9,100,000 units ($1.34 million) and category B2 secondary trust 27,280,000 units
($4.01 million). The B1 units were purchased by members of management of Erdos
TCH and the B2 units were purchased by Xi’an TCH. Under the Agreement, the
annual base interest rate is 9.94% for A1 preferred trust fund units with a term
of two years, 11% for A2 preferred trust fund units with a term of three years,
12.05% for A3 preferred trust fund units and 8.35% for the category B secondary
trust fund units, each with a term of four years.
Erdos TCH
provides a lien on its equipment, assets and accounts receivable to guarantee
the loans under the Agreement. Xi’an TCH and Mr. Guohua Ku (the Company’s CEO)
also provided unconditional and irrevocable joint liability guarantees to
Beijing Trust for Erdos TCH’s performance under the Agreement. Erdos (the
minority shareholder and customer of Erdos TCH) provided a commitment letter on
minimum power purchase from Erdos TCH.
On
December 18, 2009, an additional RMB 25,000,000 ($3.68 million) was raised to
support the Company’s Erdos Power Generation Projects. The Company sold
25,000,000 trust units at RMB 1 per unit which included 20,000,000 category A1
preferred trust units ($ 2.94 million) and 5,000,000 category B2 secondary trust
units ($ 0.74 million). The B2 units were purchased by Xi’an TCH.
In
addition to the above, if the financial index reflected on the Borrower’s
audited financial reports for the fiscal year prior to the expiration of the
loan term meets certain thresholds, the Borrower shall pay the Lender (category
B secondary trust purchaser) a sum of management stimulation profit (or
incentive benefit). The management incentive benefit is calculated by a formula
tied to Erdos TCH’s net profit and average registered capital of the fiscal year
prior to the maturity date of the loan. Under the formula the management
incentive benefit is paid at the end of year four and can range between 0% and
100% of the net profit of Erdos TCH in the fiscal year prior to the maturity
date of the loan depending upon the amount of average contributed capital of
Erdos TCH at the time of measurement.
In
December 2009, the Company sold 206,880,000 units for RMB 206,880,000 ($30.30
million), of which, 9,100,000 units ($1.33 million) were purchased by the
management of Erdos TCH; 32,280,000 units purchased by Xi’an TCH, the amount of
$4.73 million was considered as investment by Xi’an TCH into Erdos TCH and,
accordingly, was eliminated in the consolidated financial statements. The net
long term loan payable under this trust plan was $25.58 million at December 31,
2009.
On April
15, 2010, Beijing Trust completed the second expansion of the Plan. The second
expansion raised RMB 93,120,000 ($13.69 million) through the sale of 93,120,000
trust units sold at RMB 1 per unit. All amounts raised under the Second
Expansion were loaned to Erdos TCH. The second
expansion includes 2,800,000 category A1 preferred trust units ($0.41
million), 5,000,000 category A2 preferred trust units ($0.73 million),
66,700,000 category A3 preferred trust units ($9.81 million) and 4,650,000
category B1 preferred trust units ($0.68 million), 13,970,000 category B2
secondary trust units ($2.05 million). The B1 units were purchased by
members of management of Erdos TCH and the B2 units were purchased by Xi’an
TCH.
With the
completion of the second expansion, the Low Carbon Fortune-Energy Recycling No.
1 Collective Capital Trust Plan has reached RMB 300,000,000 ($44.12 million) and
completed all its trust plan raising work, of which, 13,750,000 units ($2.01
million) were purchased by the management of Erdos TCH; 47,850,000 units
purchased by Xi’an TCH, of which, 46,250,000 ($6.78 million) was B2 units and
1,600,000 ($235,600) units was A1 units, the amount was considered as investment
by Xi’an TCH into Erdos TCH and, accordingly, was eliminated in the consolidated
financial statements. The net long term loan payable under this trust plan was
$37.13 million at June 30, 2010. Interest expense accrued
on this trust loan was $1,363,584 and $0 at June 30, 2010 and December 31,
2009.
BANK LONG TERM
LOAN
The
Company entered a loan agreement with Industrial Bank Co., Ltd., Xi’an Branch
(the “Lender”) for a loan designed for energy saving and emission reduction
projects, whereby the Lender agreed to loan RMB 30,000,000 ($4,411,700) to Xi’an
TCH for a term of three years from April 6, 2010 to April 6, 2013. The proceeds
of the loan are required to be used in payment for equipment for Xi’an TCH’s
energy saving and emission reduction projects. The Loan Agreement has a floating
interest rate that resets at the beginning of each quarter at 110% of the
national base interest rate for the same term and same level loan (currently
5.4%). Under the loan, Xi’an TCH is required to make quarterly
interest payments and, beginning six months after the date of the release of the
funds, to make minimum quarterly principal payments of RMB 3,000,000
(approximately $441,800) each quarter. The Loan Agreement contains standard
representations, warranties and covenants, and the loan is guaranteed by Xi’an
TCH, Shaanxi Shengwei Construction Material Group and Mr. Guohua Ku. At June 30,
2010, the loan principal that will be repaid within one year was $1,325,304,
which has been classified as current liability.
16. CONVERTIBLE
NOTES PAYABLE AND REVOLVING FINANCING AGREEMENT
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% and was due November 16, 2009. The principal
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 a 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.
On April
29, 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
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 under the First Note (and waived
any accrued interest thereon) into 4,065,040 shares of common stock of the
Company at $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 (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 April 29, 2011. The principal face
amount of the Second Note, together with any interest thereon, converts, 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. As more
fully described in the Second Note, the obligations of the Company under the
Second Note are senior to all other debt of the Company.
The
Second Note and the 8% Note described below 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 a beneficial conversion feature prior to
the year ended December 31, 2009 because the conversion price and convertible
shares were contingent upon 2009 audited net profits.
On June
25, 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 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 was recorded as a decrease in 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
$1.23 per share for $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.
On April
29, 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.
On April
29, 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. This note is considered to have
a beneficial conversion feature starting from January 1, 2010 because the
conversion price for this note was $1.29 based on 2009 audited net profits and
the stock price on April 29, 2008 was $1.88. Accordingly, the beneficial
conversion feature of $2,316,116 was recorded separately as unamortized
beneficial conversion feature based on the intrinsic value method and the Second
Note was recorded in the balance sheet at face value less the unamortized
beneficial conversion feature as of June 30, 2010. During the six and
three months ended June 30, 2010, the Company amortized $880,466 and $435,468
from unamortized BCF.
On April
29, 2009, the Company also agreed with the Investors to amend and restate the
Registration Rights Agreement for the convertible notes to amend the rights for
demand registration by the Investors and the applicable liquidated damages for
the Company if it fails to timely comply with the demand for
registration.
Revolving Financing
Agreement
On
October 26, 2009, Xi’an TCH and Erdos TCH entered into a one-year Non Promissory
Short Term Revolving Financing Agreement (the “Citi Agreement”), effective
October 12, 2009, with Citi Bank (China) Co., Ltd., Shanghai Branch
(“Citi”). The maximum financing provided under the Citi
Agreement is RMB 20 million ($2.9 million). The Citi Agreement allows for
Xi’an TCH and Erdos TCH 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 Citi
Agreement are secured by an account maintained by the Company with Citi,
accounts receivable of Xi’an TCH and Erdos TCH and the guarantees of Shanghai
TCH Energy Technology Co., Ltd, an affiliate of Xi’an TCH, and Guohua Ku, the
Chairman of the Board and Chief Executive Officer of the Company.
Citi has
the discretion to accelerate the maturity date of the outstanding loans and
request for payment as well as to cancel or terminate the financing if the
monthly income for Xi’an TCH and Erdos TCH is less than 70% of the expected
income for that month. As of June 30, 2010 and December 31, 2009, Xi’an TCH and
Erdos TCH had no amounts outstanding under the Citi Agreement.
17. 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 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 August
4, 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 for as a modification to the
options that were cancelled on June 25, 2008. The grant date fair value of
options was $5.04 million.
On
November 9 and 11, 2009, the Company and three optionees agreed to cancel
vested but unexercised options for 87,000 vested but not exercised shares and
forfeit unvested options for 203,0000 unvested shares. On November 11,
2009, the Company granted options to two other employees for 290,000 shares of
the Company’s common stock with an exercise price of $2.35 per share. The
options vest over 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 3.84%, and dividend
yield of 0%. The grant date fair value of options was
$518,513.
The
following table summarizes activity for employees in the Company’s
Plan:
|
|
Number of
Shares
|
|
|
Average
Exercise
Price per Share
|
|
|
Weighed
Average
Remaining
Contractual
Term in Years
|
|
Outstanding
at December 31, 2008
|
|
|
3,000,000
|
|
|
$
|
0.80
|
|
|
|
4.59
|
|
Granted
|
|
|
290,000
|
|
|
|
2.35
|
|
|
|
5.00
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Cancelled
vested options
|
|
|
(87,000
|
)
|
|
|
0.80
|
|
|
|
-
|
|
Forfeited
|
|
|
(203,000
|
)
|
|
|
0.80
|
|
|
|
-
|
|
Outstanding
at December 31, 2009
|
|
|
3,000,000
|
|
|
|
0.95
|
|
|
|
3.62
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding
at March 31, 2010
|
|
|
3,000,000
|
|
|
|
0.95
|
|
|
|
3.37
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding
at June 30, 2010
|
|
|
3,000,000
|
|
|
$
|
0.95
|
|
|
|
3.12
|
|
On
October 30, 2009, the Company granted stock options to acquire 130,000 shares of
the Company’s common stock, par value $0.001, at $1.85 per share to three
independent directors. The options vest and become exercisable on the six-month
anniversary of the grant date with 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 3.54%, and dividend yield
of 0%. The grant date fair value of options was $183,000.
On
January 20, 2010, the Company granted stock options to acquire 40,000 shares of
the Company’s common stock, par value $0.001, at $4.68 per share to another
independent director. The options vest and become exercisable on the six-month
anniversary of the grant date with 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 3.54%, and dividend yield
of 0%. The grant date fair value of options was $142,085.
The
following table summarizes option activity with respect to the independent
directors:
|
|
Number of
Shares
|
|
|
Average
Exercise
Price per Share
|
|
|
Weighed
Average
Remaining
Contractual
Term in Years
|
|
Outstanding
at January 1, 2009
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
Granted
|
|
|
130,000
|
|
|
|
1.85
|
|
|
|
5.00
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding
at December 31, 2009
|
|
|
130,000
|
|
|
$
|
1.85
|
|
|
|
4.83
|
|
Granted
|
|
|
40,000
|
|
|
|
4.68
|
|
|
|
5.00
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding
at March 31, 2010
|
|
|
170,000
|
|
|
$
|
2.52
|
|
|
|
4.64
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding
at June 30, 2010
|
|
|
170,000
|
|
|
$
|
2.52
|
|
|
|
4.39
|
|
On
October 1, 2009, the Company granted warrants to acquire 200,000 shares of the
Company’s common stock, par value $0.001, at $1.50 per share to certain investor
relations firms. The warrants are exercisable, in whole or in part, at any time
and from time to time from and after July 1, 2010 (the “Vesting Date”) and prior
to October 1, 2014 (the “Expiration Date”). The fair value of the warrants was
calculated using the following assumptions: estimated life of five years,
volatility of 100%, risk free interest rate of 3.54%, and dividend yield of
0%. The grant date fair value of the warrants was approximately $272,000.
The Company accounted for the warrants issued 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 warrants.
The
following table summarizes activity for the warrants to certain investor
relations firms:
|
|
Number of
Shares
|
|
|
Average
Exercise
Price per Share
|
|
|
Weighed
Average
Remaining
Contractual
Term in Years
|
|
Outstanding
at January 1, 2009
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
Granted
|
|
|
200,000
|
|
|
|
1.50
|
|
|
|
5.00
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding
at December 31, 2009
|
|
|
200,000
|
|
|
$
|
1.50
|
|
|
|
4.75
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding
at March 31, 2010
|
|
|
200,000
|
|
|
$
|
1.50
|
|
|
|
4.50
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding
at June 30, 2010
|
|
|
200,000
|
|
|
$
|
1.50
|
|
|
|
4.25
|
|
The
Company recorded $1,407,547 and $442,191 compensation expense for stock options
and warrants during the six months ended June 30, 2010 and 2009, and for the
three months ended June 30, 2010 and 2009, the Company
recorded $664,147 and $52,815 stock compensation expense
respectively. There were no options or warrants exercised during the six
and three months ended June 30, 2010.
18. SHAREHOLDERS’
EQUITY
On April
29, 2008, 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 under the
Purchase Agreement.
On June
25, 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 to 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, the Company 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.
On June 29, 2010, Xi’an
TCH entered into a Biomass Power Generation Asset Transfer Agreement (the
“Transfer Agreement”) with Dong. a natural person with Chinese
citizenship. Under the Transfer Agreement, Dong transferred the
Biomass Systems to Xi’an TCH, and Xi’an TCH will pay Dong RMB
100,000, 000 (approximately $14,705,900) for the systems, including RMB
20,000,000 in cash and RMB 80,000,000 with equivalent shares of the Company’s
common stock. The stock price will be the same price as the Company’s public
offering price in the first public offering which occurs in 2010 or 2011 but in
no circumstance less than $4 per share. The exchange rate between
U.S. Dollar and Chinese RMB in connection with the stock issuance is
1:6.8. At
June 30, 2010, the Company recorded shares to be issued of $11.78 million in
connection with this transaction.
19. STATUTORY
RESERVES
Pursuant
to the corporate law of the PRC effective January 1, 2006, the Company is only
required to maintain one statutory reserve by appropriating from its after-tax
profit before declaration or payment of dividends. The statutory reserve
represents restricted retained earnings.
Surplus
Reserve Fund
The
Company 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
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 to which the Company can elect to
transfer 5% to 10% of its net income. This fund can only be utilized on capital
items for the collective benefit of the Company’s employees, such as
construction of dormitories, cafeteria facilities, and other staff welfare
facilities. This fund is non-distributable other than upon liquidation. The
Company did not participate in this voluntary fund.
20. 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.
21. COMMITMENTS
Zhongbao
Binhai 7MW Capacity Electricity Generation
Project
In
September, 2008, the Company signed a contract to recycle waste gas and waste
heat for China Zhonggang Binhai Enterprise Ltd. (“Zhonggang”) in Cangzhou City,
Hebei Province, which subsequently transferred the contract to Zhongbao Binhai
Nickel Co., Ltd. (“Zhongbao”) in July 2009, a nickel-alloy manufacturing joint
venture between Zhonggang and Shanghai Baoshan Steel Group established in
June 2009. According to the contract, the Company will install a 7MW
capacity electricity-generation system. It will be an integral part of the
facilities designed to produce 80,000 tons of nickel-alloy per year. The project
will generate 7MW capacity electricity and help reduce in excess of 20,000 tons
of carbon dioxide emissions every year. Total investment in this project will be
approximately $7.8 million (RMB 55 million). Construction on the project started
in March of 2009, but the Company did not incur any material expenses on the
project in 2009. The Company originally expected the completion of the project
by February 2010. The construction was delayed, however, due to the
delay in installation of a furnace cove by Zhongbao. Construction was resumed in
February of 2010; the Company paid approximately $1.97million as construction in
progress for this project as of June 30, 2010; the Company expects the project
to be completed in the beginning of 2011. Zhongbao agrees to purchase all the
electricity and steam to be generated from the system for a term of 9 years, at
a pre-agreed price. Zhongbao also agrees to guarantee the minimum monthly
payment of electricity and steam fees no less than $365,000 (RMB 2.5 million)
per month after the deduction of all raw material costs of Zhongbao used by
Xi’an TCH. By the end of the term, the system shall be transferred
to Zhongbao at RMB 1.
Erdos Phase II and III of
Power Generation Projects
In April
2009, Erdos TCH signed a contract with Erdos Metallurgy to recycle heat from
groups of furnaces of Erdos Metallurgy’s metal refining plants to generate power
and steam, to be sold back to Erdos Metallurgy. According to the contract, Erdos
TCH will install a group of power generation projects with a total of 70MW power
capacity, which may grow up to 120MW , and 30-ton steam per hour, with an
estimated total investment in excess of $75 million (RMB 500 million). The
Company split the construction of the projects into three phases, two units of
power generation in Phase I with a total of 18MW power capacity, three units in
Phase II with a total of 27MW power capacity and one unit in Phase III with 25MW
power capacity. For each phase of the project, the lease term is 20
years starting from the date of completion of the phase. During the
lease term, Erdos TCH will be responsible for operating the projects and charge
Erdos Metallurgy for supply of electricity and steam. Erdos
Metallurgy agreed to pay a fixed minimum of $0.22 million (RMB 1.5 million) per
month for each 9MW capacity power generation system. Effective
January 1, 2010, Erdos TCH outsourced to an independent third party the
operation and maintenance of the first 9MW power generation project for $
922,000 (RMB 6.27 million) per year. After 20 years, the units will be
transferred to Erdos without any charge.
During
the first quarter of 2010, Erdos power generation system Phase I project was
completed and put into operation. Effective April 1, 2010, Erdos TCH outsourced
to an independent third party the operation and maintenance of the second 9MW
power generation project for $922,000 (RMB 6.27 million) per
year.
As
of June 30, 2010 the projects of Erdos Phase II and Phase III are under
construction. At June 30, 2010, the Company paid $44.17 million for Phase II and
Phase III. The Company currently expects to complete Phase II and
Phase III in 2010.
22. SUBSEQUENT
EVENT
On August
13, 2010, the Board of Directors authorized the grant of options for an
aggregate of 2,200,000 shares of common stock to be issued to 36 employees,
including options for 1,460,000 shares granted to Guohua Ku, the Company's
Chairman of the Board and Chief Executive Officer, with an exercise price of the
closing price on the date of grant. Under the vesting terms of the options,
one-third of the options will vest in 2011 if the Company meets its minimum
guidance targets for revenue and earnings upon the release of the Company's
audited financial statements for the fiscal year ending December 31, 2010, which
provide confirmation that the targets have been met. The remaining two-thirds of
the options will vest in equal amounts in 2011 and 2012 if the Company meets
performance targets set by the Compensation Committee for each of the fiscal
years ending December 31, 2011 and December 31, 2012, respectively; in each
case, the shares will vest, if at all, upon release of the Company's audited
financial statements for the applicable fiscal year, which provide confirmation
that the targets have been met. The fair
value of the options of $5,092,889 was calculated using the following
assumptions, estimated life of five years, volatility of 100%, risk free
interest rate of 3.54%, and dividend yield of 0%. No estimate of forfeitures was
made as the Company has a short history of granting options.
Item 2. Management’s Discussion and
Analysis of Financial Condition and Results of Operations
Note
Regarding Forward-Looking Statements
This
quarterly report on Form 10-Q and other reports filed by the Company from time
to time with the SEC (collectively the “Filings”) contain or may contain
forward-looking statements and information that are based upon beliefs of, and
information currently available to, Company’s management as well as estimates
and assumptions made by Company’s management. Readers are cautioned not to place
undue reliance on these forward-looking statements, which are only predictions
and speak only as of the date hereof. When used in the filings, the words
“anticipate”, “believe”, “estimate”, “expect”, “future”, “intend”, “plan”, or
the negative of these terms and similar expressions as they relate to Company or
Company’s management identify forward-looking statements. Such statements
reflect the current view of Company with respect to future events and are
subject to risks, uncertainties, assumptions, and other factors (including the
statements in the section “results of operations” below), and any
businesses that Company may acquire. Should one or more of these risks or
uncertainties materialize, or should the underlying assumptions prove incorrect,
actual results may differ significantly from those anticipated, believed,
estimated, expected, intended, or planned.
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
annual report, 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
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 June
23, 2004, we completed a stock exchange transaction with the stockholders 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 stockholders of Sifang Holdings. Pursuant to the
Securities Exchange Agreement, we issued 13,782,636 shares of our common stock
to the stockholders 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.
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 TRT systems and
other renewable energy products.
On March
8, 2007, we changed our name from China Digital Wireless, Inc. to China
Recycling Energy Corporation.
Our
current business is primarily conducted through our wholly-owned subsidiary,
Sifang Holdings, its wholly-owned subsidiaries, Huahong New Energy Technology
Co., Ltd. (“Huahong”) and Shanghai TCH, Shanghai TCH’s wholly-owned
subsidiaries, Xi’an TCH Energy Technology Company, Ltd (“Xi’an TCH”) and Xingtai
Huaxin Energy Tech Co., Ltd. (“Huaxin”), and Xi’an TCH’s subsidiary Erdos TCH
Energy Saving Development Co., Ltd (“Erdos TCH”), in which 90% of the investment
will be from Xi’an TCH, a joint venture between Xi’an TCH and Erdos Metallurgy
Co., Ltd. Shanghai TCH was established as a foreign investment
enterprise in Shanghai under the laws of the PRC on May 25, 2004, currently with
a registered capital of $50 million. Xi’an TCH was established as a
foreign investment enterprise in Xi’an, Shannxi Province under the laws of the
PRC on November 8, 2007. Huaxin was incorporated in Xingtai, PRC in November,
2007. Erdos TCH was incorporated in April, 2009. Huahong
was incorporated in February, 2009.
On April 8, 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. Due to Yingfeng’s lack of capital in pursuing this project
alone, Yingfeng sought Shanghai TCH’s cooperation. 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 a result, the contractual relationships between Shanghai TCH and
Yingfeng under the TRT Project Joint-Operation Agreement entered on April 8,
2007 were terminated.
On April
14, 2009, the Company incorporated a joint venture (“JV”) between Xi’an TCH and
Erdos Metallurgy Co., Ltd. (“Erdos”) to recycle waste heat from
Erdos’ 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. 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 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 from the JV,
respectively.
Our
Projects
Hebei
Xingtai Steel Group Project
On April
8, 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”). Under the Joint-Operation Agreement, Shanghai
TCH and Yingfeng jointly pursued a project to design, construct, install and
operate two TRT systems for Xingtai Iron and Steel Company, Ltd. (“Xingtai”).
Shanghai TCH provided various forms of investments and properties into the
project including cash, hardware, software, equipment, 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 regular cash payments made by Xingtai and other property
rights and interests. 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. According to the
transferred contracts, Shanghai TCH installed and owns two TRT systems and
leases them to Xingtai for a term of 5 years, from January 25, 2007 to January
25, 2012. During the lease term, Xingtai will pay Shanghai TCH a
monthly rent of RMB 0.9 million ($0.13 million) for usage of the systems.
Assuming all amounts due under the lease have been paid, Shanghai TCH will
transfer the title of the systems to Xingtai free of charge.
Shanxi
Zhangzhi Steel Group Project
Under the
Joint-Operation Agreement discussed above, Shanghai TCH and Yingfeng also
jointly pursued a project contract, which was entered between Yingfeng and
Zhangzhi Iron and Steel Company, Ltd. (“Zhangzhi”) on June 22, 2006, to design, construct,
install and operate a TRT system for Zhangzhi Iron. Shanghai TCH provided
various forms of investments and properties into the project including cash,
hardware, software, equipment, 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
regular cash payments made by Xingtai and other property rights and interests.
On October 31, 2007, Shanghai TCH acquired this contract as part of its
asset-transfer agreement with Yingfeng as discussed above. According to the
transferred contracts, Shanghai TCH installed and owns a TRT system and leases
it to Zhangzhi for a term of 13 years, from July 25, 2007 to July 25, 2020.
During the lease term, Zhangzhi will pay Shanghai TCH a monthly rent of RMB 1.1
million ($0.16 million). After the term is over and all due rents are paid off,
Shanghai TCH will transfer the title of the system to Zhangzhi free of
charge.
Shengwei
Group – Tongchuan Project
In
November 2007, Shanghai TCH signed a cooperative agreement with Shengwei Group
to build two sets of 12MW cement low temperature heat power generation systems
for Shengwei’s two 2,500-tons-per-day cement manufacturing lines in Jin Yang and
for a 5,000-tons-per-day cement manufacturing line in Tong Chuan. At
the end of 2008, construction of the cement low temperature heat power
generation in Tong Chuan was completed at a cost of approximately $6,191,000
(RMB 43,000,000) and put into operation. Under the original
agreement, the ownership of the cement low temperature heat power generation
systems would belong to Shengwei from the date the projects were put into
service. Shanghai TCH is responsible for the daily maintenance and
repair of the projects, and charges Shengwei a monthly electricity fee based on
the actual power generated by the projects at 0.4116 RMB per KWH for an
operating period of five years with the assurance from Shengwei 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, Shanghai TCH will have no further obligations
under the cooperative agreement. On May 20, 2009, Shanghai TCH
entered into a supplementary agreement with Shengwei Group to amend the timing
for title transfer to the end of the lease term. In addition, the supplementary
agreement provided that Shanghai TCH will charge Shengwei based on actual power
usage subject to a minimum of $0.31 million (RMB 2.1 million) per
month during the operating period.
Binhai
Project
In
September 2008, we signed a contract to recycle waste gas and waste heat for
China Zhonggang Binhai Enterprise Ltd. (“Zhonggang”) in Cangzhou City, Hebei
Province, which subsequently transferred the contract to Zhongbao Binhai Nickel
Co., Ltd. (“Zhongbao”) in July 2009, a world-class nickel-alloy manufacturing
joint venture between Zhonggang and Shanghai Baoshan Steel Group established in
June 2009. According to the contract, we will install a 7MW
electricity-generation system, which will reduce in excess of 20,000 tons of
carbon dioxide emissions every year. Total investment in this project is $7.8
million (RMB 55 million). Construction and preparation on the project began in
March of 2009, but we did not incur any material expenses for the project in
2009 due to a delay in the installation of furnace cove by Zhongbao.
Construction resumed in February 2010, and we now expect the project to be
completed in the first quarter of 2011. Zhongbao agrees to purchase all the
electricity and steam to be generated from the project for the term of 9 years,
at a pre-agreed price. Zhongbao also agrees to guarantee the minimum monthly
payment of electricity and steam fees no less than $365,000 (RMB 2.5 million)
per month after the deduction of all raw material costs of Zhongbao used by
Xi’an TCH. At the end of the term, the waste energy recycling system
will be transferred to Zhongbao at a nominal price of RMB
1.
Erdos
Phase I Project
On April
14, 2009, the Company incorporated the JV between Xi’an TCH and Erdos Metallurgy
Co., Ltd. (“Erdos”) to recycle waste heat from Erdos' 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
initial registered capital of the JV was $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). In November of 2009, Xi’an TCH
injected further capital of $5.05 million (RMB 34,500,000). As of March 31,
2010, total registered capital was $11.71 million (RMB 80,000,000), of which
$11.45 million (RMB 78,200,000) was from Xi’an TCH and $0.26 million (RMB
1,800,000) was from Erdos. At April 15, 2010, total registered capital was
increased to $17.55 million (RMB 120 million), of which $16.37 million (RMB 112
million) was contributed by Xi’an TCH and $1.18 million (RMB 8 million) was
from Erdos Metallurgy. Total investment for the project is estimated
at approximately $74 million (RMB 500 million) with an initial investment of
$17.55 million (RMB 120,000,000). 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 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 from the JV, respectively. The profits to be distributed will be computed
based on Chinese generally accepted accounting principles. The principal
difference between US GAAP and Chinese GAAP with regards to the Erdos TCH
project is that a sales-type lease under US GAAP is treated as an operating
lease under Chinese GAAP. When the term of the JV expires, Xi’an TCH
will transfer its equity in the JV to Erdos at no additional cost.
At the
end of 2009, Erdos TCH completed the first 9MW power station of Phase I of the
project and put it into operation. At the end of March 2010, Erdos TCH completed
the construction of Phase I through completion of the second 9MW power station
and delivery of it for operation. Phase I includes two 9MW systems
for a combined 18MW power capacity. Pursuant to the Co-operation Agreement and
the supplement agreements signed between Erdos and Erdos TCH, Erdos shall
purchase all the electricity and steam to be generated from the JV’s power
generation systems. Erdos TCH leased the two 9 MW systems to Erdos and will be
responsible for their operation and maintenance. For each phase of the project,
the lease term is 20 years starting from the date of completion of the phase.
Erdos agreed to pay a fixed minimum of $0.22 million (RMB 1.5 million) per month
for each 9MW capacity power generation system. In addition Erdos will pay the
actual amount if the actual sale of the electricity generated is more than $0.22
million (RMB 1.5 million) monthly per unit. Effective January 1, 2010 and April,
2010 respectively, Erdos TCH outsourced to an independent third party the
operation and maintenance of the two 9MW power generation projects for $922,000
(RMB 6.27 million) each per year. After 20 years, the units will be transferred
to Erdos without any charge.
As of
June 30, 2010 the projects of Erdos Phase II and Phase III are under
construction. At June 30, 2010, the Company paid $44.17 million for Phase II and
Phase III. The Company currently expects to complete Phase II and
Phase III in 2010.
Shengwei
Group – Jinyang Project
On June
29, 2009, construction of the cement low temperature heat power generation
system in Jin Yang was completed at a cost of approximately $7,318,000 (RMB
50,000,000) and put into operation. Shanghai TCH charges Shengwei a
technical service fee of $336,600 (RMB 2,300,000) monthly for the sixty months
of the lease term. Shengwei has the right to purchase
the ownership of the cement low temperature heat power generation system
for $29,000 (RMB 200,000) at the end of lease term. Shengwei 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 cement
low temperature heat power generation. Shengwei Group collateralized
the cement manufacturing lines in Jin Yang to guarantee its obligations to
provide the minimum electricity income from the waste energy power generator
system under the agreement during the operating period. Effective
July 1, 2009, Shanghai TCH outsourced the operation and maintenance of the
cement low temperature heat power generation systems in Tong Chuan and JinYang
to a third party for $732,000 (RMB 5,000,000) per year.
Shenmu
Project
On
September 30, 2009, Xi’an TCH delivered to Shenmu County Jiujiang Trading Co.,
Ltd. (“Shenmu”) a set of three 6 MW capacity waste gas power generation 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. These 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 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 us an annual
“energy-saving service fee” of approximately $5.6 million in 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 per month. We are responsible for operating the projects 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. If gas supply is less,
Shenmu agrees to pay Xi’an TCH the energy-saving service fee described above for
up to 10.80 million kilowatt-hours 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. At the end of the
10-year term, ownership of the projects transfers to Shenmu at no
charge. Shenmu gave a lien on its production line to guarantee its
performance under the Contracts. Shenmu’s three major stockholders provided an
unlimited joint liability guarantee to Xi’an TCH for Shenmu’s performance under
the Contracts and the Yulin Huiyuan Group, an independent third party, provides
a guarantee to Xi’an TCH for Shenmu’s performance under the
Contracts.
Biomass
Project
On
January 20, 2010, Xi’an TCH entered into a Technical Reconstruction Letter of
Intent with Xueyi Dong (“Dong”) a natural person with Chinese
citizenship for Xi’an TCH reconstructing and transforming a Thermal Power
Generation Systems owned by Dong into a 12MW Biomass Power Generation Systems
(“Biomass Systems” or “BMPG”) for approximately RMB 15 million (approximately
$2.2 million), of which, RMB 7 million ( approximately $1.03 million) was
payable to Dong, and RMB 8 million (approximately $1.18 million) was payable to
one of the Company’s shareholder, who had previously paid that amount to Dong on
behalf of the Company. These amounts are part of accounts payable and other
payables respectively as at June 30, 2010.
After the successful
transformation of the systems, Xi’an TCH enter into a Biomass Power Generation
Asset Transfer Agreement (the “Transfer Agreement”) with Dong on June 29,
2010. Under the Transfer Agreement, Dong transferred the Biomass
Systems to Xi’an TCH, and Xi’an TCH will pay Dong RMB 100,000,
000 (approximately $14,705,900) for the systems, including RMB 20,000,000 in
cash and RMB 80,000,000 with equivalent shares of the Company’s common stock.
The stock price will be the same price as the Company’s public offering price in
the first public offering which occurs in 2010 or 2011 but in no circumstance
less than $4 per share. The exchange rate between U.S. Dollar and
Chinese RMB in connection with the stock issuance is 1:6.8. At June 30, 2010, the
Company recorded accounts payable of RMB 20,000,000 (approximately $2.94
million), and shares to be issued of $11.78 million in connection with this
transaction.
On June
29, 2010, Xi’an TCH entered into a Biomass Power Generation Project Lease
Agreement with PuCheng XinHengYuan Biomass Power Generation Co., Ltd.,
(“XHY”). Under this lease agreement, Xi’an TCH leased this same set
of 12MW biomass power generation systems to XHY at minimum RMB 1,900,000 per
month (approximately $279,400) for 15 years. The leasing fee will
increase proportionately with the biomass generated electricity fee in China
during the term of this lease agreement.
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 (“US GAAP”). The preparation of these financial statements
requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements as well as the reported net
sales and expenses during the reporting periods. On an ongoing basis, we
evaluate our estimates and assumptions. We base our estimates on historical
experience and 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 were prepared in accordance with
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 JV,
Sifang Holdings, Shanghai TCH, and Shanghai TCH’s subsidiaries Xi’an TCH, Huaxin
and Huahong. Xi’an TCH, Huaxin and Huahong engage in the same business as
Shanghai TCH. Substantially all of the Company’s revenues are derived from the
operations of Shanghai TCH and its subsidiaries, which represent substantially
all of the Company’s consolidated assets and revenues. 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 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.
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 estimated lives as follows:
Building
|
20
years
|
Vehicle
|
2 -
5 years
|
Office
and Other Equipment
|
2 -
5 years
|
Software
|
2 -
3 years
|
Revenue
Recognition
Sales-type
Leasing and Related Revenue Recognition
The
Company constructs and then leases waste energy recycling power generating
projects to its customers. The Company usually transfers ownership of the waste
energy recycling power generating projects to its customers at the end of each
lease. Investment in these projects is recorded as investment in
sales-type leases in accordance with Statement of Financial Accounting Standards
(“SFAS”) No. 13, “Accounting for Leases” (codified in Financial Accounting
Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 840)
and its various amendments and interpretations. The Company manufactures and
constructs the waste energy recycling power generating projects and finances its
customers for the price of the projects. The sales and cost of sales
are recognized at the time of sale or inception of the lease. The investment in
sales-type leases consists of the sum of the total minimum lease payments
receivable less unearned interest income and estimated executory cost. Unearned
interest income is amortized to income over the lease term so as to produce a
constant periodic rate of return on the net investment in the
lease. While a portion of revenue is recognized at the inception of
the lease, the cash flow from the sales-type lease occurs over the course of the
lease. Revenue is net of Value Added Tax.
Contingent
Rental Income
The Company records the income from
actual electricity usage in addition to minimum lease payment of each
project as contingent rental income in the period contingent rental income is
earned. Contingent rent is not a part of minimum lease payments.
Operating
Leases
During
2008, The Company leased two energy recycling power generation equipment systems
which were then subleased to two different parties under one-year,
non-cancellable leases with the rents paid in full. The leases and
the subleases were not renewed when they expired in April 2009. These
transactions were accounted for as operating leases. In an operating
lease revenue is recognized as payments are received; the initial direct costs
were deferred and amortized over the lease term on a straight-line basis, thus
matching them against rental revenue.
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 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.
NEW
ACCOUNTING PRONOUNCEMENTS
On July
1, 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.
On
February 25, 2010, the FASB issued ASU No. 2010-09 Subsequent Events Topic 855
“Amendments to Certain Recognition and Disclosure Requirements,” effective
immediately. The amendments in the ASU remove the requirement for an SEC filer
to disclose a date through which subsequent events have been evaluated in both
issued and revised financial statements. Revised financial statements include
financial statements revised as a result of either correction of an error or
retrospective application of US GAAP. The FASB believes these amendments remove
potential conflicts with the SEC’s literature. The adoption of this ASU did not
have a material impact on the Company’s consolidated financial
statements.
On March
5, 2010, the FASB issued ASU No. 2010-11 Derivatives and Hedging Topic 815
“Scope Exception Related to Embedded Credit Derivatives.” This ASU clarifies the
guidance within the derivative literature that exempts certain credit related
features from analysis as potential embedded derivatives requiring separate
accounting. The ASU specifies that an embedded credit derivative feature related
to the transfer of credit risk that is only in the form of subordination of one
financial instrument to another is not subject to bifurcation from a host
contract under ASC 815-15-25, Derivatives and Hedging — Embedded Derivatives —
Recognition. All other embedded credit derivative features should be analyzed to
determine whether their economic characteristics and risks are “clearly and
closely related” to the economic characteristics and risks of the host contract
and whether bifurcation is required. The ASU is effective for the Company on
July 1, 2010. Early adoption is permitted. The adoption of this ASU will not
have a material impact on the Company’s consolidated financial
statements.
In April
2010, the FASB codified the consensus reached in Emerging Issues Task Force
Issue No. 08-09, “Milestone Method of Revenue Recognition.” FASB ASU
No. 2010-17 provides guidance on defining a milestone and determining when
it may be appropriate to apply the milestone method of revenue recognition for
research and development transactions. FASB ASU No. 2010-17 is
effective for fiscal years beginning on or after June 15, 2010, and is
effective on a prospective basis for milestones achieved after the adoption
date. The Company does not expect this ASU will have a material impact on
its financial position or results of operations when it adopts this update on
January 1, 2011.
RESULTS
OF OPERATIONS
Comparison
of Six Months Ended June 30, 2010 and 2009
The
following table sets forth the results of our operations for the periods
indicated as a percentage of net sales:
|
|
2010
|
|
|
2009
|
|
|
|
$
|
|
|
% of Sales
|
|
|
$
|
|
|
% of Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
32,663,947
|
|
|
|
100
|
%
|
|
$
|
15,459,969
|
|
|
|
100
|
%
|
Sales
of products
|
|
|
31,921,309
|
|
|
|
98
|
%
|
|
|
9,513,077
|
|
|
|
62
|
%
|
Contingent
rental income
|
|
742,638
|
|
|
|
2
|
%
|
|
|
-
|
|
|
|
-
|
|
Rental
income
|
|
-
|
|
|
|
-
|
|
|
|
5,946,892
|
|
|
|
38
|
%
|
Cost
of sales
|
|
|
(24,600,160
|
)
|
|
|
75
|
%
|
|
|
(11,466,323
|
)
|
|
|
74
|
%
|
Cost
of products
|
|
|
(24,600,160
|
)
|
|
|
75
|
%
|
|
|
(7,317,751
|
)
|
|
|
77
|
%
|
Rental
expense
|
|
|
-
|
|
|
|
-
|
|
|
|
(4,148,572
|
)
|
|
|
70
|
%
|
Gross
profit
|
|
|
8,063,787
|
|
|
|
25
|
%
|
|
|
3,993,646
|
|
|
|
26
|
%
|
Interest
income on sales-type lease
|
|
|
6,418,263
|
|
|
|
19
|
%
|
|
|
2,333,472
|
|
|
|
15
|
%
|
Total
operating income
|
|
|
14,482,050
|
|
|
|
44
|
%
|
|
|
6,327,118
|
|
|
|
41
|
%
|
Total
operating expenses
|
|
|
(2,746,173
|
)
|
|
|
8
|
%
|
|
|
(1,355,741
|
)
|
|
|
9
|
%
|
Income
from operations
|
|
|
11,735,877
|
|
|
|
36
|
%
|
|
|
4,971,377
|
|
|
|
32
|
%
|
Total
non-operating income (expenses), net
|
|
|
(1,170,583
|
)
|
|
|
(4
|
)%
|
|
|
(438,921
|
)
|
|
|
(3
|
)%
|
Income
before income tax
|
|
|
10,565,294
|
|
|
|
32
|
%
|
|
|
4,532,456
|
|
|
|
29
|
%
|
Income
tax expense
|
|
|
2,898,043
|
|
|
|
9
|
%
|
|
|
225,151
|
|
|
|
1
|
%
|
Net
income attributable to noncontrolling interest
|
|
|
(486,573
|
)
|
|
|
(1
|
)%
|
|
|
3,158
|
|
|
|
-
|
%
|
Net
income
|
|
$
|
7,180,678
|
|
|
|
22
|
%
|
|
$
|
4,310,463
|
|
|
|
28
|
%
|
SALES. Net sales for the six
months ended June 30, 2010 were $32.66 million while our net sales for the
comparable period of 2009 were $15.46 million, an increase in revenues of $17.2
million. The increase primarily was due to 1) the completion and sale of the
second 9MW capacity power station of Erdos Phase I project through sales-type
lease in the first quarter of 2010, which included two 9MW units, the first 9MW
capacity power station was completed and sold in December of 2009; 2) the
completion of transformation and sale of Pucheng Biomass Power Generation
System; and 3) contingent rental income of $0.74 million from actual usage
of the electricity in addition to the minimum lease payments from our Shengwei
Group - Tongchuan Project, Erdos Project and Shenmu Project. While in the
same period of 2009, we recorded sales income of $9.51 million from Shengwei
Jinyang Heat Power Generation System and rental income of $5.95 million from our
operating lease of two power generating systems, which were not renewed when
they expired in April 2009. For the sales-type lease, sales (net of VAT) and
cost of sales are recorded at the time of leases; the interest income from the
sales-type leasing is our other major revenue source in addition to sales
revenue.
COST OF SALES. Cost of sales
for the six months ended June 30, 2010 was $24.60 million while our cost of
sales for the comparable period in 2009 was $11.47 million, an increase of
$13.13 million. Our cost of sales consisted of the second 9MW capacity power
station of Erdos Phase I project and Pucheng biomass power generation system.
For the comparable period of 2009, the cost of sales was for Shengwei Jinyang
heat power generation system and the operating lease as we leased two power
generating systems under one-year, non-cancellable leases since April of 2008,
which we subleased for higher monthly rental income under a one-year,
non-cancellable lease.
GROSS PROFIT. Gross profit
was $8.06 million for the six months ended June 30, 2010 compared to $3.99
million for the comparable period in 2009, representing a gross margin of 25%
and 26% for the six months ended June 30, 2010 and 2009, respectively. The gross
profit was mainly from the selling of the Erdos Phase I second 9MW capacity
power station in the first quarter of 2010 and Pucheng Biomass power generation
system in the second quarter of 2010, while in the first quarter of 2009, it was
mainly for the selling of Jinyang Shengwei heat power generation system and the
operating lease business in connection with leasing out two energy recycling
power generation equipment systems since April of 2008.
OPERATING INCOME. Operating
income was $14.48 million for the six months ended June 30, 2010 while our
operating income for the comparable period in 2009 was $6.33 million, an
increase of $8.15 million. The growth in operating income was mainly due to the
increase in interest income from selling and leasing our energy saving systems
through sales-type leasing. Interest income on sales-type leasing for the six
months ended June 30, 2010 was $6.42 million, $4.09 million increase from $2.33
million for the comparable period in 2009, this increase was mainly due to
increased interest income from energy saving systems that were sold and put into
operation since April of 2009. During first six months of 2010, the
interest income was based on seven systems: two TRT systems, two CHPG
systems, one WGPG system, and two waste heat power generating systems associated
with our Erdos Phase I project. During the comparable period of 2009, the
interest income was derived from our two TRT systems and one CHPG
system.
OPERATING EXPENSES. Operating
expenses consisted of selling, general and administrative expenses totaling
$2.75 million for the six months ended June 30, 2010 compared to $1.36 million
for the comparable period in 2009, an increase of $1.39 million or 102%. The
increase was due to proportional increases in our payroll, traveling and
marketing expenses as a result of sales on second 9MW capacity power station of
Erdos Phase I project and Pucheng biomass power generation system and continuous
expansion of our business; in addition, we recorded $1.41 million compensation
expense for stock options and warrants during the six months ended June 30,
2010, compared to $0.44 million for the same period in 2009.
NON-OPERATING EXPENSES.
Non-operating expenses consisted of non sales-type lease interest income,
interest expense, bank charges and some miscellaneous expenses. For the six
months ended June 30, 2010, the net of non-operating expenses was $1.17 million;
compared to the same period of 2009, this was an increase of $0.73 million from
$0.44 million, mainly due to the $0.88 million interest expense related to the
beneficial conversion feature for the convertible note that was issued April 29,
2008 with the conversion price to be tied to be 2009 audited net profit; there
was no similar non-operating expense for the comparable period in
2009.
INCOME TAX EXPENSE. The
income tax expense was $2.90 million for the six months ended June 30, 2010, an
increase of $2.67 million from $0.23 million for the same period of 2009. The
increase was mainly due to the increase of taxable income from $4.53 million
during the six months ended June 30, 2009 to $10.57 million in the same period
of 2010. The income tax rate for Shanghai TCH was 20% and 22% for 2009 and 2010,
respectively. Xi’an TCH’s effective income tax rate for 2010 and 2009 is 15% as
a result of its high tech enterprise status that was approved by the taxing
authority. Xingtai Huaxin’s effective income tax rate for 2010 and 2009 is
25%. Huahong and Erdos TCH’s effective income tax rate for 2010 is
25%.
NET INCOME. Our net income
for the first six months ended June 30, 2010 was $7.18 million compared to $4.31
million for the comparable period in 2009, an increase of $2.87 million. This
increase in net income was mainly due to the sales of the second 9MW capacity
power system of Erdos Phase I project and Pucheng 12MW biomass power generation
system, besides that interest income for energy saving systems that were sold
and put into operation after April of 2009. In addition, we recorded
$0.88 million interest expense related to beneficial conversion feature for the
convertible note that was issued April 29, 2008 with the conversion price to be
tied with 2009 audited net profit for the six months ended June 30, 2010
compared to no similar non-operating expense for the comparable period in
2009.
Comparison
of Three Months Ended June 30, 2010 and 2009
The
following table sets forth the results of our operations for the periods
indicated as a percentage of net sales:
|
|
2010
|
|
|
2009
|
|
|
|
$
|
|
|
% of Sales
|
|
|
$
|
|
|
% of Sales
|
|
Sales
|
|
$
|
22,538,511
|
|
|
|
100
|
%
|
|
$
|
11,137,076
|
|
|
|
100
|
%
|
Sales
of products
|
|
|
21,795,873
|
|
|
|
97
|
%
|
|
|
9,513,077
|
|
|
|
85
|
%
|
Contingent
rental income
|
|
742,638
|
|
|
|
3
|
%
|
|
|
-
|
|
|
|
-
|
|
Rental
income
|
|
-
|
|
|
|
-
|
|
|
|
1,623,999
|
|
|
|
15
|
%
|
Cost
of sales
|
|
|
(16,801,915
|
)
|
|
|
75
|
%
|
|
|
(8,444,650
|
)
|
|
|
76
|
%
|
Cost
of products
|
|
|
(16,801,915
|
)
|
|
|
75
|
%
|
|
|
(7,317,751
|
)
|
|
|
77
|
%
|
Rental
expense
|
|
|
-
|
|
|
|
-
|
|
|
|
(1,126,899
|
)
|
|
|
69
|
%
|
Gross
profit
|
|
|
5,736,596
|
|
|
|
25
|
%
|
|
|
2,692,426
|
|
|
|
24
|
%
|
Interest
income on sales-type lease
|
|
|
3,323,695
|
|
|
|
15
|
%
|
|
|
1,134,941
|
|
|
|
10
|
%
|
Total
operating income
|
|
|
9,060,291
|
|
|
|
40
|
%
|
|
|
3,827,367
|
|
|
|
34
|
%
|
Total
operating expenses
|
|
|
(1,386,476
|
)
|
|
|
6
|
%
|
|
|
(560,303
|
)
|
|
|
5
|
%
|
Income
from operations
|
|
|
7,673,815
|
|
|
|
34
|
%
|
|
|
3,267,064
|
|
|
|
29
|
%
|
Total
non-operating income (expenses), net
|
|
|
(682,089
|
)
|
|
|
(3
|
)%
|
|
|
(378,608
|
)
|
|
|
(3
|
)%
|
Income
before income tax
|
|
|
6,991,726
|
|
|
|
31
|
%
|
|
|
2,888,456
|
|
|
|
26
|
%
|
Income
tax expense (benefit)
|
|
|
1,861,277
|
|
|
|
8
|
%
|
|
|
(342,960)
|
|
|
|
(3)
|
%
|
Net
income attributable to noncontrolling interest
|
|
|
(92,132
|
)
|
|
|
(0.4
|
)
%
|
|
|
3,198
|
|
|
|
-
|
%
|
Net
income
|
|
$
|
5,038,317
|
|
|
|
22
|
%
|
|
$
|
3,234,614
|
|
|
|
29
|
%
|
SALES. Net sales for the
three months ended June 30, 2010 were approximately $22.54 million while our net
sales for the three months ended June 30, 2009 were $11.14 million, an increase
in revenues of approximately $11.4 million. The increase in sales in the
second quarter of 2010 primarily is attributed to the sales of Pucheng biomass
power generation system and contingent rental income of $0.74 million from
actual usage of electricity generated in addition to the minimum lease payments
from our Shengwei Group-Tongchuan Project, Erdos Project and Shenmu Project
compared to the same period of 2009 in which sales for the Shengwei Jinyang CHPG
system and operating leasing income occurred. We recorded sales of the Pucheng
biomass power generation system of $22.54 million; compared to the same period
in 2009, when we recorded $9.51 million for Shengwei Jinyang CHPG system and
rental income of approximately $1.62 million from leasing our two power
generating systems in the second quarter of 2009. 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 in the second quarter of 2008 and ended in April of 2009. Sales (net
of VAT) and cost of sales are recorded at the time of the 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 three months ended June 30, 2010 was approximately $16.80 million
while our cost of sales for the same period in 2009 was $8.44 million, an
increase of approximately $8.36 million. Our cost of sales for the second
quarter of 2010 was a sales-type lease of Pucheng biomass power generation
system with a cost of $16.80 million. In the comparable period of 2009, the cost
of sales consisted of the cost of the operating lease as we leased two power
generating systems under one-year, non-cancellable lease at a favorable price
during 2008, which we subleased for higher monthly rental income under a
one-year, non-cancellable lease; and the cost of a sales-type lease during the
second quarter of 2009 to Shengwei Jinyang CHPG of a system with a
cost of $7.31 million.
GROSS PROFIT. Gross profit
was approximately $5.74 million for the three months ended June 30, 2010 as
compared to $2.69 million for the same period in 2009, representing a gross
margin of approximately 25% and 24% for the second quarter of 2010 and 2009,
respectively. The increase in gross profit was mainly from the profit of the
sales-type leases of Pucheng biomass power generation system with a gross profit
margin of about 25%, and in the comparable period of 2009, the gross profit was
from the sales type lease of Shengwei Jinyang CHPG system with a profit margin
of 23% and 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%. The operating lease term ended in April of
2009.
OPERATING INCOME. Operating
income was approximately $9.06 million for the three months ended June 30, 2010
while our operating income for the same period in 2009 was approximately $3.83
million, an increase of approximately $5.23 million. The growth in operating
income was mainly due to the sales of the Pucheng biomass power generation
system and increase in interest income from selling and leasing the sales-type
lease systems, which were two TRT systems, two CHPG systems, one WGPG
system, and two waste heat power generating systems associated with our Erdos
Phase I project. The interest income for the three months ended June 30, 2010
was $3.32 million, compare to interest income of $1.13 million in the same
period of 2009 increased $2.19 million, which had two TRT and one CHPG system
only.
OPERATING
EXPENSES. Operating expenses consisted of selling, general and
administrative expenses totaling approximately $1.39 million for the three
months ended June 30, 2010 as compared to approximately $0.56 million for the
same period in 2009, an increase of approximately $0.83 million or 148%. This
increase was mainly due to proportional increases in our payroll, travel and
marketing expenses as a result of our increased sales and expansion of our
business; in addition, we recorded $0.67 million compensation expense for stock
options and warrants during the three months ended June 30, 2010, compared to
$52,815 for the same period in 2009.
NON-OPERATING EXPENSES.
Non-operating expenses consisted of non sales-type lease interest income,
interest expense, bank charges and some miscellaneous expenses. For the three
months ended June 30, 2010, the net of non-operating expenses was $0.68 million;
compared to the same period of 2009, this was an increase of $0.30 million from
$0.38 million during three month ended June 30, 2009, mainly due to the $0.44
million interest expense related to the beneficial conversion feature for the
convertible note that was issued April 29, 2008 with the conversion price to be
tied to 2009 audited net profit, there was no similar non-operating expense for
the comparable period in 2009.
INCOME TAX EXPENSE. The
income tax expense was $1.86 million for the three months ended June 30, 2010,
an increase of $2.20 million compared to an income tax benefit of $0.34 million
for the same period of 2009. The increase was mainly due to the increase of
taxable income from $2.89 million during three month ended June 30, 2009 to
$6.99 million during the same period of 2010. The income tax rate for Shanghai
TCH was 20% and 22% for 2009 and 2010, respectively. Xi’an TCH’s effective
income tax rate for 2010 and 2009 is 15% as a result of its high tech enterprise
status that was approved by the taxing authority. Xingtai Huaxin’s effective
income tax rate for 2010 and 2009 is 25%. Huahong and Erdos TCH’s
effective income tax rate for 2010 is 25%.
NET INCOME. Our net
income for the three months ended June 30, 2010 was approximately $5.04 million
as compared to approximately $3.23 million for the comparable period in 2009, an
increase of approximately $1.81 million. This increase in net income was mainly
due to sale of the Pucheng biomass power generation system in the second quarter
of 2010 and increased interest income from sales-type leases of one CHPG system,
one WGPG system and two waste heat power generating systems. In addition, we
recorded $0.44 million interest expense related to the beneficial conversion
feature for the convertible note that was issued April 29, 2008 with the
conversion price tied to 2009 audited net profit; there was no
similar non-operating expense for the comparable period in 2009.
LIQUIDITY
AND CAPITAL RESOURCES
Comparison
of Six Months Ended June 30, 2010 and 2009
As of
June 30, 2010, the Company had cash and cash equivalents of $5.09 million, other
current assets were $9.35 million and current liabilities were $20.30
million. Working capital was negative $5.86 million. The
debt-to-equity ratio was 0.82:1 at June 30, 2010.
The
following is a summary of cash provided by or used in each of the indicated
types of activities during six months ended June 30, 2010 and 2009:
|
|
2010
|
|
|
2009
|
|
Cash
provided by (used in):
|
|
|
|
|
|
|
Operating
Activities
|
|
$
|
11,096,438
|
|
|
$
|
8,991,410
|
|
Investing
Activities
|
|
|
(24,656,213
|
)
|
|
|
(9,770,171
|
)
|
Financing
Activities
|
|
|
17,516,467
|
|
|
|
8,187,100
|
|
Net cash
flow provided by operating activities was $11.10 million during the six
months ended June 30 2010, as compared to $8.99 million provided in the
comparable period of 2009. The increase in net cash inflow was mainly due to the
increase in net income as well as increase in interest payable and tax payable
partially offset by decrease in accounts payable.
Net cash
flow used in investing activities was $24.66 million during the six months ended
June 30, 2010, compared to $9.77 million used in the comparable period of 2009.
The increase of net cash flow used in investing activities during the six months
ended June 30, 2010 was mainly due to our gross investment receivable of $1.99
million for the second 9MW capacity power station of Erdos Phase-I recycling
waste heat power generating system, $4.13 million for the Biomass Power
Generation system of Pucheng and $18.20 million payment for construction in
progress of Erdos Phase II and III projects and Zhongbao Binhai project, as well
as increase in restricted cash of $0.2 million to the bank as collateral for the
bank acceptance.
Net cash
flow provided by financing activities was $17.52 million for the six months
ended June 30, 2010 compared to net cash provided by financing activities of
$8.19 million for the comparable period in 2009. The increase was mainly due to
the proceeds from a long term bank loan of $4.40 million and the
second expansion of the Erdos trust plan of $11.36 million,
the advance of $0.85 million from the minority shareholder of Erdos
TCH for paying certain operating expenses of Erdos project, and $0.91 million
capital contribution by the minority shareholder of Erdos TCH.
We
believe we have sufficient cash to continue our current business through June,
2011 due to stable recurring receipts from interest income from sales type
leases in place. As of June 30, 2010, we have two TRT systems, two CHPG systems,
one WGPG system, two recycling waste heat power generating systems and one BMPG,
currently generating net cash inflow. In addition, we may have access to a
revolving line of credit and other forms of bank loans in case of instant need
for working capital. We believe we have sufficient cash resources to cover our
anticipated capital expenditures in 2010.
We do not
believe that inflation has had a significant negative impact on our results of
operations during 2010.
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
On April
29, 2008, we issued and sold to Carlyle Asia Growth Partners III, L.P. and CAGP
III Co-Investment, L.P. a 5% Secured Convertible Promissory Note of
$5,000,000. The terms for the Note were amended and restated on April
29, 2009.
This note bears interest at 5% and
matures on April 29, 2011. The principal amount of the note, together with any
interest thereon, convert, at the option of the holders at any time on or after
March 16, 2010 and prior to maturity, into shares of the Company’s common stock
at an initial conversion price tied to the after-tax net profits of the Company
for the fiscal year ending December 31, 2009. Based on our after-tax
profits in 2009, the initial conversion price is $1.29 per share, and this note
was convertible in full into 3,875,969 shares of our common stock as of June 30,
2010. 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.
On April
29, 2009, we issued an 8% Secured Convertible Promissory Note 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
our common stock, at any time on or after March 16, 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, and this note was
convertible in full into 3,750,000 shares of our common stock as of June 30,
2010. These shares rank pari-passu with those convertible under the 5% Secured
Convertible Promissory Note.
Notes
Payable – Bank Acceptances
We had
notes payable for bank acceptances of $2,076,308 at June 30, 2010, which was
collateralized by depositing cash in the bank as restricted cash. We
endorsed the bank acceptances to vendors as payment of our
obligations. Most of the bank acceptances have a maturity of less
than six months.
Loan
Payable – Collective Capital Trust Plan
On
December 3, 2009, Beijing International Trust Co., Ltd. (“Beijing Trust”) formed
a Low Carbon Fortune-Energy Recycling No. 1 Collective Capital Trust Plan
(“Plan”). Under the Plan, Beijing Trust raised RMB 181,880,000 ($ 26.75 million)
through the sale of 181,880,000 total trust units at RMB 1 per unit. All amounts
raised under the Plan were loaned to Erdos TCH in connection with its waste heat
power generation projects Phase II and Phase III construction and operation,
pursuant to the Capital Trust Loan Agreement entered into by Erdos TCH Energy
Saving Development Co., Ltd and Beijing Trust dated November 19,
2009.
The Plan
included 145,500,000 category A preferred trust units ($ 21.4 million),
consisting of category A1 preferred trust 12,450,000 units ($ 1.8 million),
category A2 preferred trust 15,000,000 units ($ 2.2 million), category A3
preferred trust 118,050,000 units ($ 17.4 million); and 36,380,000 category B
secondary trust units ($ 5.35 million), consisting of category B1 secondary
trust 9,100,000 units ($ 1.34 million) and category B2 secondary trust
27,280,000 units ($ 4.01 million). The B1 units were purchased by members of
management of Erdos TCH and the B2 units were purchased by Xi’an TCH. Under the
Agreement, the annual base interest rate is 9.94% for A1 preferred trust fund
units with a term of two years, 11% for A2 preferred trust fund units with a
term of three years, 12.05% for A3 preferred trust fund units and 8.35% for the
category B secondary trust fund units, each with a term of four
years.
Erdos TCH
gave a lien on its equipment, assets and accounts receivable to guarantee the
loans under the Agreement. Xi’an TCH and Mr. Guohua Ku, our CEO, also gave
unconditional and irrevocable joint liability guarantees to Beijing Trust for
Erdos TCH’s performance under the Agreement. Erdos (the minority stockholder and
customer of Erdos TCH) provided a commitment letter on minimum power purchase
from Erdos TCH.
On
December 18, 2009, an additional RMB 25,000,000 ($3.68 million) was raised by
Beijing Trust to support the Company’s Erdos Power Generation Projects. Beijing
Trust sold 25,000,000 trust units at RMB 1 per unit which included 20,000,000
category A1 preferred trust units ($ 2.94 million) and 5,000,000 category B2
secondary trust units ($ 0.74 million). The B2 units were purchased by Xi’an
TCH.
Besides
the base interest rate, Erdos TCH must share any benefits derived
under the Clean Development Mechanism (“CDM”) of the Kyoto
Protocol equally with
Beijing Trust during the term of the loan, as well as to pay a management
incentive benefit to be calculated by a formula tied to Erdos TCH’s net profit
and average registered capital of the fiscal year prior to the maturity date of
the loan. Under the formula the management incentive benefit is paid at the end
of year four and can range between 0% and 100% of the net profit of Erdos TCH in
the fiscal year prior to the maturity date of the loan depending upon the amount
of average contributed capital of Erdos TCH at the time of
measurement.
At
December 31, 2009, Beijing Trust had sold 206,880,000 units for RMB 206,880,000
($30.3 million), of which, 9,100,000 units ($1.3 million) were purchased by the
management of Erdos TCH; 32,280,000 units purchased by Xi’an TCH for $4.7
million was considered as an investment by Xi’an TCH into Erdos TCH and,
accordingly, the investment was eliminated in the consolidated financial
statements. The net long term loan payable under this trust plan was $25.6
million at June 30, 2010.
On April
15, 2010, Beijing Trust completed the second expansion of the Plan. The second
expansion of the Plan raised RMB 93,120,000 ($13.69 million) through the sale of
93,120,000 trust units sold at RMB 1 per unit. All amounts raised
under the Second Expansion of the Plan are to be loaned to Erdos
TCH. The second expansion of the Plan includes 2,800,000 category A1
preferred trust units ($0.41 million), 5,000,000 category A2
preferred trust units ($0.73 million), 66,700,000 category A3 preferred trust
units ($9.81 million) and 4,650,000 category B1 preferred trust units ($0.68
million) and 13,970,000 category B2 secondary trust units ($2.05
million). The B1 units were purchased by members of management of
Erdos TCH and the B2 units have been purchased by Xi’an TCH. With the
completion of the second expansion of the Plan, the Low Carbon Fortune-Energy
Recycling No. 1 Collective Capital Trust Plan has reached RMB 300,000,000
($44.12 million) and completed its entire trust plan fund raising
work. The net long term loan payable under trust plan, after
including the second expansion, was $37.13 million at June 30,
2010.
Bank Long Term
Loan
The
Company entered a loan agreement with Industrial Bank Co., Ltd., Xi’an Branch
(the “Lender”) for a loan designed for energy saving and emission reduction
projects, whereby the Lender agreed to loan RMB 30,000,000 ($4,411,700) to Xi’an
TCH for a term of three years from April 6, 2010 to April 6, 2013. The proceeds
of the loan are required to be used in payment for equipment for Xi’an TCH’s
energy saving and emission reduction projects. The Loan Agreement has a floating
interest rate that resets at the beginning of each quarter at 110% of the
national base interest rate for the same term and same level loan (currently
5.4%). Under the loan, Xi’an TCH is required to make quarterly
interest payments and, beginning six months after the date of the release of the
funds, to make minimum quarterly principal payments of RMB 3,000,000
(approximately $441,800) each quarter. The Loan Agreement contains standard
representations, warranties and covenants, and the loan is guaranteed by Xi’an
TCH, Shaanxi Shengwei Construction Material Group and Mr. Guohua
Ku.
Revolving
Financing Agreement
On
October 26, 2009, Xi’an TCH and Erdos TCH entered into a one-year Non Promissory
Short Term Revolving Financing Agreement (the “Citi Agreement”), dated and
effective from October 12, 2009, with Citi Bank (China) Co., Ltd., Shanghai
Branch (“Citi”). The maximum financing provided in the Citi
Agreement is RMB 20 million ($2.9 million). The Citi Agreement allows
for Xi’an TCH and Erdos TCH 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 Citi
Agreement are secured by an account maintained by the Company with Citi,
accounts receivable of Xi’an TCH and Erdos TCH and the guarantees of Shanghai
TCH and Guohua Ku, our Chairman of the Board and Chief Executive
Officer.
Xi’an TCH
and Erdos TCH agreed not to use the loan to pay for related party
transactions without Citi’s
permission. Xi’an TCH and Erdos TCH also agreed to deposit their
income from sales of products and services into their accounts with Citi with a
combined average monthly income amount of no less than RMB 5 million
($0.73 million). Xi’an TCH and Erdos TCH may not draw on the
Citi Agreement until the monthly income amount reaches 80% of expected income
amount, as set forth in
the Citi Agreement for that month. Each loan of Xi’an TCH and Erdos
TCH should be no more than 35% of the maximum financing limit. If the single
monthly income amount for Xi’an TCH and Erdos TCH is less than 70% of the
expected income amount of that month, Citi has the right to suspend, cancel or
terminate the financing and accelerate the maturity date of any outstanding
amount and request immediate reimbursement. As of June 30,
2010, Xi’an TCH and Erdos TCH had no amounts outstanding under the Citi
Agreement.
Commitments
Zhongbao
Binhai 7MW Capacity Electricity Generation
Project
In
September, 2008, the Company signed a contract to recycle waste gas and waste
heat for China Zhonggang Binhai Enterprise Ltd. (“Zhonggang”) in Cangzhou City,
Hebei Province, which subsequently transferred the contract to Zhongbao Binhai
Nickel Co., Ltd. (“Zhongbao”) in July 2009, a nickel-alloy manufacturing joint
venture between Zhonggang and Shanghai Baoshan Steel Group established in
June 2009. According to the contract, the Company will install a 7MW
capacity electricity-generation system. It will be an integral part of the
facilities designed to produce 80,000 tons of nickel-alloy per year. The project
will generate 7MW capacity electricity and help reduce in excess of 20,000 tons
of carbon dioxide emissions every year. Total investment in this project will be
approximately $7.8 million (RMB 55 million). Construction on the project started
in March of 2009, but the Company did not incur any material expenses on the
project in 2009. The Company originally expected the completion of the project
by February 2010. The construction was delayed, however, due to the
delay in installation of a furnace cove by Zhongbao. Construction was resumed in
February of 2010; the Company paid approximately $1.97million as construction in
progress for this project as of June 30, 2010; the Company expects the project
to be completed in the beginning of 2011. Zhongbao agrees to purchase all the
electricity and steam to be generated from the system for a term of 9 years, at
a pre-agreed price. Zhongbao also agrees to guarantee the minimum monthly
payment of electricity and steam fees no less than $365,000 (RMB 2.5 million)
per month after the deduction of all raw material costs of Zhongbao used by
Xi’an TCH. By the end of the term, the system shall be transferred
to Zhongbao at RMB 1.
Erdos Phase II and III of
Power Generation Projects
In April
2009, Erdos TCH signed a contract with Erdos Metallurgy to recycle heat from
groups of furnaces of Erdos Metallurgy’s metal refining plants to generate power
and steam, to be sold back to Erdos Metallurgy. According to the contract, Erdos
TCH will install a group of power generation projects with a total of 70MW power
capacity, which may expand up to 120MW, and 30-ton steam per hour, with an
estimated total investment in excess of $75 million (RMB 500 million). The
Company split the construction of the projects into three phases, two systems of
power generation in Phase I with a total of 18MW power capacity, three systems
in Phase II with a total of 27MW power capacity and one system in Phase III with
25MW power capacity. For each phase of the project, the lease term is
20 years starting from the date of completion of the phase. During
the lease term, Erdos TCH will be responsible for operating the projects and
charge Erdos Metallurgy for supply of electricity and steam. Erdos
Metallurgy agreed to pay a fixed minimum of $0.22 million (RMB 1.5 million) per
month for each 9MW capacity power generation system. Effective
January 1, 2010, Erdos TCH outsourced to an independent third party the
operation and maintenance of the first 9MW power generation project for $
922,000 (RMB 6.27 million) per year. After 20 years, each system will be
transferred to Erdos without any charge.
During
the first quarter of 2010, Erdos power generation system Phase I project was
completed and put into operation. Effective April 1, 2010, Erdos TCH
outsourced to an independent third party the operation and maintenance of the
second 9MW power generation project for $ 922,000 (RMB 6.27 million) per
year.
As of June 30, 2010 the projects of
Erdos Phase II and Phase III are under construction. At June 30, 2010, the
Company paid $44.17 million for Phase II and Phase III. The Company
currently expects to complete Phase II and Phase III in
2010.
Item
3. Quantitative
and Qualitative Disclosures About Market Risk.
Not applicable.
Item
4. Controls
and Procedures.
Evaluation
of disclosure controls and procedures
We
evaluated the effectiveness of the design and operation of our “disclosure
controls and procedures” as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the
period covered by this report. This evaluation (the “disclosure
controls evaluation”) was done under the supervision and with the participation
of management, including our chief executive officer (“CEO”) and chief financial
officer (“CFO”). Rules adopted by the SEC require that in this section of our
Quarterly Report on Form 10-Q we present the conclusions of the CEO and the CFO
about the effectiveness of our disclosure controls and procedures as of the end
of the period covered by this report based on the disclosure controls
evaluation.
This
quarterly report does not include an attestation report of our registered public
accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by our registered public
accounting firm pursuant to temporary rules of the SEC that permit us to provide
only management’s report in this quarterly report.
Objective
of Controls
Our
disclosure controls and procedures are designed so that information required to
be disclosed in our reports filed or submitted under the Exchange Act, such as
this Quarterly Report on Form 10-Q, is recorded, processed, summarized and
reported within the time periods specified in the SEC’s rules and
forms. Our disclosure controls and procedures are also intended to
ensure that such information is accumulated and communicated to our management,
including the CEO and CFO, as appropriate to allow timely decisions regarding
disclosure controls and procedures, including the possibility of human error and
the circumvention or overriding of the controls and
procedures. Accordingly, even effective disclosure controls and
procedures can only provide reasonable assurance of achieving their control
objectives, and management necessarily is required to use its judgment in
evaluating the cost-benefit relationship of possible disclosure controls and
procedures.
Conclusion
Based upon
the disclosure controls evaluation, our CEO and CFO have concluded that as of
the end of the period covered by this report, our disclosure controls and
procedures were effective to provide reasonable assurance that the foregoing
objectives have been achieved.
Changes
in Internal Control Over Financial Reporting
There has
been no change in our internal control over financial reporting during the
quarter ended March 31, 2010 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.
PART
II - OTHER INFORMATION
Item 1. Legal
Proceedings
The
Company is not currently involved in any material pending legal
proceedings.
Item 1A. Risk
Factors
There
have been no material changes in our risk factors from those disclosed in Part
I, Item 1A, of our Annual Report on Form
10-K as
of and for the year ended December 31, 2009.
Item 2. Unregistered
Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults
Upon Senior Securities
None.
Item
4. [Removed
and Reserved.]
None
Item 5. Other
Information
None.
Item 6. Exhibits
Exhibit
Number
|
|
Description
|
10.1
|
|
Loan
Agreement for Energy Saving and Emission Reduction between Xi’an TCH and
Industrial Bank Co., Ltd., Xi’an Branch*
|
|
|
|
31.1
|
|
Certification
of Chief Executive Officer pursuant to Rule 13a-14(a).*
|
|
|
|
31.2
|
|
Certification
of Chief Financial Officer pursuant to Rule 13a-14(a).*
|
|
|
|
32.1
|
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section
1350.*
|
|
|
|
32.2
|
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section
1350.*
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
CHINA
RECYCLING ENERGY CORPORATION
|
|
|
|
|
|
|
|
/s/
Guohua Ku
|
|
|
|
Guohua
Ku
Chairman
of the Board and Chief Executive Officer
|
|
|
|
|
|
|
|
|
|
Date:
August 16, 2010
|
|
/s/
Xinyu Peng
|
|
|
|
Xinyu
Peng
Chief
Financial Officer and Secretary
|
|
EXHIBIT
INDEX
Exhibit
Number
|
|
Description
|
10.1
|
|
Loan
Agreement for Energy Saving and Emission Reduction between Xi’an TCH and
Industrial Bank Co., Ltd., Xi’an Branch
|
|
|
|
31.1
|
|
Certification
of Chief Executive Officer pursuant to Rule 13a-14(a).
|
|
|
|
31.2
|
|
Certification
of Chief Financial Officer pursuant to Rule 13a-14(a).
|
|
|
|
32.1
|
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section
1350.
|
|
|
|
32.2
|
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section
1350.
|